OCIP 2.0 – Building A Better Wrap-Up
Part 1: Intro to Wrap-Up Insurance Programs
What is an OCIP or a Wrap-Up? Is an OCIP a viable mechanism to reduce cost of risk? Is an OCIP utilized more than a CCIP? Does an OCIP improve contractual risk-transfer? Obtaining definitive answers to these questions has baffled risk managers for decades. You would think since wrap-up insurance programs have been used on projects for over fifty years these questions would have specific answers. But, the answer is, “it depends!”
This is the introduction to a series of posts I’ve entitled, “OCIP 2.0 – Building a Better Wrap-Up”. Hopefully, these articles/posts will provide you with insights to increase your cognizance of what is required to design, structure, implement, and manage an effective owner controlled insurance program (OCIP) on your construction project.
But, before we jump into this knowledge-transfer process, a little history is warranted.
After spending the first decade of my career in the construction industry working with construction and engineering firms, and shortly after completing my MBA in finance, I was recruited into the insurance industry to develop construction insurance programs. This was an exciting time in my career to be able to augment my practical construction project management experience with new risk-transfer and risk finance methodologies.
I was especially intrigued with owner-controlled insurance programs (OCIPs), and how an OCIP can be used as an alternative to traditional insurance on construction projects.
Although, it wasn’t until I was a risk manager and owner’s representative that I fully realized that regardless of how good your OCIP insurance program structure is, if you have weak project management, a poor implementation, or haphazard administration processes, you will not achieve any of the potential benefits of an OCIP on your project.
About the same time I initially established C-RISK, I had published several articles in construction industry publications on owner-controlled insurance programs (OCIPs) aka, Wrap-Ups. I wrote those journal articles to educate CFOs, and other construction professionals on the potential benefits of using an OCIP as a risk financing approach in lieu of using a traditional contractor-provided insurance program. OCIPs, if structured properly offer enhanced controls and can potentially reduce project insurance costs.
Those OCIP articles helped many CFOs and project owners become knowledgeable about OCIPs, not only about the procurement and placement of insurance coverages, but to help them determine if using an OCIP was the right approach for them for their construction projects. Those articles were written from a project owners perspective. These articles/posts are written from a project owner’s perspective as well. They will provide project owners with some practical insights on advantages and disadvantages, feasibility, program structures, and other methods of using an OCIP on a project.
A lot has changed in the past decade in the construction industry. However, the use of an OCIP to wrap-up the construction project insurance is still a very viable approach. Project owners involved with large transportation infrastructure construction projects have more challenging risks to manage than residential and commercial developers. Public entity project owners especially need to know about OCIPs and how they can be used to manage project risks. The increased use of new project delivery methods such as design-build (DB) and creation of public-private partnerships with other variations like design-build-finance (DBF) or design-build-operate-maintain (DBOM), will stimulate a renewed interest in the use of OCIPs by public entity project owners for future projects.
Why are OCIPs more efficient to project owners to reduce inflated premiums expenses? Because, with an OCIP the project owner furnishes the insurance coverage(s), and a project owner can remove the gross premium costs submitted by contractors, which typically includes broker commissions and fees, and a contractor’s mark-up for OH&P.
With an OCIP, a project owner benefits from paying only the net cost of insurance. In addition, a project owner can maintain more control over the risk-transfer process. This is an attractive dynamic for many project owners who have the most skin in the game. On today’s major projects, this risk factor is a compelling reason for project owners to be knowledgeable about the proper use of an OCIP. The operative word here is “control”.
Using an OCIP, in addition to being an efficient and effective risk financing approach for risk-transfer with insurance coverages, it is a control mechanism. An OCIP will also reinforce safety management and mitigate subrogation claims on construction projects. Project owners will be equipped to better manage numerous risk factors with an OCIP.
The following sections on OCIPs will take you through a methodical process to convey what an OCIP is, why use an OCIP, and how to design and manage an OCIP to maximize your potential for achieving success. These sections will be pragmatic and will facilitate an OCIP knowledge-transfer process. These sections cover individual components of an OCIP and will provide you with valuable insight on what I have learned over the years about OCIPs, but more importantly, what you need to know about OCIPs to keep you out of the weeds. I’m confident you will benefit from my lessons learned from inheriting some flawed OCIPs. That experience was very frustrating at the time, but it provided me with a unique perspective on the do’s and don’ts. It has enabled me to reverse engineer the flaws out of an OCIP design, formation, administration, and management processes. My goal is to help you in building a better wrap-up on your own construction projects.
Part 2: What’s an OCIP? & Why use an OCIP?
What’s an OCIP?
A strict definition defines an owner-controlled insurance program (OCIP) as a wrap-up under which a project owner provides various insurance coverages to contractors and subcontractors. OCIPs make up the largest percentage of wrap-up programs being used in the U.S. (I will not cover which States in the U.S. allow and/or disallow wrap-up insurance programs. Each State’s department of insurance regulates this. It varies from State to State, and is subject to change.) Another type of wrap-up, which I will reference without going into detail is a contractor-controlled insurance program (CCIP). This is a wrap-up that a general contractor controls the program versus a project owner. The entity that controls the program is the “sponsor”, on either an OCIP or on a CCIP.
OCIPs and CCIPs are basically the same. The main difference is sponsorship (a project owner for an OCIP, and a general contractor for a CCIP). The key consideration is who has the ultimate control for the program, i.e. Who is responsible for what? The issue of control can pose potential problems for either type of program, especially if a wrap-up program is not properly structured with partnering and collaboration in mind. Having proper scope definition, a clear delineation of responsibilities, and definitive program structure, with communication and cooperation, are critical for success on a wrap-up.
Is an OCIP the most viable approach?
The key success factor in building a better wrap-up consist of taking a holistic approach for ensuring a controlled insurance program process. This takes into consideration all the phases of a wrap-up, including; conceptual design, insurance program structure, formation, implementation, administration, management, close-out, and final audit.
The first step in the process, other than doing an initial gut-check on the reasonableness of using an OCIP in the first place, is to prepare a comprehensive OCIP feasibility study. This should be based on the specific idiosyncrasies of the project under consideration.
An OCIP feasibility study is designed to provide more than a cursory risk assessment for a Go/No-Go decision for using a wrap-up insurance program. A well-formulated OCIP feasibility study should provide an overview of the primary issues related to the viability and practicality of using an OCIP as a risk financing program strategy on a project.
The OCIP feasibility study’s purpose is to identify any “make or break” issues which could prevent a project owner from being successful in the implementation of an OCIP on a project. In other words, an OCIP feasibility study validates if this risk management approach for the project under consideration is viable and makes economic sense.
Keep in mind, a project owner needs to be objective when evaluating an OCIP feasibility study. Some project owners may want to overlook or minimize deficiencies in their project management team. This can be a fatal flaw in the process because no matter how good a project plan may be, or how complete a OCIP feasibility study is, it will never compensate for ineffective project management on an OCIP?for a construction project. Success on an OCIP is directly dependent on the enforcement of the OCIP requirements by project management, in collaboration with risk management and the OCIP broker.
An objective and realistic evaluation of a project owner’s prior track-record with the enforcement of construction contracts, and more importantly contractor compliance, will determine if an OCIP can be effectively managed by a project owner. This requires a thorough evaluation of all the stakeholders in the OCIP, i.e. all the departments directly responsible for enforcement of the contract terms and conditions of the OCIP. Specific contract provisions stipulating the OCIP requirements need to be an integral part of all construction contracts. This is a critical success factor, and probably the single most important criteria for any project owner who is considering using a project OCIP.
Enforcing contractor compliance with construction contract provisions starts with crafting stringent contract language for both indemnification provisions and for the OCIP insurance requirements. It also includes being very clear on the other required contractor-provided insurance coverages outside of the owner-furnished coverages.
