Indirect Loss Costs Explained
So what are indirect loss costs exactly? Simply put, these are costs that a business incurs that are not thought to be directly associated with a workers’ compensation claim. To illustrate, consider the following scenario:
Employee A is injured on the job and files a workers’ compensation claim. Due to the nature of his injuries, he will be away from his job for eight months as he recovers. As many businesses would, Employee A’s company has to hire a replacement employee to handle the duties of the injured worker. The business incurs a hiring cost because the human resource (HR) department must hire a new employee. The new employee must be trained, which can take several weeks and ultimately removes another individual from his or her regular duties. Employee A has seven years of experience and the replacement is not nearly as productive. HR is also responsible for monitoring Employee A and handling procedural items until he is deemed fit to return to work, adding yet another responsibility to that individual’s workload. Employee A’s company could also have to repair and / or replace any equipment that was damaged at the time of the injury.
As you can see from this scenario, it can be difficult to determine the extent of indirect loss costs associated with a workers’ compensation claim. As the scenario unfolds, those costs continually add up. There have been a number of studies conducted to measure these expenses and are often in the form of a multiplier of the direct loss costs. One of the earliest was conducted in 1929 by Herbert William Heinrich, an American industrial safety specialist who served as the Assistant Superintendent of the Engineering and Inspection Division of Travelers Insurance Company. Heinrich went on to republish his study in 1959, which maintained that indirect versus direct loss costs could be measured by a ratio of 4:1. He ultimately argued that there were $4 of additional indirect costs for every $1 of direct costs related to a claim.1
Crunching More Numbers
Frank E. Bird, often viewed as a pioneer in the occupational safety profession, also published material on this subject in the 1970s and 1980s. His basic theory referenced an iceberg that illustrated a cost ratio of 5:1, with indirect loss costs representing the larger, more substantial costs hidden below the surface. Although he provided the 5:1 ratio, he did believe that indirect loss costs could be considerably higher depending on the circumstances.2
In 1981, Stanford University published a report specifically referencing the construction industry, finding ratios of 1.6:1, but felt the difference could be higher because OSHA fines and third party actions weren’t factored into the equation.3
OSHA conducted its own survey in 2007 in an effort to update the findings provided in the Stanford University report. They found ratios on claims exceeding $10,000 to be in the 1.2 to 1.4 range. Another survey conducted by the National Council on Compensation Insurance (NCCI) in 2004 found similar results. (See table below.)
At SilverStone Group, we measure indirect loss costs based on geography and by industry type. They are updated in real time using SaaS technology and reflect accepted indirect loss costs by other Chief Financial Officers from companies in our nationwide database. While these are constantly moving, they run in ranges similar to the findings from the varying reports.
The Big Picture
So why is it important to have a true understanding of indirect loss costs? If you are only considering direct claim costs, you are missing a significant expense factor that can adversely impact your business’ profits. Failure to take these costs into account invalidates any analysis and can make it difficult to manage profits and achieve business goals. Knowing where your financial leakage occurs can help you control your costs and better manage your bottom line. Our Risk Management experts can get you started.
1 Manuele, Fred A. “Reviewing Heinrich: Dislodging Two Myths from the Practice of Safety.” Professional Safety. October 2011. Accessed on April 7, 2016
2, 3 Manuele, Fred A. On the Practice of Safety. Fourth Edition. 2003. Accessed on April 7, 2016
This article originally appeared in the 2016 | ISSUE TWO of the SilverLink magazine under the title “Indirectly to the Point. How TCOR Indirect Loss Costs Impact Your Financials.” To receive a complimentary subscription to the SilverLink magazine, sign up here.