JIM ALEXANDER, CFO AT DAVID WEEKLEY HOMES in Houston, recalls when the job of protecting his company against the risks inherent in running a home building business began to change dramatically. It became clear, he says, during the weeks that followed Sept. 11, 2001—when rising concerns about mold and construction defect litigation converged with the financial hardships suddenly cast upon many insurers.

“It was obvious we were going through a sea change,” he says. “Insurance costs increased dramatically. It was very obvious that not only was it difficult to obtain insurance renewals, but the nature of the coverage changed.” Insurance companies were in crisis: Their capacity to absorb risk diminished even as they hiked prices dramatically. There were many places in the country where even large and well-established builders could not obtain coverage, recalls Alexander.

David Weekley, like many builders, had no choice but to assume a greater share of the risk. But with that came the added burdens of management responsibility—and increasing complexity—involved in reducing risk throughout an entire organization and across dozens of jobsites. For builders across the country, one thing has become clear: It's a big job and one that many CFOs are hard pressed to manage by themselves, or at least as they once did. What's less clear is how best to shoulder the load.

Risk Reduction
  • Start at the beginning. Risk reduction starts with the construction process, says George Dale, an attorney who consults with builders regularly on risk management and has been active in the California Building Industry Association risk-management committee. “Make sure all your subcontractors are on the same page; that they are also committed to high quality; and that they have the resources to do the job right.“
  • Fully assess your policies. Make sure your insurance and indemnity policies are not just in order, but are clear about exclusions and are the best possible policies you can afford.
  • Line up third-party inspectors. Independent quality inspections that make sure each new home is built right from the foundations up are a growing trend, especially in the West, observes Dale. Do not rely on government inspectors, he advises. “They're looking for life and safety hazards, and they're underfunded.” While safety issues are important, third-party inspectors are checking for quality. A byproduct of using these companies, says QualityBuilt's president Beth Michaelis, is a return of pride in craftsmanship.
  • Educate home buyers about maintenance. In addition to orienting home buyers with homeowners' manuals, welcome guides, and detailed walkthroughs, it's important to “manage their expectations and tell them how to maintain their home,” says Dale. In California, a document is now required informing homeowners how to clean their gutters, caulk their tubs, and clean the filters on their air conditioning units, among other items requiring maintenance. Dale adds that educating homeowners' associations is also an important component of risk management in developments or condominiums with such associations.
  • Improve after-sale follow-ups. Formalize policies and customer service procedures for after-sale follow-ups, including phone response and in-person inspections after the sale, even beyond the warranty time period. When in doubt, says Dale, “just say yes” to follow-up concerns of home buyers.
  • Offer preventative maintenance. Consider offering a home buyer a preventative maintenance program or providing other regularly scheduled maintenance reminder programs.
  • Have a customer service department that commands the respect of everyone in the organization. Fund customer service properly, have software that tracks complaints, and make sure the complaints and actions taken are integrated into the rest of the organization, advises Dale, so that a problematic subcontractor or development is noted. Make sure there's an appeals process if a customer is dissatisfied with the customer service department, he recommends.
  • Consider third-party services to handle complaints. If there is a claim, consider retaining a third-party service to handle disputes. “It's the last line of defense before a lawsuit,” says Dale. Look for qualified, independent mediators who are well-versed in construction defect and other homeowner complaints
  • Know your obligations when a lawsuit is filed. If all else fails and litigation ensues, it's important for all involved, particularly subcontractors, to know their obligations. “There are still a lot of problems coordinating liability and allocating blame,” says Dale. Wrap-up insurance can take care of most of these issues, but sometimes it is not available for every job.
  • Get involved Builders should work together to address issues of risk management, advises Dale. Shared experiences and solutions can help everyone weather the insurance crisis and improve the reputation of the entire industry.
  • The task of turning division managers into better risk managers comes at a time when builders are already working overtime to improve customer satisfaction and the quality and efficiency of their work. Yet in many ways, the systematic steps builders having taken to improve construction quality are also helping to reduce litigation and other risks.