Another critical success factor is OCIP administration. Who will manage the OCIP? There also needs to be a contractual risk-transfer element for all, or a portion of, the OCIP insurance policy deductibles. The deductible responsibility should be transferred to the enrolled contractors so the contractors have some “skin in the game”. Integration of the construction contract provisions with the OCIP insurance requirements is key. The OCIP insurance policy(s), safety and claims manuals, and OCIP administration procedures, need to be explicit. The comprehensiveness of the OCIP documents is a required best practice. Making sure they are adhered to will ensure a successful OCIP.
Remember, an OCIP feasibility study only starts the OCIP process. Planning is a critical component of a successful OCIP. However, planning alone won’t guarantee success. The plan must be strategic, realistic, and based on reasonable expectations for the OCIP.
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Why OCIPs now?
Why OCIPs now? That’s a good question! Answer: It’s all about timing! These are unique and interesting times. There is now a major focus on rebuilding America’s deteriorating infrastructure. This will stimulate increased growth in transportation, manufacturing, and construction sectors. Knowing what a key role infrastructure plays in the USA’s economic competitiveness and strengthening economic growth in both urban and rural areas are factors that should provide a boom in the building industry.
Combining this fact with an abundance of private capital from investors and a growing interest in the creation of public-private partnerships (P3s), will present new project opportunities. In addition to interests in P3s, there will be renewed interest in the use of OCIPs to wrap-up the insurance on these types of innovative risk financing projects.
OCIPs have been around for more than 50 years. It’s not a retro thing, but OCIPs are making a comeback. In the past several decades, OCIPs have been used on numerous commercial construction projects. There has also been a proliferation of OCIPS used on large public works and transportation projects. These types of megaprojects are great candidates for using an OCIP because they tend to attract a lot of public attention, have substantial impacts on communities, the environment, have large budgets, and many of these megaprojects can cost more than $1 billion in?construction costs to build.
The use of OCIPs continues to grow because of several key factors:
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Part 3: Who & What is Included & Excluded in an OCIP?
Who & What is Included & Excluded in an OCIP?
As previously noted, OCIPs help project owners to better control the cost of insurance and risk financing on large construction projects. An OCIP is basically a wrap-up under which a project owner provides certain insurance coverages to contractors on a project. OCIPs can potentially reduce a project’s cost by approximately 1-2%, compared to using traditional insurance that are usually provided by contractors on construction projects.
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Who & What Is Included in an OCIP?
An OCIP can be site-specific or it can be used for multiple jobsites. Most OCIPs are multi-year programs with a fixed duration. For large capital construction projects, the duration of an OCIP can be as short as two years, or as long as five, and even ten years for some large transportation infrastructure construction megaprojects.
The project owner’s project management team and project controls departments usually establish project durations. It is important as part of a project owner’s due diligence that they coordinate with their insurance broker to obtain an indication from the insurance and reinsurance markets to determine if these markets can support the specific duration of the project owner’s construction project to underwrite the OCIP insurance coverages.
The OCIP normally applies to all contractors and subcontractors performing work at the project jobsite. The project jobsite is defined to include the construction project site, as well as on-site fabrication shops and associated material storage and laydown yards.
The insurance coverages most commonly included in an OCIP can include workers’ compensation and employer’s liability, commercial general liability (CGL), and excess/umbrella liability. (In some states, e.g. Washington State, which is monopolist, workers’ compensation insurance is administered through the Washington State Department of Labor and Industries [L&I] for the state's workers' compensation system, and managed and regulated by a State Fund.)
In addition, (but not always), an OCIP can include builder’s risk, professional liability insurance for design professionals, and environmental liability insurance coverages. Several markets used to bundle the professional liability with environmental liability insurance to provide design errors & omissions and pollution coverage as a package policy. However, this is less common today.
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Who & What Is Excluded in an OCIP?
If the majority of a contractor’s work is performed away from the project site, that contractor may be excluded from an OCIP. The reason is simple. These contractors have limited construction jobsite exposure. Therefore, they have basically limited potential for incurring any construction jobsite injuries, and resulting insurance claims.
An OCIP could also exclude various contractors with a contract amount below a certain threshold. Depending on the total project construction costs, some project owners have established threshold values of between $25,000 to $50,000 in total construction value or total contract value (TCV) that have been used. This can sometimes to be a good rule of thumb if a project owner wishes to exclude contractors from participating in an OCIP. (This is totally at the project owner’s discretion. However, it may be more efficient for OCIP administration to establish a requirement that all contractors involved with the project are enrolled in the OCIP so that there is continuity with all contract terms.)
It is important to note that commercial auto liability insurance coverage is typically excluded from an OCIP. This is due to the difficulty of controlling or verifying losses. If included, this coverage could negatively impact any potential for OCIP cost savings.
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Part 4: OCIP vs. Traditional Insurance Program
Let's review how the OCIP insurance coverage compares to the insurance coverage provided by most contractors in a traditional program.
To gain a better understanding of an OCIP, we need to examine how a project owner would typically mitigate risk on a construction project. A project owner and a contractor typically execute a construction contract which includes an indemnification clause. The exculpatory language in this clause expressly states that the contractor shall hold the project owner harmless for any loss arising out of the execution of the contract.
These types of indemnification clauses protect a project owner from any vicarious liability and mitigate a project owner’s contributory negligence exposure. This is a prudent contractual risk-transfer method that should be included in all construction contract agreements between a project owner and a contractor.
In addition to this contract provision, the project owner would require that contractors purchase and maintain adequate insurance coverage with specified minimum limits of liability. At a minimum, a project owner should normally require contractors to purchase workers’ compensation, employer’s liability, and commercial general liability (CGL) insurance coverage.
Project owners will usually require the contractor to name the project owner as an additional insured on the contractor’s own liability policies. This ensures that the contractor will defend the project owner for any third-party-over action claims. (a third-party-over action is defined as a type of action in which an injured employee, after collecting workers’ compensation benefits from the employer, sues a third party for contributing to the employee’s injury.?Then, because of some type of contractual relationship between the third party and the employer, the liability is passed back to the employer by prior agreement. Depending on the nature and allegations of the action, coverage may be afforded under the contractual liability section of the employer’s commercial liability policy or the employers’ liability section of the employers’ workers’ compensation policy. Reference from: The International Risk Management Institute (IRMI) – Insurance Glossary – IRMI, Inc., Dallas, TX)?
Under a traditional insurance program, one alternative to a project owner being named as an additional insured is for a project owner to require that the contractor purchase an owners’ and contractors’ protective (OCP) liability policy. This project-specific insurance coverage is a stand-alone policy purchased and maintained by the contractor for the benefit of the project owner to provide coverage for vicarious liability the project owner may incur as a result of the contractor’s construction work. An OCP will also cover any liability that may arise from a project owner’s own acts related to the project owner’s supervisory oversight of a contractor’s construction operations on the project. The cost for this optional OCP policy is usually reimbursed by a project owner when a project owner specifically requires this type of supplemental insurance coverage on a project.
In comparison to a traditional insurance program, under an OCIP, certain insurance coverages (e.g. workers’ compensation and commercial general liability) are provided by the project owner to the contractors. The indemnification provision still exists, but the standard contractor insurance requirements are removed.
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Part 5:?Advantages & Disadvantages for Project Owners
OCIP Advantages for Project Owners
OCIPs have advantages and disadvantages for project owners as well as for contractors performing work on a project. Let’s first review some of the advantages that have been identified for project owners, which include:
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OCIP Disadvantages for Project Owners
An OCIP can have some challenges for project owners. An OCIP may not be a panacea for all project management, risk management, and administration on a construction project. Here are several OCIP disadvantages that have been noted by project owners:
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The Time Factor
In many cases, the additional administrative burden associated with an OCIP can be outsourced to the incumbent insurance broker, a risk management consultant, or a third-party administrator. Although, even with these additional resources, there can still be an administrative impact on a project owner’s operations. Some departmental staff (e.g. legal, accounting, finance, contract administration, construction, facilities, safety, and risk management) may be affected in OCIP implementation and administration.
