Jon Critelli, Randall Coxworth, Paul Ryan and Christian Gordon | StoneTurn
In 2022, the United States experienced 18 separate weather and climate disasters costing at least one billion dollars according to NOAA. In 2023, that number rose to 28 separate billion dollar weather events. The frequency and large geographical areas that these catastrophes are impacting means owners and risk managers should be aware and prepared for not if but when a catastrophe may impact your business.
As noted in Part One of this series, approximately one in four businesses do not reopen after a disaster, according to FEMA. The ability to react effectively while mitigating any risk begins with being prepared, as we have outlined, but is also a continuous effort during the natural disaster and reconstruction phase.
Risks Awareness for Owners
Just because your business has felt the impact of a catastrophe, does not mean your reconstruction efforts need to be a disaster. Following an event, it is necessary to quickly evaluate, understand, and begin to mitigate the damage. During the event aftermath and reconstruction phases, it is important to understand and make decisions based on the following risks which could impact a property:
- Project Delivery Method & Contracts
- Oversight & Controls
- Fraud, Waste, and Abuse (FWA)
Project Delivery Method & Contract Risks
Depending on the phase of the project, work is frequently done on a time and material (“T&M”) basis in order to quickly engage stakeholders and contractors, mitigate damages, protect the property, and prevent further damage following a catastrophe. A simple T&M example may be that the roof is leaking and needs to be tarped to prevent further water intrusion and damage, an issue that needs to be resolved when there is not time to get an estimate for the work.
T&M contracts need to include pre-negotiated rate sheets inclusive of labor and material rates. These factors are particularly helpful during business continuity scenarios when every moment counts. Additionally, T&M contracts promote owner involvement and availability of data, giving an extra layer of risk mitigation. Once damages are mitigated, a disaster recovery project can continue to be performed on a T&M basis if the impact to the operations is critical and there is still not time to get an estimate, or estimates are obtained and a fixed price agreement is implemented. The T&M project delivery system requires hands-on oversight from the owner to ensure change management procedures are adhered to, costs are in accordance with the rate sheets, and that the project and financial controls – established prior to an event – are implemented.
However, without oversight and controls enforcement, T&M work can easily result in scope creep and/or budget overruns. When a project goes over budget in a T&M contract, the owner is responsible for those overages. As a result, T&M contracts should manage scope and changes similar to fixed-price contracts. Cost and time estimates should be communicated, not-to-exceed clauses, and payment milestones should be considered to ensure risk exposure is mitigated when using a T&M contract structure.
Appropriate Controls Limit Risk and Exposure
Changes must be managed effectively, and project teams need to provide the data necessary to make informed decisions during a catastrophic event. Without an understanding of progress, spend, and expected completion timing, your organization can be left guessing how much the project will cost and when reconstruction will be completed. Inspections, audits, and a requirement for field teams to report progress, issues, changes, budgeting, and scheduling are “must haves” on all projects, but even more essential after a catastrophic event.
It is likely that unforeseen conditions are going to be a factor of a project following a disaster—sometimes, you will not know what you are getting into until you begin removing interior and exterior surface materials. For a variety of reasons scope is typically loosely defined during disaster recovery as unforeseen conditions are likely, resulting in scope changes. Without the right project oversight and change management procedures, unforeseen conditions can widen the scope of a project and create significant upticks in cost.
Situational Schemes and Red Flags to Bear in Mind
The construction industry is no stranger to Fraud Waste and Abuse (FWA). According to the ACFE’s 2022 Report to the Nations, the median fraud-related loss experienced by construction companies was over $200,000 per incident. The ACFE puts construction in the top five industries impacted by fraud, among utilities, transportation and warehousing, real estate, and wholesale trade. This means it’s not only common, but costly.
As the owner of the project, it is critical to be aware of common fraud schemes to ensure the appropriate controls are in place prior to a disaster and are robust enough to identify and prevent these schemes from occurring.
The lack of resource availability during a catastrophe can increase the risk of FWA. During reconstruction, vendors and contractors undertaking the reconstruction work are attempting to acquire or procure the same equipment, labor, and materials from the same concentrated geographical area—resulting in critical shortages. These shortages can lead to the substitution of non-approved materials and therefore the possibility of falsified billing for these substituted materials. False billing is also an example of fraudulent records or reporting, but this can also include false progress reporting, unfounded environmental or mitigation test results, and ultimately used to conceal fraud.
As mentioned previously, the complexity and magnitude of disasters poses its own challenges which can distract from the necessity of managing and enforcing compliance related project controls from the owner’s perspective. Relying on contractors and vendors isn’t enough; anti-fraud policies, internal and external audit practices, and formal fraud risk assessments will help protect and mitigate FWA exposure across an organization and therefore, disaster recovery projects during chaotic post-disaster times.
When one of your cases is in need of a construction expert, estimates, insurance appraisal or umpire services in defect or insurance disputes – please call Advise & Consult, Inc. at 888.684.8305, or email experts@adviseandconsult.net.