Risk management experts, safety experts, accountants, actuaries, and other professionals make the distinction between direct and indirect costs of accidents, lawsuits, and similar events.
For example, the cost of turnover in the HR That Works Turnover Cost Calculator includes direct costs (such as paying for a Help Wanted ad) and indirect costs (such as not growing the business due to lack of manpower). Two of the most commonly insured employee risks are work-related injuries and employment-practice claims. The direct costs associated with a workers' compensation injury are those related to medical expenses and expense reimbursement, which the workers compensation carrier usually pays.
We usually recommend that our clients pay the compensatory portion of the claim because if they don't, the insurance company will pay it and then recoup its cost by increasing your experience modifier over the next three years. In a sense, the carrier finances the claim rather than absorbing it. In addition to the increase in the experience modifier (MOD) and the cost of future insurance, there are also indirect costs.
Indirect costs
- Damage to property (building, tools, machinery, etc.)
- Emergency supplies costs
- Possible media exposure or brand change
- Investigation time and claim management time
- Effect on employee morale
- Overtime and costs of replacing the employee
- Increased experience modifier
- Damage to client relations if an accident occurs on-site
- Injury to third parties
- Additional legal fees
Of course, the ratio of indirect to direct costs depends on the type of claim or injury, the type of business, days lost from work, and other factors. When it comes to an employment-practices claim, direct costs are attorney fees, litigation costs, and any settlement or verdict payout. The indirect costs include loss of employee morale, damaged customer and client relations, copycat claims, and loss of institutional knowledge and training.
For industry-specific workers' comp information, see Sheet Metal Manufacturing Workers Compensation. For related liability coverage information, see Malpractice (Professional Liability) Insurance.
Risk management literature offers a wide range of expert opinions on the ratio of direct to indirect costs. Only one of many surveys identifies indirect costs as lower than a 1:1 ratio to direct costs; some estimates go as high as 20 times the direct costs (for example, when an expensive piece of machinery is destroyed).
Based on experience, it is usually safe to assume at least a 1:1 ratio in most circumstances. For example, you might pay $50,000 to settle a lawsuit and incur another $50,000 in indirect costs to replace the employee. Unfortunately, these indirect costs are often uninsurable and can dwarf the insurable costs in a given risk scenario. Interestingly, the indirect-cost ratio has been diminishing as medical and legal expenses continue to rise.
Factors that affect these ratios
- Type of claim or injury
- Type of business
- Claim value
- Days lost from work
- Legal jurisdiction
- Management response
Frequently Asked Questions
What are indirect costs of a workplace accident?
Indirect costs include lost productivity, hiring and training replacements, investigation time, damaged client relationships, and effects on employee morale.
Should a business pay small workers' compensation claims out of pocket?
Many advisors recommend paying smaller compensatory amounts to avoid higher experience modifiers and increased premiums, but the choice depends on your specific situation and cash flow.
How do indirect costs affect insurance premiums?
Indirect costs themselves are often uninsurable, but when insurers pay claims the resulting higher experience modifier can increase future premium costs.
Can indirect costs be insured?
Most indirect costs—like lost business opportunities or morale impacts—are not covered by standard insurance policies and must be managed through safety, retention, and risk mitigation strategies.