Apart from risk management and safety, who typically have a more personal stake in the day-to-day involvement with an OCIP, the anticipated time burden placed on the other departments is minimal. Typically, it may require only a few hours during initial design and during the project kick-off and OCIP implementation phase.
Post-implementation, a project owner’s involvement should only be intermittent. It will be limited to a project owner’s involvement in reviewing insurance premium payments, and attending claim review meetings. Also, reiterating to department staff that success on the OCIP will only be achieved with everyone’s commitment to the OCIP project.
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Other Project Owner Considerations
Project owners should be aware of the financial risk inherent with a loss-sensitive OCIP. They need to fully understand how this insurance program structure differs from using guaranteed-cost insurance with all losses paid by an insurer. Most project owners know this since many have transitioned their operational insurance programs to a deductible program or self-insured retention (SIR) program, which has now become the norm.
With a traditional insurance program, the project owner transfers all risk of loss to the contractor and the contractor’s subcontractors on a project. The project owner also pays a fixed premium to the insurer for guaranteed-cost insurance, or for whatever type of insurance & risk management program they have procured for their own operations.
When the project owner transitions from a fixed-price, guaranteed-cost program to a loss-sensitive OCIP, the project owner is trading off some financial certainty for the potential to lower the cost of risk. The cost of risk is limited by the application of a per occurrence and an aggregate limit retention. Project owners can control additional risk by implementing a stringent safety and loss-control program to reduce losses.
As much as project owners strive to transfer as much risk as they can, they cannot totally protect themselves from all risks. Purchasing a guaranteed-cost insurance program that comes with higher fixed costs, is cost-prohibitive. I’m not even sure if guaranteed-cost insurance for construction operations is still available in the market.
The best a project owner can do is to purchase a high deductible insurance program. Then, through contractual risk-transfer, transfer the responsibility for payment of a portion, or the whole deductible, to the contractor for any claims that may proliferate during the course of construction. The construction contract between a project owner and the contractor needs to be explicit regarding the contractual risk-transfer of the deductible responsibility and the established insurance policy deductible amounts.
In addition, a deductible charge-back procedure should be considered by a project owner. Especially, for the commercial general liability (CGL) insurance to cover any bodily injury (BI) or property damage (PD) claims submitted by third-parties against the project OCIP. This recommendation may be an additional level of effort, but it will be in the best interest of a project owner who requires an effective risk-transfer method for contractors to have some skin in the game to limit losses on a construction project.
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Part 6: Advantages & Disadvantages for Contractors
OCIP Advantages for Contractors
Just as there are advantages for project owners, an OCIP can be beneficial and have advantages for contractors participating in this risk financing program, including:
Well, like everything else in life, there is good news and there is bad news. OCIPs are not perfect. They can present a downside for contractors, just as they do for project owners. Here are several of the disadvantages that have been identified by some contractors:
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OCIP Disadvantages for Contractors
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The Time Factor
Contractors should expect the incorporation of the OCIP documentation to add more time to the preparation of each bid package. (This would include the OCIP manual and associated pre-bid and bid clarification meetings with subcontractors bidding work on the project.) However, under a traditional insurance program, the contractor would probably have expended about the same amount of time for tracking its subcontractors’ certificates of insurance. Under an OCIP, this burdensome task is not required.
In addition, the contractor’s and subcontractors’ insurance policies must be modified to dovetail with the OCIP coverages. Subcontractors must complete wrap-up enrollment forms and monthly payroll reports. They must report claims to an OCIP administrator and OCIP insurers in lieu of their own insurers. Additional time should be budgeted for participating in any OCIP orientation or status meetings, completing enrollment forms, and preparing periodic payroll reports.
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Other Contractor Considerations
As previously mentioned, contractors have additional administrative burdens associated with an OCIP, as do the subcontractors enrolled in the OCIP. First, the contractor must expand its bid package to define the OCIP for its subcontractors and should identify the subcontractors’ insurance deductions.
The project pre-bid and pre-mobilization meetings must be expanded to educate all contractors and subcontractors about the implementation and administration of the OCIP. The contractor must also work with the project owner’s insurance representative, risk management department, or designated OCIP administrator, to validate insurance deductions and enroll all subcontractors in the OCIP who will be working on the project.
Part 7: Potential Savings from an OCIP
In this section, we will review the potential savings that could be derived from an OCIP by a project owner. “If an OCIP is structured properly.” (Emphasis added.)
Potential Savings from an OCIP for a Project Owner
It’s extremely difficult to determine the total savings a project owner can realize from an OCIP because these potential savings can vary significantly based on several factors.
Savings are derived when contractors and subcontractors remove insurance costs from their bids because these bid reductions lower the total contract price. A project owner’s cost for providing workers’ compensation, CGL, and excess liability coverage on behalf of the contractors and subcontractors will likely be substantially less than the deduction received from the contractors and subcontractors. The potential savings is the difference between the contractor’s bid reductions from removing insurance cost from their bid, and the project owner’s cost of the contractor and subcontractor-provided insurance.
Contractor and subcontractor bid deductions can vary between 2-5% of construction costs. However, the amount contractors and subcontractors spend on OCIP-provided coverages will vary by geographic area, contractor size, and type of project. The range is variable depending on several other factors, including; the insurance and reinsurance market conditions, and the premium rates of the coverage(s), at time of procurement.
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Let’s Crunch some Numbers
A study conducted several years ago by an independent risk management association provided some statistical data on the average cost of insurance. This data was collected from approximately 30 contractors on their cost of risk (COR) based on annual revenue. I realize this is a relatively small sample size versus obtaining a larger population of contractor COR data, but for our example it will suffice for making a rough calculation.
The largest contractors that participated in this study indicated a COR of approximately $25 per $1,000 of revenue. Okay, let’s use this rate to formulate a theoretical calculation for a project’s cost of insurance. If you subtract the cost of the insurance coverages that an OCIP would not normally include, e.g. auto liability insurance coverage. Then, if you subtract a contractor’s average risk management administration costs. The difference of the OCIP-provided insurance cost would be less than $20 per $1,000, or 2% of revenue.
Assuming a total bid reduction of 2%, total project owner savings would be 2% of the construction costs, less what the project owner expends to purchase the OCIP-provided insurance coverages. An estimated savings in the range of 0.5-1% of construction costs.
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Cost Comparisons
Most construction estimators use one of several techniques when preparing their bids. When bidding fixed-price work, they may use either a unit rate (cost per square foot for an office building or cost per floor, room, etc., for a hotel). Or, they may use labor and material estimates provided by the project owner or project owner’s design professional.
When bidding cost-plus work, estimators may use prevailing wage rates for the project geographical area, then, gross-up this rate to include G&A expenses. Regardless of what method is used to estimate the work, the contractor’s bid will contain insurance costs.
The costs on fixed-price bids are usually embedded in the wage rate. This can be directly factored into the estimate or indirectly included in the unit rate. The contractor’s bid includes wage rates that are comprised of its employees’ base wages and overheads, and are usually expressed as a percentage of the base wage. Some of the overheads that are factored into the gross billing rate include profit, G&A, benefits, taxes, and insurance.
Contractors typically include state workers’ compensation rates (adjusted by their own experience modification rates), and use their company-specific general liability rates in their insurance overhead calculations. The insurance overhead assumes first-dollar coverage (i.e. no retrospective rating plan or deductible fixed-cost insurance plan). This insurance overhead is usually in a range of 8-14% of payroll, depending on the project’s geographic location and other factors.
