Traditional versus Project Insurance
Large construction projects create a mosaic of risks for all project participants—owner, architects, engineers, manufacturers, vendors, and contractors. In the standard form agreements for construction, the owner attempts to shift the risk to the construction manager/general contractor (CM/GC) via various provisions, including indemnification, consequential damages, cost, and schedule, just to name a few.
Despite this attempt to transfer the risks of the project contractually to third parties, the owner still may be liable for certain risks: extra hazardous operations, claims arising in common areas, owner-provided equipment, owner-retained contractors, or owner-provided design, assuming safety responsibilities or other liabilities or obligations in the construction agreement and vicarious liability arising out of the operations of the contractors.
Certain risks on the project are insurable, and the construction agreement requires the CM/GC and their subcontractors to provide certain insurance coverages and a certificate of insurance evidencing that the stated coverages are in force. This approach of having the CM/GC and all subcontractors provide the required insurance is often referred to as the “traditional insurance” approach and is used in many construction projects.
However, larger construction projects, generally over $50 million on commercial projects and $10 million-plus on “for sale” residential projects, lend themselves to be considered for insurance coverage on a project-specific basis, otherwise known as “wrap-up” insurance. Insurable risks that are commonly considered for project-specific coverages include the following.1
- Commercial general liability and umbrella or excess liability
- Workers compensation
- Contractor’s pollution liability
- Professional liability
The following advantages of project-specific coverage over traditional insurance are well documented.
- Sponsor retains first-named insured status and more direct control over claims process
- Completed operations extension or “tail” coverage (GL/XS/CPL/PL)
- Higher catastrophic insurance limits
- Broad coverage terms
- Increases the size of the pool of bidders
- Increased scrutiny on safety
- Reduced internal time and expense devoted to insurance compliance
- Potential for cost savings of the insurance line item by bundling the insurance spend of all the parties
Routinely, an owner is faced with two options to access the advantages of project-specific insurance coverages: the owner can purchase, or “sponsor” the coverage, known as an owner controlled insurance program (OCIP); alternatively, the CM/GC can purchase the coverage, known as a contractor controlled insurance program (CCIP). For purposes of this article, we will be limiting the discussion to OCIP versus CCIP insuring workers compensation and/or general liability/excess liability coverages.
OCIP versus CCIP—an Owner’s Perspective
Many midsized and large contractors have established CCIP programs, and it is common for them to propose utilizing their CCIP coverage for large projects.2 This is a good thing; it provides the owner with the options of relying on traditional insurance, purchasing an OCIP, or paying the CM/GC to provide the project-specific insurance coverage via a CCIP.
Once the owner’s chief financial officer or risk manager becomes aware of the capital project, it is quite common for them to engage their insurance broker or a consultant to prepare a financial pro forma to determine the extent of potential cost savings by sponsoring an OCIP. Routinely, the pro formas generate significant savings to the owner by assuming a large deductible or self-insured retention and controlling the claims expense; however, the owner should be cautious, relying on the projected savings as there are many variables and assumptions that go into the pro forma. This is particularly relevant if the owner is comparing the costs and savings in the OCIP pro forma to the cost of a CCIP.
Ideally, both parties (the owner’s broker or consultant and the CM/GC) will provide OCIP/CCIP cost estimates based on the same set of data, which can either be provided by the owner’s broker or consultant or the CM/GC.
- Project description
- Desired lines of coverage and limits
- Project term (estimated start/end dates)
- Project budget
- Workers compensation payroll by workers compensation code
By having both the owner and the CM/GC provide pricing based on the same data set, it will enable the owner to evaluate the costs of both OCIP and CCIP on a consistent basis.
Advantages of a CCIP versus OCIP—an Owner’s Perspective
Bifurcation of construction risks. To me, this is the leading reason to consider project-specific insurance. Because an OCIP or CCIP insures all contractors and the owner under a single policy, it allows the owner to insulate its corporate insurance program from losses arising out of construction operations, which can prevent adverse loss experience arising out of the construction project from driving up insurance rates on its core business. The CCIP accomplishes this bifurcation of construction risk.
