The cost/benefit analysis is a well-known business gauge that can shed telling light on the actual value of a proposed course of action. But for risk managers who must measure the potential value of preventative practices—especially regarding security issues—those cost and benefit figures can be hard to capture, and this gauge may not seem to have the legs it needs to stand on.
Employee screening is one such preventative practice that may come under the risk manager’s cost/benefit scrutiny. Conceptually, it is not difficult to visualize a positive cost/benefit analysis for screening measures such as background checks and drug tests. Relatively small expenditures in these areas can help preserve a company’s invaluable assets of safety, security, reputation and competitiveness. But when it comes to justifying employee screening as a budget expenditure, an abstract value analysis of this nature will probably not cut it.
So how does a risk manager put together a dollars-and-cents demonstration in support of employee screening? On its most basic level, the cost/benefit analysis entails subtracting the cost of a particular course of action from the benefits of that course of action to arrive at a positive or negative benefit outcome. The analysis also typically includes a payback period calculation, which shows how long it will take for the benefits of the course of action to repay its costs.
In contrast to employee screening, other preventative practices may appear to more readily lend themselves to a cost/benefit analysis. Consider the practice of getting regular oil changes for your car. Very simply, the cost could be estimated at four oil changes per year at $30 each, for a total of $120 annually. If the car is driven for seven years, the total preventative maintenance cost is $840.
If you fail to get regular oil changes for your car, the engine will likely seize up and require replacement, at an estimated cost of $3,000. This $3,000 savings could be quantified as the benefit of the practice.
To arrive at the cost/benefit analysis, simply subtract the cost ($840) from the benefit ($3,000), which shows a positive $2,160 outcome. To determine the payback period, divide the cost ($840) by the benefit ($3,000), which shows that the practice will pay for itself in approximately two years.
Unlike the analysis above, however, quantifying employee screening’s true costs and benefits may seem a slippery slope of subjective, intangible values. But it is possible to put real numbers around these programs.
First, the cost of specific employee screening practices can readily be calculated, especially if a consistent program is put in place companywide. On the benefit side, you could factor in the savings realized by avoiding the staffing, training and vacancy costs of replacing a bad employee, which are estimated by the Employment Policy Foundation to be $12,506 per full-time vacancy. However, a more complete analysis will show the bottom-line benefits of screening go far beyond saving the simple replacement costs for unsuitable employees.
The primary benefit to employee screening lies in avoiding the potentially enormous financial fallout from liability, lawsuits and damage to the company’s reputation stemming from a bad hire. According to a 2001 report by Public Personnel Management, employers have lost more than 79% of negligent hiring cases and settlements average $1.6 million. While it may be difficult to put an exact number on the savings employee screening can help your company realize, some very persuasive ballpark figures can be gleaned by taking a forensic look at several case studies.
For each of the real cases that follow, a simple cost/benefit analysis has been constructed, based solely on the actual legal and other liability expenses that resulted after a failure to conduct background checks, drug tests or other screening measures.
Scenario #1: A Cost/Benefit Analysis In Progress
An emerging case involving retail giant Wal-Mart could be considered a cost/benefit analysis in progress. In recent months, the media revealed two separate incidents in which a Wal-Mart employee was accused of sexually assaulting a young girl on the job. In both incidents, the accused employee was a previously convicted, registered sex offender. At least one has spawned litigation, alleging Wal-Mart’s lack of background checks led to the hiring of pedophiles.
Soon after the incidents, Wal-Mart announced it would now require criminal background checks on all new hires. Surely a cost/benefit analysis played a role in this decision, and Wal-Mart determined that the annual expenditure for such checks was less costly than the repeated reputational damage and risk of the liability expenses it stands to weather in this or any subsequent case.
Total Cost: According to a 2004 Forbes article, Wal-Mart has 1.5 million employees, plans to hire 83,000 new employees per year, and has an employee turnover rate of 50%, for an estimated total of 833,000 new hires annually. If we estimate the cost for a basic criminal check on each employee at $15, Wal-Mart’s total annual employee screening costs would be $12.5 million.
Total Benefit: The outcome of the lawsuit is still pending, but a $12.5 million employee screening investment may end up being far less than what Wal-Mart will spend for legal fees and monetary awards in the case. The investment may also prove to be significantly less than lost retail sales connected to the case, if damage to Wal-Mart’s reputation has occurred.
Analysis Outcome: Because we do not yet know the outcome of the case, it is difficult to calculate an exact analysis at the time of this writing. But if just 1% (8,330) of the 833,000 new hires projected by Wal-Mart turn out to be candidates the company would not have otherwise hired, and just 1% of those hires (83) lead to legal action, each resulting in an average settlement ($1.6 million), Wal-Mart’s background screening investment would have paid for itself many times over.
