This article was reprinted from the First Quarter 2004 edition of The Contractor’s Compass with permission from the American Subcontractors Association.
In April 2003, the Texas Comptroller of Public Accounts recommended that state law should be amended to create a Rolling-Owner Controlled Insurance Program to reduce the insurance costs of Texas’ public construction projects.” The plan supported by the comptroller would create a “statewide OCIP” organized to benefit “state agencies, counties, cities, school districts and others” by saving them millions of dollars on highway and other types of construction projects.1 When you consider that the National Governors Association estimated Texas’ budget shortfall at almost $1.8 billion for fiscal year 2003, it’s not hard to see the public appeal of the comptroller’s proposal.2 The comptroller estimates Texas’ potential savings just on highway projects to be approximately $6 million annually. Is it reasonable for owners to expect significant savings on wrap-ups, and what is the financial impact of wrap-ups on subcontractors?
The Texas comptroller’s office’s idea is not new. Like many other state governments, Texas hopes to find savings by “wrapping up” much of the insurance premium for workers’ compensation, commercial general liability and builder’s risk coverage on state and locally funded projects, paying less than the costs of premium charged by prime contractors and subcontractors when they purchase their own insurance.
As evidence of potential savings, the comptroller’s office cited a well known U.S. General Accounting Office report on “Transportation Infrastructure: Advantages and Disadvantages of Wrap-Up Insurance for Large Construction Projects,” published in June 1999. That report stated:
“According to insurance industry officials, wrap-up insurance can save project owners up to 50 percent on the cost of traditional insurance, or from 1 to 3 percent of a project’s construction cost. 3
Owner-controlled and contractor-controlled insurance programs (OCIPs and CCIPs, respectively) have been used on such high-profile projects as the San Francisco International Airport, Boston’s Central Artery project and the Xcel Energy Center in St. Paul, Minn. Many smaller projects are covered by ” master” or “rolling” OCIPs, such as a $5,000 asphalt patch job performed for the Chicago Public Schools, which has a master wrap-up program. While the media reports owners’ claims of hundreds, thousands, and millions of dollars saved by wrap-ups, many subcontractors, and some owners, suspect that the alleged “savings” on wrap-up projects are not as substantial as presumed.
Costly Administrative Nightmares
Take the example of Imperial Mill & Fixtures, a millwork company headquartered in Corpus Christi, Texas. Imperial Mill & Fixtures has performed work on several ROCIP school construction projects in Texas, and the experience has been less than satisfactory, reports Vice President James Kollaja. As an example, Kollaja cited Imperial Mill & Fixtures’ experience receiving the last check on two school projects 16 months after completion of punch list work. The projects were part of a ROCIP, and the insurance audits extended the time of final payment. “What’s really nasty about these is that none of the ROCIP insurance companies or underwriters are contractually bound to a timeline—and the premiums of the insurance are paid up-front,” says Kollaja.
A 16-month delay of a final payment due to the subcontractor could easily cost a specialty trade contractor its entire profit margin (typically, 2.5 percent of revenues4) on a job, especially if retainage was part of final payment. Multiply that revenue-sapping scenario over all of the subcontractors on a project, and it is not hard to imagine that the owner’s “savings” on a typical wrap-up could be largely financed by earnings made on the subcontractors’ late payments!
Even when payments to subcontractors are being made in a timely manner, the costs of the added administrative burdens of OCIPs diminish the owner’s savings. Even strong advocates of wrap-ups admit that their administrative complexity fosters inefficiencies. The total administrative cost of OCIPs to construction owners is not known, but several public owners’ experiences suggest that reports of savings are overblown. Robert Hixon Jr., director of the General Services Administration’s Center for Construction and Project Management, says that on one of GSA’s OCIP projects, “The funding is gone but the bills are still coming in,” and suggests that GSA should consider not using OCIPs.5 On the “Big Dig,” Massachusetts’ state auditor’s office had to step in to ensure that the state benefited fully from wrap-up “savings” offered by excessive insurance premium charges.6 The level of savings from wrap-ups is not obvious to all owners. For example, wrap-up insurance was not used on the U.S. Capitol Visitor Center, in part because the proposed project savings “would have required a more detailed cost/benefit analysis in order to receive a favorable opinion from GAO.”7
Likewise, the average cost of the administrative burdens of OCIPs and CCIPs to subcontractors is not known.
