Managing to Stay Profitable

Firm management practices such as effective communication may be just as important as technical expertise in keeping your firm out of legal hot water. That’s just one of XL Design Professional's findings after examining more than 17,000 claims handled between 1989 and 2000.

Trends identified by our "Risk Drivers" study included:

Growth — The 1990s were a period of unprecedented growth in construction activity around the United States. From 1993 to 1999, the number of architectural and engineering firms increased more than 30% to approximately 100,000 firms. In 1999 alone, these firms generated $140 billion in fees.

Profit — While gross revenues have increased for many if not most firms, average firm profits have remained at around 8.5% — roughly equivalent to revenues of $80,000 per employee. So, while revenues are up, the costs of doing business — especially in the areas of finding and keeping the most qualified staff and providing them with equipment and training — have also increased significantly. Some firms, however, are reporting profits in excess of 16% — about $105,000 in revenue per employee.

Staffing — No surprises here: firms are having a tougher time finding qualified staff. There are several causes but, for engineers, the two primary causes are competition and the laws of supply and demand. Engineering firms now compete with consulting and technology firms eager to obtain — and willing to pay for — the analytical and process skills engineering students possess. Additionally, there are simply fewer engineering students in school and an increasing demand for their services. We’re also seeing a decline in the number of architecture graduates who become licensed practitioners.

Training — There seems to be a correlation between how much a firm spends on training employees and the amount of profit they make. Firms that invest in employee training are more profitable. However, it’s not clear whether firms are more profitable because they invest in training, or if more profitable firms tend to spend more on training because they can afford to. Industry-wide, A/E firms spend an average of just $200 per employee for training each year.

Changes in the industry haven’t confined themselves to these issues, however. There have also been some dramatic changes in a firm’s exposure to liability as well as their odds of facing a lawsuit.

Claim Frequency on the Rise

XL Design Professionals found that during this period of outstanding growth and opportunity for design firms, there was also an increase in the frequency of claims — the number of claims per 100 policies. As the design industry’s revenues rise you naturally expect to see an increase in the number of claims. However, if all factors remained constant, you would not expect to see a significant increase in the frequency of claims. But XL Design Professional’s study clearly shows that something is amiss: claims frequency jumped 47% during the period — an increase significantly greater than the corresponding increase in billings for the firms we insure. That means that for every dollar of income A/E firms generated, the odds of being sued or threatened with a suit increased. For an insurance company like XL Design Professionals, it also means redoubling our efforts to reduce claims through effective loss prevention services as well as looking at how we price our services. We recognize that the right price over time may not always appear to be the most competitive price. But it is the one that ensures our ability to provide long-term protection for our policyholders.

XL Design Professional’s Risk Drivers study digs deeper into claims trends than most insurance industry studies and benefits from XL Design Professional’s 30 years of experience in working with A/E firms. It goes beyond the traditional indicators of claims trends, such as analysis by project type, firm type or discipline, to pinpoint some of the underlying causes of claims. What we found will surprise many design firms.

Non-Technical Causes of Claims

While recognizing that claims typically have a fundamental "technical" cause that provides a concrete basis for the dispute, such as a design error or omission, code violation or cost overrun, there are also "non-technical" factors that contribute to or exacerbate a dispute. In our research into these Risk Drivers, we discovered that non-technical factors led to, or contributed to seven out of every ten claims we handled.

The top three non-technical factors involved in claims are:

Communication issues — A significant factor in 27% of all claims, these problems primarily revolved around breakdowns in the communication of project responsibilities and expectations, the lack of documentation of changes and the lack of established procedures for identifying and addressing issues and conflicts. Communication affects every phase and aspect of your project, and effective communication could mean all the difference between resolving real issues quickly and facing a lawsuit.

Project team capabilities — A significant factor in 24% of all claims, these problems were concentrated in two areas: unqualified design staff and/or an unqualified project manager assigned to a project. These issues should come as no surprise given the industry-wide struggle to find, train and retain qualified staff.

Client selection issues — A contributing factor in 16% of all claims, client selection challenges arose in three significant areas: working with a contractor selected by a low-bid litigation and working with a client that is unfamiliar with the project type or design process. By putting as much diligence into your business practices as you do into your technical expertise, your firm can minimize the risks to which other firms are often exposed. XL Design Professional’s research concludes that the best way to manage risk is to effectively manage your firm, which has the added benefit of discovering ways to become more profitable.