    A new era of risk management has dawned for builders, observes George Dale, an attorney and president of Los Angeles-based D.B.H. Resources, a risk management consulting company specializing in home building. He calls it the age of “reputation management.”

    “We're definitely spending more time on risk management than we did before,” acknowledges David Weekley's Alexander. “We went back and went through anything that had to do with water intrusion,” the main cause of mold-related complaints, he explains. “We've always had high-level focus on quality, but three or four years ago, we added one thing: third-party inspections. We brought in outside experts to advise us on different materials and different techniques.”

    There was no pushback from contractors, he says, some of whom welcomed the feedback. “Sometimes the contractors don't get enough feedback,” Alexander said he learned. Other areas where the builder is focusing include air quality and soil investigation, he said.

    Who's In Charge? As risk management and minimization of exposure becomes more important to builders, the role and reliability of third-party inspection firms has clearly taken on greater visibility. “The field has definitely become increasingly professionalized,” notes Beth Michaelis, president of QualityBuilt, an independent inspection firm that partners with builders on quality control and risk-management issues. “Most builders who built less than 400 homes a year used to rely on their insurance broker and used outside counsel warily. They'd shy away because attorney fees were uncertain,” she explains.

    Now there is little question for all but the smallest builders that risk management is worth an up-front investment, Michaelis says. “There could be as many 14 to 20 people as members of the risk-management team each with defined responsibilities. The team is composed of executives, insurance experts, sophisticated builders, suppliers, someone from construction, and third-party inspectors,” she says. Every member of the team brings up issues to control risk and asks “How does that work for everyone else on the team?”

    Thus, risk-management concerns, which used to require less than 1 percent of a builder's budget per project, now consume perhaps 3 percent or 4 percent of the budget. “That correlates with what insurance companies pay in loss control,” Michaelis observes, adding that the percentage includes internal expenses such as payroll, but also third-party forensic reviews and safety consultants.

    Who has overall responsibility for managing that effort, and what career paths seem best suited for the job, however, still seem to vary widely by builder. Many builders have asked their in-house counsel to handle risk management because so much of the field involves preventing and handling litigation. In-house counsel Stacy McDaniel, of Newport Beach, Calif.-based John Laing Homes, and legal counsel Deborah Broom, of KB Home in Los Angeles, handle risk management as part of their legal portfolios.

    Other builders rely principally on their CFOs, who are accustomed to handling the financial aspects of risk management. Joel Rassman, executive vice president and CFO at Toll Brothers, is in charge of risk management at the Huntingdon Valley, Pa.-based builder. Sometimes risk managers are hired directly from the insurance industry: If a builder was a satisfied client, why not bring that insurance lawyer or broker in-house?

    More and more builders are hiring veteran risk managers from other industries, such as a products company, because they are well versed in products liability concerns. MBK Real Estate, parent of MBK Homes, of Irvine, Calif., for instance, recruited Caron Dean Shore as vice president of risk management. Before joining MBK in November, she was a vice president in charge of global risk management at Wimberly Allison Tong & Goo, an architecture and design consulting firm. Shore has since hired a consultant to inspect properties for safety and quality, and regularly visits construction sites.

    The complexity of the job, however, ultimately demands individuals with diverse strengths.

    “A risk manager is part actuary, part underwriter, part claims person, and part psychologist,” says Jeff Masters, a partner at Cox Castle & Nicholson in Los Angeles. “The person has to work at all levels of the company, so they are typically senior people” with diverse skills, he says. Risk management is something that affects all operations, emphasizes attorney Dale. “Risk management is not something that can be delegated to one person or department or outsourced,” he says emphatically. “Builders need to take a moment to see how claims avoidance and reputation management are involved in everything they do. People need to take some time to reflect and discuss that issue.”

    Masters agrees. “About five or 10 years ago, risk management was referred to as ‘insurance management,' ” he recalls. But even then insurance was only one part of risk management, he says. Today, most big builders have in-house risk managers who are specially trained. They have strong backgrounds in insurance, loss control, safety, and construction quality, Masters observes.

