Guest EssaysGuest EssaysThe federal government has conducted stress tests of financial institutions after lending billions of dollars in the Temporary Assistance Recovery Program (TARP). The main aim of the tests is to determine if banks can survive the economic downturn without additional capital. The idea is to avoid a repeat of the financial crisis that occurred last year when Lehman Brothers, Bear Stearns and other lenders went bust as a result of miscalculating their risk.
What impact has this misjudgment of risk had on the design and building industry? During a slow economy claims and litigation increases. The economic climate is forcing companies to consider budget-cutting measures including layoffs, changing business strategies, operations decisions and practices just to stay afloat. These measures also increase a firm's risk. Losses develop due to alleged negligence, error, omission and fraud thereby increasing professional lawsuits. Based on the heightened litigation, could your firm pass a stress test?
Just to survive and obtain work, many firms are changing practices, services, even lowering standards and bids. These decisions are placing companies at higher risk. It is important firms realize where their risk lies. Architects and engineering (A/E) firms and other building professionals should being asking themselves targeted questions.
Examples of Stress Test Questions:
Has a realistic budget and schedule been established for completing this project?
Do you have the financial capacity and cash flow to successfully compete the project?
Are practices in place for evaluating project team capabilities; financial position, experience, insurance, past claim history, reputation, etc.?
If your gross revenue adjusts by greater than 20% has a formalized process been performed evaluating business practices ensuring effective operational performance?
If staffing level adjusts by greater than 20% has a formalized process been performed ensuring proper levels of experience and qualified staffing is maintained?
When expanding into new regions, project types or service segments, has proper due diligence analysis been performed? (qualification and experience needed to be successful, legal and insurance requirements, licensing requirements, capabilities, etc.)
Do contracts or other agreements clearly outline; fees for basis services, additional services, billing and invoicing schedule, suspension and termination, limitation of liability (LOL), indemnification and mediation provisions?
When selecting Professional Liability (PL) insurance, do you look beyond premium costs evaluating carriers; financial strength, performance, outlook, policy provisions, experience, pre-claim & claims handling, risk management program?
Insurance Note: The economic downturn and financial problems has affected some insurance carriers. Insured firms might decide to cancel coverage mid-term in the event of an insurer's rating downgrade supported by contractual requirements. It is good practice to understand the implications of early termination of an insurance policy. It is common for an insurer to impose a "short rate" penalty.This is a 10% charge against the unearned premium. Simply put, a firm will receive only 90% of the pro rata premium in return for coverage cancellation. While not a pleasant prospect, the short rate penalty is typically a manageable number. However, in many instances a minimum earned premium can range from 25% to 35% of the full term premium. A 35% charge early in a policy term can be a large sum of money at any time, not only during this challenging economic period. The amount of a minimum earned premium can often be negotiated down but typically only prior to coverage issuance.
A very successful method for answering stress tests questions is through a risk assessment that includes an in-depth analysis of practices, business operations and risk management strategies. The objective is to evaluate risks, liabilities and vulnerabilities identifying areas of concern with mitigating recommendations. The risk assessment process includes evaluating: experience & staffing levels, financial capabilities, business operations & practices, project team management, project management, contract and insurance. If a firm is changing business strategies or has had claim or claims, etc. a risk assessment is critical for identifying, mitigating risk and improving performance. It also helps a great deal when renewing you PL insurance indicating a proactive approach to your carrier. When a firm focuses on risk management, the natural fallout improves overall performance and profitability. This "holistic" risk management approach addresses strategies helping in protecting the financial viability of the firm.
During this economic downturn, and period of increased litigation, would your firm pass a stress test? The economic crisis is forcing firms to change their operational profile and implement cost-cutting measures just to survive. It is extremely important to know your risks and exposures, as well as implement effective risk management practices moving forward. Properly assessing and implementing risk management strategies improves profitability and performance as well as mitigate risk. Risk assessments are excellent tools used as stress tests; evaluating and measuring program abilities.
Timothy J. Corbett is founder and President of SmartRisk LLC, a Pasadena California based risk and performance management consultancy for design and building professionals. If you have any questions or comments, Tim can be reached at 626-665-8150 or tcorbett@smartrisk.biz. Visit the website; www.smartrisk.biz.
This article is intended for general discussion of the subject, and should not be mistaken for legal advice. Readers are cautioned to consult appropriate advisors for advice applicable to their individual circumstances.
