Originally posted Monday, 13 September 2010
Written by Tim Walsh
It’s 2:47 in the afternoon and you get the call you hoped you would never receive. A crane has collapsed on your construction site and several workers have been sent to the hospital. The project team institutes its emergency action plan and many months of investigation, meetings and uncertainty begin.
It’s this type of instance, a catastrophic loss event, which necessitates the discipline of risk identification, management, mitigation and sound risk transfer mechanisms on construction projects. Despite the fact that a catastrophic event can have a significant impact on cost, schedule and human life, these risks are routinely inadequately addressed when negotiating a contract with the general contractor/construction manager.
Traditional approach – still a safe bet?
Traditionally, an owner attempts to transfer their risk through the indemnification clause of the construction agreement. Additionally, rather than relying solely on the assets of the GC/CM to back up the indemnification obligation, the owner imposes a series of insurance requirements on the GC/CM and subcontractors.
This coverage is intended to protect both the contractors and the owner in the event either party is brought into a lawsuit.
The owner is protected on the contractor’s general liability insurance policy by being named as an additional insured on the contractor’s policy. An owner seeks coverage through this status for claims which arise both during the execution of the work and for those which arise from the contractor’s completed operations.
However, due to class action lawsuits on condominium projects originating back to the early 1980s, insurers have resisted providing additional insured coverage to owners for completed operations of the contractor. Insurers have also attached problematic exclusions to contractor policies, including: subsidence, residential construction, contractual liability and prior completed work, just to name a few.
Claims uninsured by contractor insurance have the potential to be paid under the owner’s insurance. These can stem from the owner’s negligence in the loss or vicarious liability arising from the construction operations. As many large owners and institutions have large self-insured retentions or deductibles on their liability insurance policies (in some cases as high as $20 million) a construction loss can have a significant financial impact. Additionally, claims paid under the owner’s insurance policy can negatively impact their premiums for three to five years after the loss event.
While the traditional approach of relying upon the contractor’s insurance to protect an owner has worked effectively in the past, restrictions by underwriters have forced owners to consider alternative options for insurance protection.
A “wrap-up” insurance program gets its name from wrapping, or bundling, specified insurance risks into a single insurance program. Instead of relying upon the GC/CM and each subcontractor to provide insurance coverage for the project, a single policy is purchased which insures all parties on the project, including the owner, GC/CM and all subcontractors.
This solution typically provides insurance protection for workers’ compensation and general liability/umbrella liability. If the wrap-up program is purchased by the owner, it is referred to as an owner-controlled insurance program. A more recent trend is for the GC/CM to provide the wrap-up insurance, referred to as a contractor-controlled insurance program. The party that purchases the coverage is referred to as the wrap-up sponsor.
There are several characteristics that distinguish a wrap-up insurance program:
• Insures all parties under a single program;
• Coverage is limited to operations at the project site;
• In the case of general liability, all parties share the limits of insurance; and
• Claims arising from completed operations are insured for 3 – 10 years after the project is complete.
Additionally, project-specific insurance policies can be purchased to insure all parties on the project for other exposures such as builder’s risk, contractor’s pollution liability, professional liability, ocean cargo and railroad protective liability. However, contractors still maintain coverage for other exposures such as off-site operations, auto liability and contractor’s equipment.
There are three types of wrap-up programs:
• Single Project – As its name suggests, insures the risks of a single construction project
• Rolling Wrap-Up – The sponsor purchases a single insurance program that insures multiple projects. These programs are typically written for projects which start within a three- or five-year term.
• Maintenance Wrap-Up – Used by sponsors who outsource labor in their facilities.
Wrap it up – I’ll take it
While wrap-up programs date back to the 1940’s, they’ve gained widespread use over the past two decades due to the following advantages over the traditional approach of relying upon contractor insurance:
Better Insurance Protection for the Owner – Since the owner purchases the coverage, it attains First Named Insured status on the policy, thereby negating the need to obtain additional insured status on the contactor’s policies. Because the owner purchases the policies, it can ensure that adequate coverage protection is in place for the project and financial ratings of the insurers meet corporate requirements.
The limits of insurance are dedicated to the owner’s project and are not diluted by the contractor’s other work. Also, coverage terms on wrap-up programs are generally broader than contractor-provided insurance. The limits of insurance purchased under a wrap-up program are generally much higher than that provided by the contractors, which provides better protection for all parties in the event of a catastrophic loss event.
Finally, wrap-up insurance uniquely provides coverage for post-construction claims arising out of the completed operations of the contractor’s work. To obtain this protection under the traditional approach, an owner would have to contractually require the contractors to maintain coverage through the statute of repose and obtain certificates of insurance on an annual basis to ensure coverage is being maintained. This proves not only to be burdensome on the Owner, but without retainage, an owner has little leverage to enforce this requirement.
Cost Savings – The insurance line item for workers’ compensation and general liability on a project makes up two to three percent of the overall project budget. By pooling the risks of all parties into a single insurance program, the owner can utilize risk financing mechanisms, such as a large deductible program, that will allow it to reduce the program’s fixed costs. By controlling the variable expense (losses) of the program, the owner can expect to realize a cost savings of one-half to one percent of the project budget.