    Expanded View Risk managers have shifted from buying insurance to overall company protection. “Big builders need to take a very broad view of what risk management is, beyond construction defect litigation, though that's still a big part of it,” says Masters. A new term Masters says he favors is company risk management, or enterprise risk management. “It expresses the view that you're looking at the entire company—not just construction risk,” he explains.

    For example, a risk manager used to be content with buying a good directors and officers (D&O) liability policy. Today, with Sarbanes-Oxley legislation requiring company executives to sign off on the validity of financial statements, and the process controls behind them, a risk manager must advise the company how to select officers, board members, and executives, and train those people on how to comply with new corporate governance requirements. This is in addition to the ordinary compliance issues—making sure the builder obeys local, state, and federal regulations.

    And all of this is done with an eye on the builder's next insurance renewal, even if it's months or even a year away. “It takes so much longer to prepare for a renewal than it did even two or three years ago,” sighs Masters. “Underwriters want more information of higher quality than ever before.” The perennial question “are we better off self- insuring this project?” persists.

    The details insurers demand are daunting. California is a world unto itself, says MBK's Caron Dean Shore, with a laugh. “California is unique,” she says, because of its stringent workers' compensation laws and its land scarcity, which creates a need to build attached housing. The latter is an invitation to class-action lawsuits. MBK builds both detached and attached housing, Shore notes.

    “But California home builders have gotten very creative in finding solutions,” particularly finding and financing insurance products, she says. MBK's 10-year warranty program, in which the builder “bends over backwards” to satisfy the home buyer, Shore says, is an example of such thinking.

    But satisfying underwriters is only part of the bigger picture. In trying to determine those factors that could cause instability either in terms of operations or income stream, Shore quickly runs down her portfolio of risks from which the builder must be protected. “There's the market risk, entitlement risk, and environmental risk,” she says. “You need to look at property risks, litigation risks, construction defect risks, safety risks, and human capital risks.” The latter involves examining employment practices as well as guarding against the possibility of losing key players, she explains. “There are compliance risks, business continuity risks, and contractual risks. You must take a big picture view of those components and decide how to best handle those risks to ensure the stability of the organization.”

    Beyond The Blueprint So what is the most important part of risk management? “Establishing channels of communication with all the operating divisions to make sure we have a plan that makes sense,” Shore says. “I'm not sitting in a corner office buying insurance, but instead trying to be a good partner with operations looking at the entire business enterprise.”

    The hardest part of the risk manager's job is mastering the breadth of topics that is now categorized under “risk management.” The easiest part of the job, says Masters, is being taken to lunch by insurance brokers. But in between is the task of implementing risk-management procedures.

    Every insurance company would like to see a solid written quality-control procedure in place for every department in the company. Good policies can be bought, and many are. They then sit in a three-binder notebook on a shelf. Implementing them in a consistent way across the company is very hard to do. “That's the psychologist part of a risk manager,” says Masters. “How do you get the divisions to implement this safety or quality program, which is for everyone's good, but takes time?”

    Here, the stance of the insurance company probably helps. For years, insurance companies were not proactive when it came to risk. But now, the risk manager receives a letter from the insurance company that says, “part of our underwriting review is examining your companies' quality control processes.” Says Masters: “They're not just looking at losses, but looking at how you act proactively to minimize risk.”

    Every division must be on board and incentive-based, with penalties for lack of compliance. Enforcement of those procedures is also part of a risk manager's job. “You've got to do it and document that it's done,” advises Masters.

    The greatest incentive to improve is, of course, competition. David Weekley Homes, which does not have a dedicated risk-management department, is constantly looking for areas in which to improve quality, says CFO and risk manager Alexander. “We have to get better to compete with sophisticated companies that are doing ever-better jobs.” But big builders, prodded by customer satisfaction reports by J.D. Power and Associates and the new underwriting demands of insurance companies, might have already made the most significant improvements. Perhaps other industries might benefit from similar competition, says Alexander. “We'd like to see more competition among insurance companies,” he says. “We need more players in the game.”

    Learn more about markets featured in this article: Los Angeles, CA.