The economic dimension of occupational safety and health management
Guy Ahonen, Finnish Institute of Occupational Health
- 1 Introduction
- 2 System view and efficiency approach
- 3 Cost reducing
- 4 Macro approach
- 5 Micro approaches
- 6 Responsible conduct
- 7 References
- 8 Links for future reading
Occupational safety and health management is basically concerned with the principles of how to organise this activity in companies and other organisations. The economic dimension adds an optimization approach to the organisational and principal perspectives. The non-economic approach typically assumes that health and safety have an intrinsic value of their own, which for instance forms the basis for the zero-accident-principle is based. The economic approach takes a more relative stance, stressing that resources are always limited and must always be rationed. From this point of view, even life and health must be compared to other values, and resources must be allocated accordingly. This chapter describes the principles of how to conduct this type of analysis.
System view and efficiency approach
The economic approach to occupational safety and health (OSH) management implies that one takes a system view or adopts an efficiency approach. Most often this kind of analysis is made in monetary terms. In a system view, the inputs and outputs of OSH activity are compared in order to draw conclusions and decisions. The highest productivity is attained when the greatest output is achieved with the smallest relative input. The best efficiency is attained when the greatest intended effectiveness as a result of the output is reached through the relatively smallest amount of input. When both the input and the output are measured in monetary terms, the efficiency can be expressed as a cost-benefit ratio. When the analysis is constrained to the boundaries of an enterprise one can talk about a financial appraisal. However, a financial appraisal can also be conducted in public organisations. The so-called new public management approach places a major emphasis on this principle. The problem with public organisations is that their output is usually not subject to market demand, which can be measured in the consumers' willingness to pay. Therefore the true application of financial appraisal would require a use of some kind of artificial pricing of consumer value.
In general, the benefits of occupational safety and health (OSH) are related to cost reduction, improved productivity and to the generation of new assets. According to Chapman´s (2005) meta-analysis, the results of well-managed occupational health promotion programmes can be seen in 27% less sickness absenteeism, 26% less health care costs and 32% less insurance costs. On average, the benefit to cost ratio among these cases was found to be 5.81.
Poor health and safety create costs for organisations. The most common costs are related to sickness absenteeism, health care, individual productivity losses or presenteeism, personnel turn-over, insurance and pension costs and indirect cost effects, such as hiring replacement, paying for overtime, subcontractor work etc. The cost reducing effects of OSH are well documented . Taken together, they send a consistent message: well planned and systematically carried out occupational safety and health measures deliver economic returns which are 3-10 times greater than the monetary investment. This appears to be the case even if there are difficulties in estimating exactly the positive productivity effects of work. Systematic literature reviews have indicated that both small-scale measures and comprehensive occupational health and safety programmes can be profitable to organisations. Finnish intervention studies have revealed that there can be positive profitability effects even without immediate measurable productivity effects, which indicates that the economic benefit-mechanisms of OSH are more subtle than often assumed.
The economic approach to occupational safety and health can be divided into macro and micro subtypes. In the macro approach, work related activities or phenomena are analysed from a social or societal point of view, in contrast to the business economic or financial approach used in the macro approach where the effects are analysed on real values and resources, not only cash-flow effects.
Cost of illness analysis
The Cost of illness (COI) analysis is the most typical macro approach, in which the total costs of health care and lost production due to an illness, injury or working conditions are calculated. Estimating such costs helps to identify the maximum benefit of affecting these illnesses attributable to poor working conditions. Loss of production usually covers absenteeism, presenteeism, early retirement, premature death. Presenteeism refers to the situation where the ill worker is present at work but contributes a sub-normal individual output due to his/her poor health.
Several studies have demonstrated that early retirement reduces significantly the productive potential of the highly developed countries, i.e. the OECD average is 6.3% of GDP. Recent calculations from Finland show that the annual loss due to early retirement is even greater, as much as 13% of GDP and some estimates have been even higher. The productive loss caused by sickness absenteeism is smaller (about 4%) but much more apparent. In addition, the hidden costs of occupational accidents are many times greater than their direct costs. In summary the total cost burden of poor health and safety is enormous, and those costs in some way or other will ultimately affect the competitiveness of individual companies.
In addition, the identification of the total amount of investment in OSH may help in policy formation at the national level. In Finland the first national survey of the total direct investment in wellness at work has been made. In this survey, the annual investment in training and development, occupational health services, work ability promotion personnel fitness, cultural activities and other personnel promotion were estimated at the company level. It was estimated that the total annual direct investment in occupational safety and health was less that one tenth of the annual cost of illness (COI). The economic return of investing in health in general has been estimated to vary between 47% and 252%.