Many large contractors will include a standard premium figure in their billing rates because their actual insurance cost is undetermined at the time they are bidding on a proposed project. They could use the previous year’s annual insurance cost to include in their bid, but contractors would be gambling on the unknown because their insurance premiums are based on their total projected project exposures. CGL is typically rated based on revenue. Workers’ compensation is typically rated based on the number of employees or payroll. Since contractor’s insurance premiums also fluctuate from year to year based on their annual construction values, using a range for bidding is reasonable.
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OCIP Costs
On an OCIP, the bid packages issued to contractors and subcontractors will contain an “Instructions to Bidders” section specifically stating that bids are to be submitted with and without insurance. However, the cost of insurance is to be included with their bids, as either an “alternate add”, “net-of-insurance” or “alternate deduct (straight deduct)”. Each of these insurance cost extraction methodologies has its positives and negatives.
Alternate Add
The alternate add method is when a contractor bids the construction contract work with a price that excludes insurance cost with an alternate add amount included in their bid. This method can be easier to manage from an OCIP administration perspective, but it has its drawbacks, e.g. the possibility of awarding a construction contract to a contractor with a poor safety record.
With the alternate add method, it is also difficult, if not impossible, to verify the accuracy of the contractor’s insurance cost. This could result in a project owner making double payments to the contractor. In addition, there is a higher probability of errors in the contractor’s submitted insurance cost estimates, since these costs are not only for the general contractor, but for all the GC’s contractors and subcontractors on an OCIP.
For these two reasons, it is recommended that a project owner incorporate a more tangible insurance cost extraction method into their OCIP such as the Alternate Deduct or Straight Deduct method, which we will discuss after the Net-of-Insurance method.
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Net-of Insurance
The net-of-insurance method is when a contractor bids the construction contract work with a price submitted without insurance costs in their bid. In principal, this method may be simplistic, but it has some deficiencies. The key deficiency is that the cost of insurance cannot be verified and may be suspect. A project owner will never be certain that all the insurance cost has been removed from the contract bid, or if this cost was just reallocated and buried in other line items in the contractor’s estimate. On fixed price lump sum bids, a project owner would probably never know the insurance cost.
The biggest deficiency from my own lessons learned on public transportation projects is that a project owner will never be able to make a comprehensive and accurate audit or a final accounting of what the cost of the insurance would have been using a traditional insurance program (without an OCIP) in order to make a direct comparison of the actual cost for the project owner-provided OCIP insurance. Putting contractors on the honor system is a novel idea for a project owner with good intentions. However, keep in mind that the road to hell is paved with good intentions!
Another lesson learned is for a project owner to not be misled by a project management team who’s thinking is flawed or is paranoid that if a more aggressive insurance cost extraction method is used in the bid process, such as an Alternate Deduct or Straight Deduct approach, there will be s higher potential for contractor bid protests. News flash! There will always be the potential for contractor bid protests on construction projects! That’s just life in the construction industry. Unfortunately, it has become more the norm than the exception on larger capital construction projects, especially on public projects where the political risk of bad media publicity makes some public entities acquiesce to contractors who use these bid protest tactics. Remember, numbers never lie!????
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Alternate Deduct (Straight Deduct)
The alternate deduct or the straight deduct method is when a contractor bids the construction contract work with the cost for insurance included in their bid. Basically, a contractor will bid the work for the OCIP project in the same way they bid the work on a non-OCIP project with traditional contractor-provided insurance. This method evens the playing field for contractors. Also, the contractors with the best safety records and lower EMR with workers’ compensation insurance will be evaluated accordingly, and this will be reflected in a project owner getting more competitive and lower bids.
Once the lowest responsible bidder, i.e. contractor, is selected by the project owner, the cost of insurance is deducted from the contractor’s construction contract price. This is done either before the issuance of a formal executed contract or through the issuance of a deductive change order to the contractor’s contract prior to the issuance of the notice to proceed to start the construction project. This method is probably the best of all the other insurance cost extraction methodologies.
It’s good for contractors with favorable safety records so that their safety performance is included in the bid evaluation process. It’s good for a project owner who is concerned about recovering their OCIP insurance costs. And, it’s good for the OCIP administration team to make the initial base bid insurance cost extraction, as well as the insurance cost extractions on subsequent change orders during the course of the construction project. It is also the best method for conducting a final audit and performing project close-out.
One caveat is the straight deduct method requires a higher level of administration effort. ?
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Insurance Market Leverage
By combining the cost for all the contractors’ and subcontractors’ owner-furnished insurance coverages into an OCIP, a project owner creates substantial leverage in the insurance market. That’s why project owners can purchase insurance at a much lower rate than individual contractors. A project owner can realize potential cost savings of as much as 10-15% due to the economies of scale of volume purchasing of OCIP insurance.
Project owners can significantly reduce project insurance costs using a higher retention on OCIP insurance policies. Assuming a higher deductible (e.g., $100K, $250K, $500K) per loss can considerably reduce the OCIP insurance costs. Additional cost savings can also be realized if the project loss experience is better than the actuarial loss experience factors contained in the insurance underwriter’s estimated projections for the OCIP. It should be noted that loss experience on a significant number of OCIPs has historically averaged less than 40% of standard insurance rates. Loss control improves these rates.
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A Hypothetical Example
Let’s look at a hypothetical example of how the OCIP insurance costs can be calculated. A project owner is considering building a $500 million luxury hotel, conference center, and entertainment complex. The construction project schedule total duration is 2 years from start to completion. The estimated payroll for this project is equal to 25% of the hard construction cost. The average contractor and subcontractor insurance rate is $10.75 per $100 of payroll (this is a composite rate, i.e. includes workers’ compensation and general liability). Using a traditional insurance approach, the insurance cost on this project would be approximately $13.5 million.
[($500M x .25)/100] x $10.75 = $13,437,500
Based on construction data collected over the past several years on various projects, we can expect to reduce this insurance cost by approximately 5% using an OCIP, spending $12.8 million over a 24-month period, instead of the $13.5 million in the above example.
$13,437,500 – (5% or $671,875) = $12,765,625
The cost of owner-provided insurance contains two components: 1.) fixed expenses, and 2.) retained losses. Fixed expenses typically include overhead expenses, claim reporting, commissions (if fixed), and premium taxes and assessments. Retained losses are the contractor’s and subcontractors’ losses that are paid on a first-dollar basis by the project owner under the project owner’s established deductible threshold. If the loss experience on this hypothetical luxury hotel project is average, the total OCIP insurance cost would be approximately $8.75 million, and the project owner’s savings would be $4.02 million.
$12,765,625 – $8,750,000 = $4,015,625
We realize that there are a number of variables in this hypothetical example. However, what our rough calculations exhibit is if a project owner can procure its OCIP insurance coverages in the market at a reasonable rate to keep fixed expenses low, can collect the estimated bid credits from all contractors and subcontractors enrolled in the OCIP, can mitigate insurance claims to keep project losses within established thresholds, and can manage the OCIP administration process efficiently and effectively, the probability is high for the OCIP to be equitable for a project owner. On this $500 million project, the project owner’s net savings of $4.02 million is a compelling factor to consider an OCIP.
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Part 8: OCIP Insurance Coverage Considerations
OCIP Insurance – Base Coverages & Optional Coverages?
In the previous section we reviewed some of the cost savings that could potentially be realized with the use of an OCIP. An OCIP, if structured properly, is an effective and efficient risk financing approach for construction project insurance. In this section, we will review some of the base insurance coverages that are the foundation of many OCIPs. We will also review some ancillary coverages that could be incorporated into an OCIP to address certain project-specific risks and exposures.
