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. Direct costs associated with a workers' compensation injury include medical expenses and expense reimbursement, which the workers' compensation carrier usually pays.
For an industry example of workers compensation, see Sheet Metal Manufacturing Workers Compensation.
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 recover the cost by increasing the experience modifier (MOD) over the next three years.
Indirect costs and examples
- Damage to property (building, tools, machinery, etc.)
- Emergency supplies, cost
- Possible media exposure or brand change
- Investigation time and claim management time
- Effect on employee morale
- Overtime and the cost of replacing an employee
- Increased experience modifier
- Damage to client relations if an accident occurs on site
- Injury to third parties
- Additional legal fees
Of course, these ratios depend on the type of claim or injury, 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. Indirect costs include reduced employee morale, damaged customer and client relations, copycat claims, and the loss of knowledge, training, and experience.
Factors that affect these ratios
- Type of claim or injury
- Type of business
- Claim value
- Days lost from work
- Legal jurisdiction
- Management response
For another industry-specific example of workers compensation coverage, see Trailer Manufacturing Workers Comp.
The risk management literature reports a wide range of expert opinion on the ratio of direct to indirect costs. Most surveys identify indirect costs at least equal to direct costs in many scenarios, and some situations can push indirect costs much higher.
Unfortunately, indirect costs are often uninsurable and can dwarf insurable costs for a given risk. These ratios can change over time as medical and legal expenses evolve.
Finally, check out OSHA's Safety Pays e-tool for practical examples and calculators to estimate safety program payback.
Frequently Asked Questions
What is the difference between direct and indirect costs?
Direct costs are measurable losses such as medical bills and settlements, while indirect costs are secondary impacts like lost productivity, training replacement employees, and reputational damage.
Should an employer pay the compensatory portion of a claim?
Many risk advisors recommend paying compensatory portions when feasible because allowing the insurer to pay may increase your experience modifier and future insurance costs.
Can indirect costs be insured?
Indirect costs are often uninsurable; some specialized policies may cover portions, but many indirect impacts such as lost morale or client relationships are not covered.
How can a company estimate indirect costs?
Estimate common items like replacement hiring, overtime, investigation time, and potential business loss, and consider using safety and payroll data or industry case studies to refine estimates.