Cost-effectiveness analysis (CEA) is a commonly used macro economic approach to compare and analyse alternative courses of action, usually related to alternative treatments of illnesses. In this approach, the costs and related health effects of the alternatives are compared by calculating cost-effectiveness ratios in the form of X effect units per $ or € spent. The alternative that displays the most effect units per monetary unit is the most efficient choice. Although CEA is often used on a macroeconomic level to analyse costs and effects at the national level, it can also be applied on a micro level.
The microeconomic approach to the management of occupational health and safety is concerned with optimizing the resource allocation at the enterprise level. Microeconomic analysis can be applied also to public organisations. Micro approaches include management control principles and procedures, financial appraisal and various calculation methods, and these will be considered in the following paragraphs.
Management control methods
Management control is about ensuring the strategic goals of an organisation. Typically the accounting system, budgeting and reward systems are used as tools for management control. Recently its has been observed that one major reason for not sufficiently taking work health into account in organisations is that these items are not properly budgeted in management control systems. Therefore, there is a need to develop management control concepts and tools which include work related health aspects. Work health can be included for instance as an element in Balanced Scorecards (BSC), human resource accounts and health accounts.
Financial appraisal method
Financial appraisal refers to an analysis conducted at the micro level in an enterprise or some other organisation. In financial appraisal all cash-flow effects of an OSH related activity or phenomenon are estimated. The simplest form is to make an estimate of the financial effects of a certain state of affairs, e.g. the current level of sickness absenteeism. A more advanced form is to analyse the economic feasibility of a specific occupational safety and health intervention, for example, a reduction of the noise level. In such an analysis, the annual input costs and the annual cost reductions and other economic benefits are compared for a number of years. By discounting the present value of the annual effects, the economic feasibility can be expressed in financial terms, e.g. return of investment (ROI).
Value-based health promotion methods
Porter and Teisberg (2006) coined the term value-based promotion of health. The term refers to an approach that is based on the total economic effects of health care. At the other end of this spectrum is transaction-based health care, which optimises the costs of each health care transaction. There is also a need to apply the value-approach in developing work health management. This places certain requirements on the information to be used in a decision-making system. One needs to know exactly what kind of information is necessary in order to make adequate decisions and the type and magnitude of work health investments. Adoptions of a value-based strategy indicate that the current levels of investment in work health are sub-optimal and directed towards the wrong activities. In a Finnish study (Parvinen et al., 2010) it was demonstrated that the adoption of a value-based strategy to promote work-wellbeing, reduced significantly sick-leave, insurance and pension costs for the company. The total benefits of the program were estimated to be 11.5 M€ this being achieved in a company with total profits in the region of 600 M€. The subjective estimate made by the management was that the real savings were much higher, around 60 M€.
Various calculation models have been developed to help in the estimation of the input costs and related financial benefits. Two such models are The Productivity Model and the Potential Model. The Potential model is an input-output model, or a before-after model. It compares two states of affairs; the one before some measure is taken or investment made and the second after the intervention is made. The effects of the differences between these two states are calculated in order to establish the financial benefit, achieved by the investment. Also the cost of the investment is calculated. Both the cost and the benefit are calculated on an annual basis. For multi-period calculations annual effects are transformed to the present value, by taking account of the interest rate in the calculation. The overall assumption when calculating the benefits is that the real value of work equals the total cost of labour divided by efficient work hours. This assumption is based on the principle that when a company is making an investment it has to be able to cover its current costs by selling what is produced by its personnel, otherwise the firm would go bankrupt. Based on this assumption, the calculation must include all labour costs, the number of all annual paid work hours, and the number of all annual non-productive work hours. In basic terms the calculation of benefits is based on the total cost of productive work hours. Ultimately, the benefit will be dependent on changes in either productive hours or the unit cost of production.
The production cost of personnel turnover is calculated by applying the productivity gap concept. The existence of the personnel turnover productivity gap is well known. It appears as a result of departing individuals reducing their effort as a result of deteriorating motivation, cooperation and morale, and slowly increasing productivity of newcomers. In the Potential Model, the productivity reductions and increases are assumed to be linear. In order to calculate the value of the productivity gap, only the number of annually departing and arriving people and the average exit period and introduction period have to be entered into the model. The model assumes the value of the productivity gap to be equal to the product of lost hours and the value of a productive hour of the firm's time.