INSURANCE COVERAGES (This is a partial list of coverages used with an OCIP.)
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Workers’ Compensation & Employer’s Liability
Each state throughout the United States statutorily requires workers’ compensation and employer’s liability insurance. Each state’s Department of Insurance regulates minimum limits of liability coverage. Workers’ compensation insurance is a typical component of most OCIPs. (Except in some states that are monopolistic, e.g. Washington State. In Washington State, the workers’ compensation insurance is administered through the Washington State Department of Labor and Industries [L&I] for the state's workers' compensation system, and it is managed and regulated by a State Fund.) ?
Workers’ compensation insurance is included in most OCIP projects due to the large premiums that are required, the level of claims handling, and the degree of control needed over the safety, loss control, and risk management aspects of these projects. Most of an OCIP’s administrative burden is associated with workers’ compensation because, in most states, individual workers’ compensation policies must be issued to all participating contractors and subcontractors. On large projects, this can be substantial.
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Commercial General Liability
The Insurance Services Office (ISO) Commercial General Liability (CGL) Coverage Form, CG 0001 is the policy form that is predominantly used on most projects to provide primary general liability coverage. The CGL provides bodily injury and property damage liability in Coverage A, personal and advertising injury liability coverage in Coverage B, and coverage for medical payments is in Coverage C of the CGL policy form.
CGL insurance is a third-party coverage. This means, a CGL provides liability coverage for contractors and the project owner for any claims that arise out of the contractor’s operations on a construction project from the general public, i.e. third-parties. The majority of CGL claims are primarily for bodily injury (BI) and/or property damage (PD) to third-parties (e.g. BI: slip & falls within the construction zone, PD: subsidence or differential settlement resulting in foundation and/or interior drywall cracking.)?
Regardless of the CGL policy form used, general liability coverage for an OCIP should include (but not be limited to) several key provisions to safeguard a project owner’s interest. These include; contractual liability, broad-form property damage, OCP liability (usually written on a separate project-specific policy, as we discussed in an earlier post), explosion, collapse, and underground coverages (typically included in most recent editions of the CGL policy form), personal injury liability; and employees-as-insureds.
In addition, there are numerous endorsements that can be used with the CGL policy to broaden coverage, reduce coverage, or just for coverage clarification purposes. This list is too extensive to cover here A couple of endorsements you should have endorsed to the CGL are; an additional insured (AI) endorsement, waiver of subrogation endorsement.
Also, when contractors participate in an OCIP, it is recommended that the contractors remove any wrap-up exclusions or add a wrap-up exclusion endorsement on their own individual CGL policy. Contractors can protect themselves by having their insurance broker or agent add a difference-in-conditions (DIC) endorsement to the contractor’s own CGL policy. DIC coverage is required so that their own CGL policy will apply as excess insurance over the OCIP-provided CGL coverage furnished by a project owner on an OCIP project. (Note: the main reason for doing this is because the coverage limits of some of these master policies may be less than the contractor would normally provide for its own non-OCIP projects.) ?Adding a DIC insurance policy, or a DIC endorsement to a contractor’s own CGL policy, provides a contractor with coverage at least as broad as provided under its own CGL insurance policy.
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Other CGL policy considerations for contractors include:
Liability limits
Under an OCIP, aggregate and per occurrence limits apply to all contractors and subcontractors for the term of the project. Aggregate limits are usually two to three times the per-occurrence limit for any given year on the project. OCIP per-occurrence limits allow the full limit of the policy for each named insured. The coverage provided under the OCIP is extended separately to each entity, which can result in pyramiding limits. Limits can usually start at $25 million and may be $100 million or more, depending on a project’s specific exposures and a project owner’s requirements.
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Guaranteed-cost vs. loss-sensitive programs
Most OCIPs are written using large deductibles, large retentions, or retrospective rating plans. Under these programs, the total OCIP cost depends on the actual losses incurred. One disadvantage to this is the continuation of premium adjustments years after the project is actually completed. OCIPs can also be written at fixed rates for the project term, but these plans are more expensive due to the risk associated with the uncertainty of large losses. Availability of coverages and program types is dependent on the market.
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Completed-operations coverage
Completed-operations coverage should extend for at least three years after final project completion or acceptance. This does not mean the completion of the contractor’s or subcontractors’ specific portion of the project work, but the completion of the total construction project as stipulated in the contract. Three years for completed operations may be insufficient for many construction projects. This is a basic timeframe for many statute of limitations, but it is insufficient for many state’s statutes of repose. I am not an attorney, so I recommended that all contractors seek legal counsel on state statutes.
(Note: Many attorneys will opine that while a statute of limitations sets a lawsuit-filing time limit based on when the potential plaintiff suffered harm, a statute of repose sets a deadline based on the mere passage of time or the occurrence of a certain event that doesn't itself cause harm or give rise to a potential lawsuit.) Properly structured OCIPs should align the completed operations coverage period with the project’s state’s statutes. This provides a direct correlation between the total construction period for the project stipulated in the contract and the coverage period in the insurance policy(s).
Contractors may also negotiate “tail coverage” (which can be endorsed on a contractor’s own CGL policy) with their own insurer to extend permanent completed-operations coverage beyond the expiration of the OCIP-provided project insurance. Contractors are strongly advised to negotiate this tail coverage with their brokers and insurers before the project work starts so as not to lose their ability to obtain this tail coverage once they have mobilized on the project site to start their work.
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Excess/Umbrella Liability
An excess liability insurance policy may be purchased in the excess & surplus market or an umbrella policy form can be purchased. These policies provide a buffer layer over the underlying CGL insurance coverage policy. They should be written on follow-form basis.
Note: Many umbrella policies contain a contractor’s limitation endorsement which may include a blanket exclusion for wrap-up projects. For the reasons previously noted, these policies need to be modified to remove any/all wrap-up exclusions to have coverage.
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Builder’s Risk
A builder’s risk insurance policy covers project exposures associated with earthquakes and floods, damage to existing/adjoining property, boilers and machinery, project delays, the transit and storage of materials off-site, and explosion and collapse. This is a first-party coverage, meaning a builder’s risk policy covers the project work during the course of construction, which is the name that was used years ago to describe this policy, i.e. “course of construction” insurance. Contractors are required to retain some portion of each property loss. The deductible should be at least $2,500 to provide an incentive for contractors to mitigate losses. However, on a large OCIP projects, the contractor’s deductible responsibility should be significantly higher based on total construction cost.
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Professional Liability
Project owners may purchase a professional liability insurance policy to provide coverage for all the design professionals (e.g., architects, engineers, etc.) on an OCIP project. Ideally, the design professionals would subtract the cost of their own individual professional liability (or practice policy) insurance from their fees on an OCIP. This may not always be possible, however, because the insurer providing the practice policy may not provide a premium reduction to the project owner.
I do not advocate a project owner to include professional liability insurance coverage in an OCIP. After my lessons learned on a flawed OCIP on a transportation infrastructure project that I inherited, which included professional liability in the portfolio of coverage, it demonstrated to me that it is best that some lines of insurance should not be bundled.
If a project owner has decided to use design-build as the project delivery approach, then it may be advantageous to include professional liability. However, professional liability is specifically for the design professional and does not cover a project owner’s interest.
Regardless of a project owner obtaining a premium cost savings, project owners may want to obtain a professional liability policy on an OCIP project to provide coverage for design professionals who may not have this coverage or whose coverage does not satisfy the project owner’s project requirements. Also, a project owner may be able to purchase broader and more uniform coverage for the OCIP than each design professional could purchase individually in a stand-alone policy.