Expertise. Owners with large capital expenditure (CapEx) programs may have sponsored OCIPs in the past or may have a “rolling” OCIP program for their CapEx program. However, there are many other owners that build a large project every several years and have limited experience with OCIPs. Internally, they may not have the expertise to evaluate, implement, and manage an OCIP; whereas, the contractor deals with construction risk every day and likely has robust risk management programs and personnel experienced in implementing and administering their CCIP. A common contractor sentiment is “if I have the risk, I should be able to purchase my own insurance to protect my risk.”
Resources. Owners have indicated to me on numerous occasions that, while they are attracted to the potential cost savings of an OCIP, their staff is lean and they lack the capacity to administer an OCIP. While the insurance broker or OCIP administrator provides many of the transactional services of marketing the insurance coverages, providing program documents, enrolling subcontractors, and collecting certificates of insurance and monthly payroll reports, the owner retains certain responsibilities as the sponsor of an OCIP, often within the owner’s risk management department.
- Selection of broker and/or OCIP administrator
- Gather and provide underwriting information required to obtain the quotes
- Review and approve OCIP documents prepared by the broker and/or administrator: underwriting submission, quotes, OCIP contractual addendum, and OCIP manual
- Select insurer, coverages, and limits of coverage
- Execute any legal agreements with insurer and post collateral, typically a letter of credit (LOC), if applicable
- Review periodic OCIP reports
- Review claims loss runs and participate in claims meetings
- Make claims settlement decisions
If the contractor has experience sponsoring CCIPs, especially if they have a “rolling” CCIP insuring multiple projects, they have established protocols and experienced risk management and field personnel to manage all aspects of the program.
Collateral requirements. As mentioned above, if the OCIP is written with a large deductible program ($250,000–$500,000 each occurrence is common), the insurer will require the sponsor to post a clean, irrevocable LOC to securitize that claims obligation. If the sponsor does not reimburse the insurer for paid claims, the insurer can present the LOC to the owner’s bank and draw down on the LOC. While LOCs have a cost element (typically .75–1 percent annual rate on the amount of the LOC), the important item to note is that the LOC obligation will likely remain in force by the insurer, generally through the statute of repose, which can be 5–12 years after substantial completion, depending on the state. In the case of a CCIP, the CM/GC holds this obligation.
Upfront insurance premiums. As a sponsor of an OCIP, you will be responsible for paying certain costs upon binding coverage. Typically, the primary insurance coverage will have a deposit premium (25–40 percent), with the remaining balance spread throughout the project. Excess/umbrella insurance coverages are typically paid 100 percent upon binding, and the broker/administrator typically requires an initial installment as well. The CM/GC will also require a payment for the CCIP coverage, sometimes 100 percent upon binding coverage, or it may be spread out as the work is billed.
Known insurance costs. For the lines of insurance provided by the CCIP, the cost of the CCIP is known at the beginning of the project. CMs/GCs typically charge for the CCIP on a percent of construction costs (e.g., 2.5 percent of contract value).3 In addition, if the payroll estimates in the pro forma were lower than the final audited payroll, the owner may be subject to additional premium4—the CM/GC bears this risk under a CCIP.
Drawbacks of a CCIP versus OCIP—an Owner’s Perspective
Loss of first-named insured status. As a sponsor of an OCIP, the owner attains first-named insured status on the general liability/excess or umbrella liability policies. In contrast, some CCIP sponsors and some insurers limit the owner to additional insured status. Their biggest concern is that they do not want the CCIP to inadvertently insure the operations of the owner (e.g., manufacturing or hospital operations) under the OCIP. Suffice it to say, in the event the owner is listed as an additional insured, it must be satisfied that the language in the additional insured endorsement provides it with an adequate mechanism to attain protection under the CCIP.
Speaking of “insureds,” It is also important for an owner to confirm that there is no “insured versus insured” or “cross-liability” exclusion on the CCIP. This provision, which prevents one insured from suing another insured, is common on wrap-up programs, particularly those placed in the excess and surplus lines market, and may prevent the owner from suing the CM/GC. Some of the endorsements restrict “named insureds” from suing other “named insureds” and other versions restrict suits between any insured under the policy. In either case, if requested, the underwriters will typically carve out an exception to the exclusion by allowing cross-suits between the owner and CM/GC.
