By MICHAEL COLLIGAN, a forensic accountant with RWH Myers & Co., which specializes in loss accounting and claim preparation
It's Monday morning. You're faced with a catastrophic nine-figure property damage claim and you're scrambling to coordinate the early stages of reconstruction. As a risk manager, are you prepared to explain the risk of erroneous contractor billings and the effect on your insurance claim to the board of directors?
In the normal course of business, construction projects are a controlled process handled by a procurement or capital projects division within the company. Unfortunately, the unpredictable environment following a loss heightens the risk of construction mistakes and possibly even abuse or fraud. Contracts are often not in place, internal resources are strained, and the typical contractor bidding process is hardly feasible.
In the wake of a natural disaster and widespread destruction, you're also not alone. Supply and demand factors within the local market can be a major factor with regards to the availability of resources.
Neighbors and competitors rush to secure the services of the same vendors needed to repair your property. As the line forms at their front door and the phone rings off the hook with desperate pleas for help, contractors will predictably assign highest priority to jobs with the highest potential for profit.
These unique pressures applied to the typical challenges of the insurance process can have significant implications on a full recovery.
ADJUSTMENT AND SETTLEMENT
In a typical insurance recovery process, insurers are seeking information early and often. With the overarching threat of failing to make repairs with "due diligence and dispatch," there is pressure on the policyholder to minimize the interruption or outage as a result of the loss.
Ideally, a reconstruction project would also rapidly produce high-quality results at a very low cost. In this challenging environment, management's refusal to sacrifice quality and speed only heightens the natural strain on cost of construction.
After a claim has been prepared, an adjuster will retain a team of consultants in an attempt to verify the legitimacy of expenditures. Building consultants and engineers will review the scope of work and reasonableness of the billings. Accountants will audit the cost of work for any errors or overcharges.
This insurance carrier audit can often take place months or even years after the actual work was completed and the contractor was fully paid and gone.
At this point, there is little or no chance of recourse against the contractor if errors or issues are discovered. Insurers are not often swayed by the fact that overpayments have already been spent, leaving the policyholder ultimately responsible for any billing overcharges.
Being proactive in the process and addressing concerns before they become larger issues becomes very important.
ASSIGNING A TEAM
Constant communication between fellow team members, vendors, and all parties is a key to recognizing problems early.
A recent survey of internal auditors at 250 of the largest U.S. companies found that only 37 percent of internal auditors, whose companies regularly enter into construction contracts, actually examine compliance issues and the legitimacy of construction costs. Among those organizations in which internal auditors don't audit the agreements, 48 percent reported not even knowing whom, or whether anyone, is responsible for overseeing contracts.
While internal staff such as architects, engineers, and accountants all play a role in evaluating the work completed by the contractor, each has limitations that can lead to inefficiency and overcharges going undetected.
Architects and engineers ensure the work is completed as intended, but often lack the necessary financial consideration. Accountants are focused exclusively on financial concerns, but seldom possess construction project understanding or experience to identify problems.
In an attempt to bridge this gap, most companies assign or hire a project manager to act as the liaison point for all team members.
The project manager is also typically expected to handle planning, safety scheduling, procurement, security, coordinating operations, safety, addressing issues, reporting progress, as well as quality and cost-control.
Is it reasonable to expect one person to juggle these responsibilities as well as conduct a thorough analysis of project costs under a compressed time frame?
Taking an active role in the review process or assigning a construction auditor to the project allows capital risks to be recognized and addressed early in the process.
A construction auditor does not replace any of the roles mentioned in the previous paragraphs, but instead serves as the project manager's right hand by evaluating billings prior to payment and verifying project cost details. The auditor must maintain both a financial and a construction perspective in their review.
Depending on the size and the inherent risks of the reconstruction project, this role can be filled by an individual or a team of experienced staff. A recent retiree with an intimate knowledge of the facility under repair could be a good fit for the temporary role.
Of course the mere suggestion of an audit could lead to internal department sensitivity. Procurement, accounts payable, and construction management may interpret the audit as an affront to their competency. In situations when this is a realistic concern, or the complexity of the reconstruction project is simply overwhelming, it may make sense to seek external help.
WHAT TO LOOK FOR
All construction projects are unique, but even the most trivial problems can become huge issues if not addressed early enough. These concerns can be identified and resolved much earlier in the process if a construction auditor is reviewing the work and asking questions prior to completion.
Has quality been compromised in any way? Shortcuts may be taken by contractors in an effort to reach deadlines. Inferior materials may even be substituted without the knowledge of the owner. If this occurs, the integrity of the structure could be compromised and result in future damage to the company's reputation or financials.
Is work being done in accordance with the agreed upon contract? Insurance adjusters and their consultants rely on conformance to the terms of the contract. Errors, omissions, and overcharges will not be reimbursed under the policy.
Are equipment and manpower being used efficiently? Simply having a presence on the worksite can eliminate many of the risks associated with idle equipment and labor overcharges. It is important to ensure that workers are safely working on site and charges for their work are being accurately reflected in the project costs. This is a common area of waste, abuse and fraud.
The audit itself is an incremental cost that most managers will naturally be hesitant to undertake, but studies have shown that the results often far outweigh the costs of the audit.
In the same survey of internal auditors at 250 of the largest U.S. companies, 90 percent of auditors performing construction cost audits found significant overcharges. On top of that, 63 percent of those who engaged in construction audits on their projects found that the results covered or exceeded the cost of the audit itself.
The Monday morning catastrophe can't be avoided. Even with the most careful planning, unpredictable elements can still leave gaping holes in a claim submission.
But taking an active role in identifying and resolving project issues associated with a rebuild will allow your business to accomplish what ultimately matters most--limiting risk and achieving a fair and timely claim resolution.
May 1, 2011
Copyright 2011© LRP Publications