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Owners’ Protective Professional Indemnity (OPPI)
Another alternative to purchasing project professional liability insurance by project owners is for a project owner to require an owners' protective professional indemnity (OPPI) policy. This type of policy is focused on project owners (i.e. owner's protective) of construction projects who execute contracts with design professionals. An OPPI policy provides first-party indemnity to a project owner for damages the project owner incurs as a result of negligence of the part of the design professionals on the project.
An OPPI policy does not extend coverage to the design team. Therefore, the probability of defense cost eroding the limit of liability within a typical professional liability policy, which is always a concern with a project professional liability program, is mitigated or eliminated. An OPPI is purchased in the name of the project owner, and it sits excess of the design professional's own PL insurance coverage. An OPPI provides a project owner with supplemental coverage and additional capacity than what a professional design firm would typically bring to a project with the use of their own annual practice policy. No design professionals are named to the policy. A benefit of an OPPI is usually cost. OPPI premiums are basically 30 - 40 percent lower than a typical project PL placement.
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Environmental Liability
An OCIP can include pollution liability coverage. There are two main types of coverage. A project owner typically purchases a pollution legal liability (PLL) insurance policy, which provides coverage to a project owner when the project owner has an insurable interest in the property where the construction project is being built. A contractor typically purchases a contractors’ pollution liability (CPL) insurance policy, which provides coverage for the potential discharge of any environmental contaminants that have been brought onto the project site by the contractor. A CPL policy is typically included in many large OCIPs.?Pollution policies can be written on an occurrence or claims-made form. The CPL policy should include completed operations coverage, and it should be written for the total duration of the construction project.
Most CPL policies provide coverage for environmental hazards arising from three sources:
1.) known pollutants existing on the jobsite which are accidentally released during construction (e.g. pollutants collected by a remediation contractor); 2.) unknown pollutants existing on the jobsite that are uncovered by excavation operations (E.G. buried fuel oil storage tanks or barrels of toxic waste); and 3.) pollutants brought to the jobsite by a contractor or subcontractor (e.g. fuels, hydraulic fluids, paint, etc.). Project owners should seriously consider obtaining coverage for these types of exposures and should also require environmental consultants to obtain environmental liability coverage.
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Surety Bonds with OCIPs?
Surety bonds (i.e. typically payment and performance bonds) are procured by the contractor at the request of the project owner as a requirement of the contract. The surety guarantees the contractor’s performance to the project owner and does whatever is necessary to get the project completed, should the contractor default.
So, should surety bonds not be included as part of an OCIP? The contractor-surety relationship is based on mutual trust, confidentiality, and the contractor’s performance and financial solvency. The contractor is also solely responsible for its own income statement and balance sheet. The project owner should not attempt to gain any additional control over the contractor’s bonding arrangement, over and above requiring such bonding for the project owner’s construction project. Therefore, surety bonds are provided by the contractor(s), but they are not included as part of the OCIP coverages.
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Subcontractor Default Insurance (SDI) An alternative to Surety Bonds?
Subcontractor default insurance provides an alternative to surety bonds. This type of coverage directly indemnifies project owners for the costs resulting from contractor or subcontractor performance default.
Coverage applies to reimbursement of both direct and indirect costs incurred to complete unfulfilled contractor obligations, including costs related to job acceleration, extended overhead expenses, and liquidated damages. This approach allows a project owner to retain control of the project if there is a default without jeopardizing any of the contractor-surety relationship issues, as mentioned above. There may also be a potential cost savings compared to using the traditional surety-bond approach.
These types of policies usually include a deductible, a copayment percentage, and an aggregate limit. The insurer underwrites the coverage by evaluating the project owner’s method of prequalifying, managing, and controlling the performance of the contractors and subcontractors (i.e., by reviewing the project owner’s project management and contract administration procedures). Project size, geographical location, and the number of contracts, as well as other underwriting subjectivities, determine pricing.
You should now have a better understanding of an OCIP’s main features, benefits, and some of their drawbacks. In the upcoming sections, we will review the OCIP assessment and implementation processes. Also, how to determine if an OCIP is the right approach to be used and how to go about putting an OCIP in place for a construction project.
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Part 9: Project Owners and Contractors Like OCIPs
There are several reasons why both project owners and contractors like OCIPs. But, before we jump into this section, let’s briefly recap what we have learned about OCIPs so far in the previous sections. It should be becoming clear that insurance coverage is a key component of any major construction project. And, an OCIP allows a project owner to maximize insurance coverages across the construction project’s numerous contractors on the project, while at the same time providing potential savings for project owners on the insurance premiums.
We also reviewed that OCIPs are an increasingly popular risk financing approach used on various types of projects, but OCIPs have more practicality on large capital projects than they do on small run-of-the-mill projects. This OCIP evaluation criteria is included as part of a comprehensive OCIP feasibility study and assesses a construction project’s “critical mass.” In addition, we reviewed some pros and cons from the project owner’s and contractors’ perspectives. And, we just reviewed insurance coverage considerations, potential OCIP savings, and other risk management issues.
Now that you have a rudimentary understanding of what OCIPs are, why they are used, and some of their key attributes, we will review if an OCIP is the optimal risk financing approach for certain construction projects. We will also review the fundamentals of the OCIP implementation process and what is required to manage a successful OCIP.
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Why Project Owners Like OCIPs
Compared to conventional insurance programs, there are several compelling reasons why some project owners consider OCIPs very appealing as a risk financing approach. Some of the main reasons, which we discussed earlier, include:
Unfortunately, over the past few years, some insurance agents and brokers have manipulated information on contractors COIs to indicate that certain coverages, or liability limits, are in place, but in actuality, the delineated coverage on the COI is insufficient and not in compliance with a project owner’s contract stipulated insurance requirements. (Note: Never be convinced with what you read on a COI because in some cases, it may be erroneous and not worth the paper it is written on. As they say, “the devil is in the details!” It is highly recommended that in addition to obtaining a COI, you should request copies of the insurance policies [if coverage is suspect], or at a minimum, obtain copies of the insurance policy declarations page, as well as copies of all endorsements that were stipulated in the construction contract’s insurance requirements.)
In comparison, an OCIP guarantees that project owner’s requirements will be met. Also, OCIPs allow project owners to secure broader coverage by leveraging premium volume with the insurers.
Under an OCIP, a project owner has direct control over the selection of insurer(s) and can monitor an insurer’s performance and financial solvency. On some OCIP projects, only one insurer is selected for the primary workers’ compensation and CGL lines of coverage. However, that is rare and not typically the case anymore.
(As a safeguard measure it is prudent to always review an insurer’s A.M. Best rating to determine the past and current stability of an insurer. A.M. Best is one of the oldest and most established rating companies in the world. The A.M Best Financial Strength Ratings (FSR) represents A.M. Best’s assessment of an insurer's ability to meet its obligations to its policyholders. The A.M. Best rating process involves quantitative and qualitative reviews of an insurer’s balance sheet, operating performance, and business profile, including how an insurance company compares to other similar insurance companies, based on industry standards and assessments of an insurer's operating plans, business philosophy, and management practices. [A higher rating is preferred, e.g. A-, A, or better.])??
Some of these programs can be structured to integrate coverage for professional design, environmental remediation, force majeure perils, and builder’s risk.
An occurrence-based insurance policy protects you from any covered incident, i.e. loss, that “occurs” during the policy period, regardless of when a claim is filed. An occurrence-based policy will respond to claims that come in even after the policy has been canceled, if the incident occurred during the period in which insurance coverage was in force.
A claims-made policy provides coverage for claims only when both the alleged incident, and the resulting claim, occur during the period the policy is in force. Claims made policies provide coverage if the insured continues to pay premiums for the initial policy coverage and for any subsequent renewals with the insurer. Every succeeding year, the claims-made policy is renewed, the “coverage period” is sequentially extended. If premiums are terminated, the coverage is terminated. Claims made to the insurer after the coverage period ends will not be covered, even if the alleged incident occurred while the insurance policy was in force.
