The 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 is the impact from misjudging risk on the design and building industry? During a slow economy claims and litigation increase. The economic climate also is forcing companies to consider budget-cutting measures including layoffs, changing business decisions, operations and practices. It also increases 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 also are placing companies at higher risk. It is important firms realize where their risk lies. Architects, engineers, contractors and builders/developers should being asking themselves some targeted 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 members including; financial capability, 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 staff are maintained?
- When expanding into new regions, project types or service segments, has proper due diligence analysis (qualification and experience needed to be successful, legal and insurance requirements, licensing requirements, capabilities) been performed?
- Do contracts or other agreements clearly outline; fees for basic services, additional services, billing and invoicing schedule, suspension and termination, limitation of liability, indemnification and mediation provisions?
- When selecting professional liability insurance, do you look beyond premium costs evaluating carriers for 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. Firms should take wider protections including provisions in insurance contracts allowing cancellation in the event of an insurer's rating downgrade and a change in claims practices in the event of an insurer suffering financial problems.
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 and contract & 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. When a firm focuses on risk management, the natural fallout improves overall performance and profitability. This “holistic” risk management approach helps in addressing strategies to protect the financial viability of the firm.
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 implemented risk management strategies improve profitability and performance as well as mitigate risk. Risk assessments are excellent tools for stress tests.