A secondary cost savings is the avoidance of payments under a large deductible or self-insured retention and future premium increases on the owner’s corporate insurance program.
Enhanced Safety – The insurers that provide wrap-up insurance coverage require a heightened level of safety on the project; including a six-foot fall protection for all trades, full-time safety director, project-specific safety program and, in some cases, drug testing. Additionally, as the cost savings inure to the benefit of the owner, owners tend to take a more active role in monitoring the safety on projects insured under a wrap-up program.
Increased MBE/WBE Participation – One of the challenges that small and disadvantaged contractors face when bidding on projects is the additional cost to comply with the owner’s insurance requirements. Owner requirements routinely exceed limits carried by these firms. By incepting a wrap-up program, this increases the owner’s pool of potential bidders by leveling the playing field on bid day.
Better Control Over Claims – As many of the wrap-up programs are written with a deductible of $250,000 to $500,000 per occurrence, the owner has more communication and leverage with the insurer in the claims process. This is especially beneficial for public entities that seek to resolve claims involving constituents in a timely and equitable manner.
Platform for Formally Addressing Construction Risks – Due to the underwriting process of obtaining the insurance, a wrap-up program provides a platform for the owner’s project team to discuss the potential risks on a project, identify the best party to assume that risk, identify catastrophic exposures and formalize a strategy for managing that risk. This process, while logical on all construction projects, rarely takes place when a project is insured under the traditional approach.
There’s no free lunch – disadvantages of a wrap-up insurance program
Owner Administration of the Program – An owner engages an insurance agent/broker to perform many of the administrative tasks on a wrap-up program. However, the owner retains responsibility for several aspects of the program, many of which are performed by the owner’s risk manager:
• Providing underwriting information about the project;
• Reviewing program documents;
• Selecting insurance carriers;
• Participating in wrap-up meetings; and
• Overseeing claims and participating in claims reviews
Unrealized Cost Savings – In most instances, the owner must decide on insuring the project under a wrap-up program before the first bid packages hit the streets. The decision to proceed with a wrap-up is based largely on a pro-forma prepared by an insurance agent/broker. There are many variables within the pro-forma and incorrect assumptions can overstate savings expectations. Agents or brokers who specialize in wrap-up programs should be utilized and the assumptions contained within the pro-forma should be vetted with the project team prior to committing to insuring the project under a wrap-up.
Insurer Collateral – As with any insurance program written with a large deductible, the insurer will require the sponsor to put up collateral in the form of cash or a letter of credit for a portion of the total potential loss exposure under the program (typically 60 to 100 percent, depending upon the financial strength of the sponsor). This collateral is held by the insurer until all claims are closed out, which can last ten years after the project is complete. There are mechanisms, however, that enable the sponsor to “buy-out” their outstanding claims at 18 months after substantial completion, and annually thereafter.
Contractor Relations – Some contractors encourage owners to sponsor wrap-up programs. This is particularly evident in industries such as residential or small contracting, where contractors are unable to obtain adequate insurance protection from their insurers. However, the vast majority of contractors would prefer to provide coverage under the traditional approach due to a variety of reasons:
• Insurance may be a profit center;
• Contractor’s preference to interface with their own insurer and agent/broker;
• Premium volume enables the contractor to negotiate more favorable terms on their insurance program, and
• Contractors with strong safety records lose their advantage on bid day if the insurance costs are leveled via a wrap-up program.
Minimum Project Size to Utilize a Wrap-Up
The project size is important from two perspectives. First, an owner needs adequate volume to cover the fixed costs of the program and generate savings. And second, many states have minimum project sizes required in order for a project to qualify to be insured under a wrap-up program.
The following is a guideline of when projects should be considered for a wrap-up program:
($100 million Construction Value);
($300 million Over a Three-Year Term);
($25 million Annual Maintenance Labor);
The state regulations can vary between private and public projects and may impose certain obligations upon the sponsor. State regulations are addressed in a variety of different sources, such as National Council on Compensation Insurance (NCCI) manuals, state civil codes, state statutes, state insurance codes and state insurance department bulletins.
An insurance agent/broker that specializes in wrap-up insurance programs can offer guidance on state-specific requirements.
An owner is going to pay two to three percent of its construction budget for insurance protection. The real question is: What level of protection is the owner receiving for this multi-million dollar investment?
The traditional approach of insuring construction projects has proven ineffective for owners due to the many restrictions of contractor’s insurance policies. In response, many owners have turned to wrap-up programs as a means of retaining control over the insurance protection and reducing project costs.
Lastly, a recent trend is emerging among owners who do not have a rolling wrap-up. On projects less than $100 million, they are requiring the GC/CM to provide a CCIP as a means of obtaining better quality insurance protection.
Tim Walsh is senior vice president and regional director of Aon’s national wrap-up group. He can be reached at 248.936.5321 or via email at firstname.lastname@example.org.