A claims-made policy will cover claims after the coverage period only if the insured has purchased “extended reporting” or “tail coverage” to cover this extended reporting period. This tail coverage will provide the insured with continuous coverage up to the pre-established time period that is procured.
Okay, now that you have a general understanding of the two types of coverage triggers, let’s revisit the issues of trying to blend two divergent coverage triggers. Let me try to explain this dynamic by an example: If you were to change insurers from a policy with a claims-made trigger to a policy with an occurrence trigger, it could leave a gap in coverage unless certain steps are taken to provide coverage for the “incurred but not reported” claims, if any. The insured must either; 1.) purchase an extended reporting period “tail” from their previous claims-made insurer or, 2.) try to negotiate with the new insurer, i.e. the occurrence-based coverage insurer, to provide coverage for the claims that have occurred prior to the new insurer’s policy period, but are made within this new insurer’s policy period. Good luck with that!
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Why Contractors Should Like OCIPs
When a project owner assumes the risk burden under an OCIP, two important benefits are realized: 1) improved loss control, and 2) improved claims management. Both of these benefits minimize the cost of retained losses. Therefore, some of the reasons why contractors should like OCIPs include:
Project owners can offer these program features to all contractors and subcontractors on an OCIP. The real advantage is to small contractors, since many small contractors would not normally benefit from these features through their individual insurance programs.
Another claims-related benefit is the streamlining of CGL claims management. Under a conventional approach to project insurance (i.e. contractor-provided insurance), the project owner, contractor, and/or subcontractor involved in a claim are all likely to be represented by different insurers and attorneys.
Using an OCIP helps to mitigate and lower the cost of claims because only one CGL insurer provides the insurance coverage for all parties. (With high limit OCIP programs, it is important that the primary CGL and excess GL coverage that excess GL policies be written on a follow-form basis in order to have seamless coverage through the excess GL tower of coverage.)
Improved safety and loss control programs, as well as enhanced claim management processes, are beneficial to both contractors and to the project owner on an OCIP.
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Part 10: The Necessary Framework for an OCIP
The OCIP Formation Process is a Sequential Process
The formation and structuring of an OCIP is like putting together the pieces of a puzzle. Let’s review some of the key components of the OCIP framework that are required in order to benefit from a successful OCIP.
Project owners who are serious about implementing a successful OCIP should adhere to the following methodology for assessment, formation, and administration processes:
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Prepare a Feasibility Study
This critical first step evaluates the advantages and disadvantages, statutory and regulatory impediments, cost savings, timing, and other key issues.
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Prepare a Request for Proposal (RFP)
Assuming an OCIP is determined to be feasible, proposals should then be obtained from insurance brokers or OCIP administrators. In many cases, the broker can be the OCIP administrator. Although, an owner’s representative or risk management consultant may also be considered.
Sometimes, on public projects, the public entity may stipulate that the entity who prepares the OCIP feasibility study be excluded from bidding on OCIP administration services and/or brokering and procurement of the OCIP insurance. This may be a good reason for a project owner to engage an independent wrap-up or risk management consultant for preparing the OCIP feasibility study.
Among other reasons for utilizing the services of an independent consultant is to maintain the impartiality of the entity preparing the OCIP feasibility study in order to reduce the possibility of any conflict between the entity’s self-interest and professional interest or public interest, especially, as respects the OCIP insurance procurement. It will produce a better outcome because independent wrap-up and/or risk management consultants are not directly involved in the market placement of the OCIP coverages.
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Issue the Request for Proposal (RFP)
The RFP should describe the scope of the construction project, anticipated coverages, and requested services. It should be used to obtain detailed information, the approach to OCIP administration processes, safety & loss control practices, claims management, document management & controls, issuance of COIs, and details on risk management information systems to be used for processing enrollments, etc., from the respondents. At a minimum, a RFP should obtain the following evaluation criteria from proposers:
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Conduct the Interview, Evaluation, and Selection Process
Firms that submit the best proposals should be interviewed. This gives a project owner an opportunity to compare and contrast different firms so the firm offering the best OCIP program structure, services, any innovative approaches, and best service fees for the specific project under consideration project can be selected.
(Note: Services and fees can vary widely between firms. Evaluate fees carefully. You can also request sample service contracts. Always negotiate changes to meet specific requirements. It is too late after contract award, i.e. “A day late, and a dollar short!”)
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Collaboration on Insurance Coverage Placement
The selected firm should work with the project owner and general contractor (if a GC has been selected) to prepare underwriting information and negotiate insurance terms. There are a variety of forms, documents, data, and information that are required for the preparation of a comprehensive insurance specification and underwriting submission. Working collaboratively to ensure the optimal insurance & risk management program has been structured, presented to the global insurance/reinsurance markets, and that quotes, terms, and minimal underwriter subjectivities are received by a project owner for the OCIP insurance coverage(s) to protect all OCIP participants is essential. ????
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Prepare All Required Documentation
This includes creating the OCIP administration manual, drafting the bid document clauses, and producing the enrollment forms and similar administrative materials.
Probably the most critical issue, as respects OCIP documentation, is that the terms & conditions, or requirements, stipulated in the construction contract documents are correlated as closely as possible with the provisions in the insurance coverage policies. Specific attention should be made for indemnity provisions in the CGL policy, and all associated endorsements, with the construction contract’s indemnification clauses.?????
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Part 11: How to Successfully Implement an OCIP
The OCIP Implementation Process
Critical Success Factors
Project owners who decide to use an OCIP should remember these words of wisdom: “OCIP administration is the critical component of a successful OCIP implementation.”
Once a project owner commits to use an OCIP approach on their project, there are several factors that will influence an OCIP’s ultimate success, which include:
Owner-Contractor Partnership
At the onset of a construction project, it is essential that the general contractor (GC) understand and accept their responsibility for his or her role in the OCIP program management. The GC typically has authority over, and responsibility for, the two most important elements of an OCIP’s financial success: 1.) facilitating with the negotiation of the insurance credits with subcontractors in collaboration with the project owner and/or project owner’s OCIP administrator, as part of the contract procurement process, and 2.) the OCIP’s construction project site safety program.
Program Design
To maximize project owner and GC support, OCIP procedures must be compatible with the project owner’s and GC’s existing practices. Therefore, the entity providing design and implementation consulting should consider mapping the project owner’s and GC’s procurement, accounting, safety, and risk management procedures in order to minimize any changes imposed by the OCIP implementation.
Information Management
If the program is to be a success, every contractor and subcontractor must understand and comply with all OCIP procedures. There are three steps a project owner should take to accomplish this:
?Documentation and Procedures
Understanding the requirements and expectations of an OCIP can be achieved by using these tools:
?Safety Program
To minimize OCIP losses, it is essential that the GC create and continually reinforce a proactive safety culture. A good safety program has many of the following characteristics:
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Program Monitoring
An OCIP monitoring program provides for the timely measurement and recording of trends and events so financial results, the effectiveness of administrative procedures, and individual contractor safety performance can be continuously monitored and evaluated throughout the course of construction, and for the life of the OCIP project. These reports should be produced monthly, be easy to read and interpret, and be written in terms consistent with the project owner’s and GC’s procedures and expectations.
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Implementation of the OCIP
Here are some key implementation and administrative tasks:
Note: It is highly recommended that you review the capabilities of the RMIS used by administrators to track contractor and subcontractor bid deductions and fixed OCIP costs. Conduct a thorough review since some systems do not track losses and variable costs. If an OCIP premium is loss-sensitive, the total OCIP costs may require a manual calculation. Carefully consider this when selecting your broker and OCIP administrator.
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Part 12: The Importance of OCIP Audits
Audits: The Devil is in the Details!