Indirect involvement in claims. OCIPs can be an effective tool for owners to address liability claims that arise from members of the public. Because the programs often have large deductibles, the owner has input in the claims settlement process, particularly when the value of the claim falls within the deductible. Municipalities, healthcare facilities, universities, and others with a sensitivity to public liability exposure prefer more direct involvement in the claims process. In contrast, when the project is insured under a CCIP, the CM/GC is the party directing the claims and has the financial incentive to minimize claims payments.
Project with multiple CM/GCs. If the project utilizes a multiprime delivery model or involves multiple CM/GCs, an OCIP lends itself better to drive consistent insurance coverage, administrative protocols, and claims management across the entire project.
CCIP may cost more than an OCIP or traditional coverage. The cost of the CCIP, established between the owner and CM/GC, may cost more than an OCIP or traditional insurance. In most cases, the OCIP cost is not known until the end of the project because the two greatest variables in the savings formula are the amount of insurance credits or deductions from the GC/CM and subcontractor bids along with favorable claims experience. Of course, if either of these elements is deficient, the OCIP can cost more than a CCIP or traditional insurance.
Additionally, the cost of the CCIP may include an array of services such as an on-site medical trailer, claims management services, CCIP administration, and internal administrative time, which may not be fully accounted for in an OCIP pro forma.
Loss of statutory immunity. In certain states, there is established case law that a sponsor of an OCIP (i.e., the owner) enjoys statutory immunity protection from civil claims from employees of contractors insured under the OCIP. This owner benefit is negated under a CCIP.
Loss of completed operations coverage. One of the greatest coverage benefits of an OCIP or CCIP is the dedicated single limit and the extension of time the general liability and excess/umbrella policies will insure bodily injury and property damage included in the products-completed operations (PCO) hazard, typically out through the statute of repose. This is accomplished via a completed operations extension endorsement, or it may be included in a wrap-up endorsement on the policy.
Each insurer has specific language in their policies that address when the coverage is effective and under what conditions the coverage is void. Common terms that void the PCO coverage extension include (varies by insurer) the following.
- The policy is canceled or nonrenewed for any reason prior to the policy expiration date.
- There is a failure to pay premiums, audits, or deductible losses when due.
- The work is not complete or abandoned prior to the policy expiration date.
- There is a material misrepresentation by the sponsor.
- There is a failure to comply with loss control recommendations or peer reviews.
- There is a failure to provide requested enrollment documentation.
These same exclusions are also commonly found in OCIP policies. However, in an OCIP, the owner has control over these variables. In the case of a CCIP, the owner has limited control and may be surprised if the PCO is canceled. If the PCO coverage is canceled, either due to one of the conditions stated on the policy or the CM/GC is replaced with another CM/GC, it will be very difficult to find an insurer to assume the PCO liability during the middle or the end of a construction project.
It is suggested that the reasons for cancelling the PCO extension be minimized and that the owner requires the CM/GC to warrant that the CCIP coverage remains in force both during construction and during the PCO extension period. The owner will also be well served by requiring the CCIP policies are endorsed to provide 30- or 60-days’ notice to the owner for nonpayment or cancellation.
Owners should weigh all available options available to them to ensure the risks arising out of construction projects are adequately protected. Project-specific insurance coverage, OCIP or CCIP, offers many coverage benefits over the traditional approach of having the CM/GC and subcontractors providing their respective insurance protection. Either OCIP or CCIP allows the owner to bifurcate its construction risk away from its core insurance program loss experience.
A CCIP affords the owner the opportunity to capture many of the protections of project-specific coverage without the internal time, expertise, expense, and resources required to administer an OCIP. That said, owners should also be aware of the drawbacks to the CCIP approach and address insurance coverage concerns during the decision process.
1Builders risk insurance is also commonly written on a project-specific basis.
2The owner will sometimes request the CM/GC provide pricing for a CCIP as part of their proposal to construct the project.
3The cost of the CCIP varies by contractor, on the services provided, premiums, the state in which the project is located, limits, and project type.
4The OCIP insurer may offer a guarantee not to charge additional premium if the audited payroll is no greater than 10 percent of the payroll used to calculate the deposit premium.