The Foundation of the American Subcontractors Association is raising funds for a research project that will help the construction industry better understand those costs. [For more information about FASA’s research, go to www.fasaonline.com on the Web.] What is certain is that subcontractors bear the added expense of purchasing insurance from multiple sources and ensuring that current insurance policies are modified to complement wrap-ups.
In addition, subcontractors incur extra costs for preparing and submitting payroll reports to general contractors. Subcontractors also lose the financial benefits of retrospective adjustments to their own insurance premiums, and lose control of back-to-work programs.
Anne Bigane Wilson, CPC, PE, president of Bigane Paving Company, has experienced the extra administrative burdens of wrap-ups on several projects in Chicago. “When you’re working with your own insurance, the insurance company does an annual audit, but on wrap-ups, the reports are monthly and on a per-project basis,” says Wilson. “That means that if I’m working on seven wrap-up projects, I’m preparing seven monthly reports instead of one monthly report.”
In addition to creating new direct costs for subcontractors, poorly structured consolidated insurance programs reward contractors that are less safe. In the process of allocating insurance cost credits, a subcontractor with a higher experience modifier rate would receive more credits than a safer subcontractor.
Insurance credit for less safe behavior is just one of many risk-related problems wrap-ups pose.
Wrap-up projects, like others, routinely require each subcontractor to make the owner an “additional insured” on the subcontractor’s commercial general liability policy, and other insurance policies. For example, the Metropolitan Washington Airports Authority’s “Owner Controlled Wrap-Up Insurance Program Manual” (April 2003 ed.) states that “the Metropolitan Washington Airports Authority shall be listed as an additional insured on all such insurance policies, except Workers Compensation and Professional Liability [emphasis in original].” The airport authority requires all subcontractors, whether enrolled or not enrolled in its OCIP, to provide additional insured protection on the subcontractor’s commercial general liability/excess liability, automobile liability and employer’s liability insurance policies.
As an additional insured, the airport authority effectively is immune from the consequences of its own actions. For example, an incident in which an authority employee negligently injured an employee of the subcontractor would be paid by the subcontractor’s insurance and reflect on the subcontractor’s loss experience. Whether calculated in its bid or not, the subcontractor ultimately would bear the added cost of insuring the owner against the loss.
Another risk-related problem for subcontractors working on OCIPs and CCIPs is inadequate insurance coverage. Inadequacies can occur at many different parts of policies. The problem of identifying any inadequacies is compounded by the variety of wrap-up policies that exist.
In the worst case, subcontractor performance may not be insured at all, leaving the subcontractor vulnerable to self-insuring losses. For example, the airport authority’s manual states: “Substantial completion, for the purposes of the OCWIP, shall be defined as the date when the product (i.e., building, facility, pavement, etc.) completed under the contract is put to its intended use. Punch list work performed after substantial completion, as well as warranty work, will not be covered under the OCWIP [emphasis in original].”
Doug Patin, head of the construction practice of the law firm of Spriggs & Hollingsworth, Washington, D.C., points out that the problem of insurance coverage on wrap-ups extends beyond what’s covered by the original wrap-up insurance policy. Wrap-up insurance policies, like others, expire. “On some projects, the original wrap-up insurance program expires and owners are having trouble finding replacement insurance,” says Patin. “When they do, deductibles go up on owners and contractors.”8
Other common problems with insurance coverage on wrap-ups include the following:
- Inadequate limits on particular lines of coverage.
- Discrepancies between excess and primary coverage.
- Completed operations coveragethat expires too soon.
- Coverage that does not addresslosses during site preparation, losses created by faulty construction, and losses incurred for pollution cleanup.
- Lack of coverage for thesubcontractor’s rental equipment.