In these models depreciated initial investments and annual operations costs make up the annual input costs. The benefits include changes in productive time (sickness absenteeism), overtime costs, subcontracting costs, personnel turnover costs health care costs and productivity. The use of these models demonstrate that the total financial benefits of occupational health and safety investments often greatly exceed the direct benefit effects. A reduced number of sickness-leave days for instance often leads to reduced overtime-work and less subcontractor work. In addition, reduced personnel turnover and increased individual productivity can be a by-product of health promotion projects. In some cases, the benefits related to improved individual productivity have been the main effect. In several cases the actual productivity effects have not been measured, though they have been assumed to be considerable. For instance the Potential Model was used to calculate the economic feasibility of the so-called Druvan-project, in which a 20-fold increase in OSH-expenditure lead to a 46% return of investment.
Examples on good practices
In order to communicate the economic significance of occupational safety and health, business cases are needed. The business cases explain in detail how certain OSH measures affect the employees and their behaviour and related cost and productivity factors for the company. Two well known business cases in Finland are the Druvan case and the Metso Corporation case (Parvinen et al., 2010). The importance of strategic business cases are based on the fact that return on investments occurs through many channels. In addition, achieving reductions in sick-leaves and health care and insurance costs, there are more subtle effects which need to be noted. For example, the participation of relevant stakeholders helps to identify changes in delivery time, reliability and client satisfaction. This kind of broader view is helpful in obtaining a more realistic perspective on the true value of work health development in companies.
In the industrial era, the cost reducing strategy was predominant. As society moves towards more knowledge intensive production and consumption the basis of competition has changed. Knowledge as the basis of business places the main focus on the three main forms of intangible assets: Human Capital, including the knowledge and skills of the employees, Structural capital, including the work community and the production processes, and relational capital, including the perceptions of the company held by the relevant stakeholders, including the perceptions of the customers, suppliers and competitors (Ahonen, 2008). All aspects of intangible assets are related to occupational safety and health. Thus safety directly affects the amount of available human capital. All forms of occupational safety and health activities impact on the quantity, quality and effectiveness of human capital. Just as education improves skills, so occupational health services increase available amounts of work and improved commitment to work increases the productivity of work. Measures taken to improve corporate culture and leadership have beneficial effects on the productivity of work and innovative activity. Finally, all measures promoting employee satisfaction improve the employer and consumer image of the company, and ultimately its economic performance. For instance, efforts have been made to analyse the effects of corporate fitness policy on the intangibles of the firm (Aura, 2006).
Setting intangible assets at the heart of competition strategy has important implications for occupational safety and health. The increasingly intangible nature of business and consumption emphasizes responsible activity. Since consumers want to behave in an ethically responsible manner, commercial enterprises are compelled to demonstrate that they conduct their affairs in a responsible manner. The increasing role of Corporate social responsibility (CSR) is an expression of this (www.globalreporting.org). In economic terms the CSR perspective is linked to the triple bottom line performance concept. According to this concept companies can be judged, not only on their financial performance, but also in terms of their social conduct and environmental impact. It is not often realized that OSH is a significant part of the social dimension of CSR.
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Links for future reading
WHO – World Health Organization, Understanding and performing economic assessment at the company level, Protection Workers Health Series No 2, WHO, Geneva, 2002. Available at: http://www.who.int/occupational_health/publications/en/pwh2e.pdf
EU-OSHA – European Agency for Safety and Health at Work, Benefits of good OSH in construction and infrastructure procurement (publishing date is not available), Retrieved on 15 June 2011, from: http://osha.europa.eu/en/topics/business-old/performance/benefits_construction_html
EU-OSHA – European Agency for Safety and Health at Work, Business aspects of OSH (publishing date is not available). Retrieved on 15 June 2011, from: http://osha.europa.eu/en/topics/business-aspects-of-osh/index_html
EU-OSHA – European Agency for Safety and Health at Work, Case studies on economic incentives (publishing date is not available), Retrieved on 15 June 2011, from: http://osha.europa.eu/en/topics/economic-incentives/case-studies-collection
Eurofound – European Foundation for the Improvement of Living and Working Conditions, Absence from work, Dublin, 2007.
GRI – Global Reporting Initiative (no publishing date), Retrieved on 15 June 2011, from: www.globalreporting.org
Porter, M., "Competitive Strategy", Free Press, New York, NY, 1980.
Sveiby, K.E., 'A knowledge-base theory of the firm to guide in strategy formulation'. Journal of Intellectual Capital, 2, 4, 2001, pp. 344-58. Available at: http://www.sveiby.com/articles/knowledgetheoryoffirm.htm