Scenario #2: Background Checks
A negligent hiring case decided in a New Jersey court ruling in 2003 resulted in a jury award of $40 million to the family of a 74-year-old woman who was stabbed to death by a home health care worker. The agency that employed the worker was found liable for 40% of damages because it reportedly failed to conduct a background check despite the worker’s disclosure of a prior burglary conviction. A background check would have also revealed the worker was previously fired from another agency. The judge in the case reduced the award to $2 million, with an option to the plaintiffs to retry the case on damages only. The case was later settled.
Total Cost: With 600 employees, and an average turnover of 100% in nurse aides, conducting annual criminal and employment checks at $30 per check would have cost the agency a maximum of $18,000 annually.
Total Benefit: It is estimated that the employer’s negligent hiring liability in the case was $800,000 and its legal fees were $200,000. Thus, an employee screening program could have provided a total benefit of $1,000,000 in savings.
Analysis Outcome: By subtracting total cost ($18,000) from total benefit ($1,000,000), we arrive at a positive $982,000 outcome.
Payback Period: In dividing the cost ($18,000) by the benefit ($1,000,000), we arrive at a payback period of slightly less than one week annually.
The company was founded in 1988, but even if it had conducted background checks on the same number of employees since its inception, its total screening investment ($288,000) would still have paid for itself in about four and a half years.
Scenario #3: Background Checks and Drug Tests
A 2000 negligent hiring case in Kansas City, Kansas resulted in a $500,000 settlement against a plumbing firm that hired a convicted felon with a history of drug abuse. The employee used money from a customer to buy crack cocaine and later returned to burglarize the customer’s home and beat the customer to death. Because the plumbing firm had reportedly failed to check the hire’s prior employment references or conduct a criminal background check, the case settled for the maximum amount permitted under Kansas law in a wrongful death/survival claim.
Total Cost: Industry data shows plumbing and other construction industry firms are typically small, with less than 10 employees, and experience an average of 60% turnover. If we assume the plumbing firm in the case had 10 employees, and conducted extensive background checks—including criminal checks, employment checks, and drug testing—on six new hires at an estimated cost of $100 per hire, the firm’s total annual employee screening cost would be just $600.
Total Benefit: Employee screening could have saved this company $500,000 in settlement fees and an estimated $100,000 in legal fees, for a total benefit of $600,000.
Analysis Outcome: By subtracting the total cost ($600) from the total benefits ($600,000), a positive outcome of $599,400 is calculated.
Payback Period: In dividing the total cost ($600) by the total benefit ($600,000), we arrive at a payback period of just one working day or eight hours annually.
This company has been in business since 1957, and the cost for conducting background checks since its inception would have cost $28,200, based on steady staffing and turnover levels. According to the same formula, this larger up-front investment would have paid for itself in just over two years.
Scenario #4: Screening for Department of Transportation Compliance
In 2001, a tractor-trailer firm and a driver it employed were forced to pay a $10 million settlement to the family of a couple killed in a collision with the driver. In a lawsuit, the family of the deceased presented evidence that the driver tested positive for cocaine following the accident, had a history of disciplinary and company violations with other employers, and held two commercial driver’s licenses, a violation of Department of Transportation regulations. They also demonstrated the driver’s log showed 235 violations of DOT regulations in his 10-month employment with the tractor trailer firm. The settlement came through mediation.
Total Cost: The company involved in the case currently has 108 drivers, and according to the American Trucking Association, annual turnover for commercial drivers is more than 100%. If the company had conducted driving record checks and employment verifications as well as the required drug and alcohol testing at an estimated cost of $75 per employee, its total annual employee screening cost would have been $8,100.
Total Benefit: Employee screening could have saved this company $10 million in settlement fees and an estimated $200,000 in legal fees for a total benefit of $10.2 million.
Analysis Outcome: By subtracting the total cost ($8,100) from the total benefits ($10.2 million), a positive outcome of $10,191,900 is calculated.
Payback Period: In dividing the total cost ($8,100) by the total benefits ($10.2 million) we arrive at a payback period of one working day or 8 hours annually.
Since many of today’s trucking companies have a long history of family ownership, this company could have conducted background checks on the same number of employees for 50 years at a cost of $405,000, and this preventative practice would have paid for itself in under two years.
Liability Protection
The cost/benefit analysis can be a useful tool for gauging the value of employee screening. These cost/benefit analyses are intentionally structured around the primary benefit of employee screening—i.e., protecting against the risk of liability and its after-effects—to show that the “dollars-and-cents” picture can play a pivotal role in determining the best preventative practices for your company’s hiring process.
While the protection that preventative screening can offer is wide-ranging, any risk that comes to fruition can significantly impact a company’s operations. And this impact only stands to rise along with the heightened awareness of security and hiring issues.
Stefan Keller is president of Truescreen, a provider of targeted background investigation, drug testing and DOT compliance services to top firms nationwide. Truescreen is based in Southampton, Pennsylvania.