- “Back-to-work” programs that wrap-up administrators use to put injured workers back on a subcontractor’s payroll, when they should be collecting benefits under the owner’s policy.
ASA’s document, “Risk Transfer: 30 Questions for Consolidated Insurance Programs,” provides a broad view of these and other risks that subcontractors may end up self-insuring when participating in a wrap-up. Download the document at www.asaonline.com/strap.htm.
The scope of the inadequate coverage and self-insurance problems on consolidated insurance programs has not yet been quantified. However, wherever subcontractors are self-insuring losses or paying higher premiums or deductibles because wrap-ups do not make appropriate adjustments to their insurance costs, subcontractors are absorbing costs that are largely hidden from view.
Individual subcontracting firms should be aware that there are a number of defensive measures they can take to limit the impact of new, direct costs, and the cost of risks shifted to them, through wrap-ups.
One way to limit direct costs is to condition your bid on a maximum total credit amount of $X per $100 of payroll based on straight time, for the “discount calculation” that is performed at the end of the project. Another way is to review the contract documents to ensure that they do not make the wrap-up administrator the “final authority” on the credit calculation. Preserve your right to dispute the administrator’s decision.
You may wish to work with your own insurance agent and attorney to comprehensively address “gaps” in wrap-up coverage. Ask whether you can provide Owners and Contractors Protective liability insurance instead of an “additional insured” endorsement. Add the amount you spend on consultations with professional advisors to your total project costs and verify that your work is still profitable. When you bid wrap-up work and subtract your insurance costs, consider adjusting the resulting amount to account for additional administrative costs that your company will incur by participating in the wrap-up.
The terms of the subcontract agreement are important too. Review the proposed language and ensure that the indemnity provision is not too broad. Where the contract clause “holds harmless,” “saves harmless” or “indemnifies” the general contractor, consider adding language that clarifies that “Any indemnification or hold harmless obligation of the subcontractor shall extend only to claims relating to bodily injury and property damage and then only to that part or proportion of any claim, damage, loss or defect that results from the negligence or intentional act of the indemnitor or someone for whom it is responsible.” Also consider adding the language “Subcontractor shall not have a duty to defend.”9 These modifications will help l imit the ability of the general contractor to seek indemnification from the subcontractor when the subcontractor is not at fault.
Pay special attention to how the subcontract language handles final payment, since insurance audits frequently delay final payment. Consider modifying the subcontract agreement so that it states that any delayed payments will accrue interest or penalties to your sole benefit. Should the audits cause delays in payment, remind the general contractor of its contractual payment obligations. ASA members can use the National Business Practices Interchange to learn more about the business practices of prospective clients by logging on to the members-only section of the ASA Web site.
Above all, if you decide to participate in a wrap-up project, be aware of the extra costs that may not be stated in the subcontract document. Carefully review whether such projects are really saving your company money. And don’t forget you can always walk away from the deal beforeh and if it’s too risky.
About the Author
David Mendes is communications director of the American Subcontractors Association.
1 “Special Report to the Legislature: Additional e-Texas Recommendations” (Texas Comptroller of Public Accounts, April 2003).
2 “The Fiscal Survey of States” (National Governors Association and National Association of State Budget Officers, June 2003).
3 “Transportation Infrastructure: Advantages and Disadvantages of Wrap-Up Insurance for Large Construction Projects,” (General Accounting Office, June 1999), p. 3.
4 “2002 Construction Industry Annual Financial Survey” (Construction Financial Management Association, 2002), p. 160.
5 Remarks made Oct. 22, 2003, at the McGraw-Hill Construction Summit in Washington, D.C.
6 “Independent State Auditor’s Report on the Activities of the Central Artery/ Third Harbor Tunnel Project Wrap-Up Insurance Program, November 1, 1992, through October 31, 1999” (Massachusetts Office of the State Auditor, June 14, 2000).
7 According to an e-mail message sent by the project’s contract manager on Oct. 30, 2003.
8 Remarks made Oct. 22, 2003, at the McGraw-Hill Construction Summit in Washington, D.C.
9 Addendum to Subcontract (American Subcontractors Association, 2003).