In this section, we will make the case for not only monitoring the OCIP administration process, but the critical need for audits during the course of construction. In addition to periodic audits, these should be a final audit done. A final audit will determine whether the OCIP was ultimately and empirically a success or a failure.
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The Importance of Audits
OCIPs are usually implemented on projects to improve safety, reduce losses, and achieve specific financial results. To accomplish these goals, the OCIP administrator needs to complete these specified implementation and administrative tasks. Periodic audits can help ensure that the quality of OCIP administration is maintained and that potential OCIP savings are being achieved.
Audits should be done annually, preferably at the same time each year prior to the anniversary date of the OCIP, and also at the completion of the project. The Audit should review documented practices and procedures related to the following:
To be effective, audits will frequently require formal interviews with representatives of the project owner, GC, contractors and subcontractors, OCIP insurance broker, OCIP administrator, and the OCIP insurer(s).
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Part 13: Wrapping up the OCIP
The purpose of this section is to pull it all together. As I noted at the beginning of these sections, OCIPs are an increasingly popular risk financing approach, and an insurance procurement option. They are typically used on large capital construction projects with many contractors and subcontractors, and for projects with total construction values in excess of $100 million. They can also be used effectively with various groups of smaller projects with multiple sites that aggregate to at least $50 million in TCV annually.?
Note: Over the past several years, many states have lowered the minimum threshold for the use of wrap-ups. Consult with your state insurance laws for specifics. An OCIP can provide project owners with some advantages over a traditional insurance program:
In addition, OCIPs offer many of these same benefits to contractors and subcontractors who choose to participate on the project.
However, an OCIP may not always be the best choice for a risk management program on all projects. That’s why project owners contemplating this type of program for a project should initiate a formal assessment process, which includes an OCIP feasibility study.
After the feasibility has been determined, a project owner should structure the OCIP carefully, with the help of a competent risk management professional. Like everything else in the construction industry, careful planning, a skilled project management team, and effective administration practices are key components of a successful OCIP.
At least now, you have some answers to the question, how to build a better warp-up? When it comes to managing processes, especially on construction projects, it is critical to have a sound foundation and effective project management and financial controls. Whether your wrap-up insurance program is an OCIP or a CCIP is irrelevant. All you need to remember is your A-B-C’s. A successful wrap-up requires the following:
The most important “C” in this list is “Control”, as in owner Controlled insurance program (OCIP), contractor Controlled insurance program (CCIP), or any type of Controlled insurance program (CIP).
Another thing to remember. The increasing complexity of today's construction projects requires thoughtful leadership and strategic insight from an experienced subject-matter expert (SME) who has practical experience with structuring and implementing OCIPs.
A project owner needs a risk management professional on their team who can not only talk the talk, but who can walk the walk. Someone knowledgeable of managing an OCIP through the feasibility phase, design of the OCIP insurance program structure, through implementation, administration, close-out, and audit. This will ensure a project owner that they will have a higher probability for achieving a successful OCIP on their project.
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Part 14: FAQs about OCIPs
OCIP – Frequently Asked Questions (FAQs)
In this section, we will review a collection of FAQs that have been collected over the years, as respects OCIPs and all the debate about OCIPs, good or bad, yes or no, etc.
This list of FAQs is not exhaustive by any means. I’m hopeful that the answers to some of these questions will provide some additional perspective about the use on an OCIP.
Project owners thinking about implementing an OCIP may receive questions from their internal management. The general contractor (GC), who a project owner may transfer a significant portion of responsibility for administration of the OCIP may have questions, as well as other contractors or subcontractors who will be considering participating in the OCIP. There may also be inquiries from regulatory agencies, union officials, or local trade associations. Here are some of the more common FAQs, and related answers:
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Q.?What’s the difference between an OCIP and a Wrap-Up?
A.??The terms “OCIP” and “wrap-up” are frequently used interchangeably. That’s because the underlying premise is basically the same. You have the same core insurance coverages (typically, workers’ compensation, general liability, excess GL or an umbrella policy), which are wrapped-up into a portfolio of coverages to establish a project-specific risk financing program structure.
There can be one major difference. The wrap-up originated as a type of consolidated insurance program that could be viewed as a contractor controlled insurance program (CCIP). However, please remember that on a CCIP, responsibility for providing project insurance for contractors and subcontractors resides with a GC. With an OCIP, the project owner is the sponsor who provides the insurance for all parties. The project owner also has total responsibility for the insurance procurement, which includes having direct responsibility for payment of premiums, along with management and administration of the entire program throughout the duration of the project.
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Q.?How does an OCIP benefit a Project Owner?
A.??The primary advantage of an OCIP is increased control (hence the name, owner controlled insurance program). A project owner benefits in many ways, including:
Other benefits to a project owner include a lower cost of risk (resulting from other cost reductions) and protection from catastrophic loss by obtaining higher limits of liability insurance coverage, and dedicated limits for a project-specific risk financing program.
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Q.?When does the decision to use an OCIP need to be made?
A.??If a project’s risk financing is going to include an OCIP approach, the final decision should be made before the project owner selects a general contractor (GC), or the prime contractors under a joint-venture (JV) arrangement. The RFP and contract documents should include OCIP-enabling language in the bid proposal, whether for a design-bid-build project, or with modified language in the RFP if it will be a design-build project.
Regardless of the project delivery method used, it is imperative that the project owner retain its options by including OCIP-enabling language in the bid documents and RFP.?This language should stipulate that the project owner has the option to implement an OCIP at its discretion, and it should require the contractor to isolate their insurance costs when bidding. (Please note: The level of effort and time involved for the collection of project information and for conducting a formal feasibility study on the viability of using an OCIP on a project can take several weeks, if not a couple of months.)
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Q.?How long before the start of construction does the OCIP program structure need to be completed?
A.??The timeframe will depend on who is developing the OCIP program structure and all the fundamental OCIP components. A project owner should allow sufficient time to; 1.) evaluate the OCIP feasibility, 2.) choose an insurance broker, 3.) select a consultant (e.g. risk management consultant and/or wrap-up consultant, if objectivity is required), 4.) provide insurance broker (in collaboration with risk management consultant) with ample time to develop a detailed insurance specification and underwriting submission, 5.) negotiate with the insurance markets, 6.) present the insurance market’s proposal results to the project owner, and 7.) develop the necessary OCIP procedures and OCIP manuals to support the program. (Please note: The level of effort and time involved is dependent on the insurance market conditions and the responsiveness of underwriters, as well as the broker. This process could take anywhere between three to six months. Although, this timeframe could be potentially accelerated in order to accommodate a project owner’s specific construction project schedule requirements.)
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Q.?Who pays the OCIP premiums and related expenses?
A.??On an OCIP, the project owner pays all OCIP insurance premium costs and related expenses for the insurance program structure design, insurance spec & underwriting submission preparation, marketing to insurance/reinsurance markets, and the OCIP administration costs. Remember, the cost for project insurance is going to paid by the project owner whether under a traditional contractor-provided insurance approach or under a project owner-furnished OCIP. One way or another, the cost of insurance will be included in the contractor’s overall bid as a project cost.
The main difference is that the premium for the OCIP insurance coverage(s) is a finite cost to a project owner, where a contractor’s traditional insurance costs can be more intangible. Especially, on lump-sum contracts because even though the coverage for the builder’s risk insurance cost are typically delineated in a contractor’s bid as a separate line item, the other insurance costs for coverages, such as the workers’ compensation, general liability, and excess liability, may be allocated in a contractor’s bid tabulation with their broker’s commission, and contractor’s overhead & profit added to this cost.
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Q.?How much additional time and level of effort will an OCIP require from a Project Owner’s management staff?
A.??On a typical OCIP, the estimated time expenditure will be more significant in the initial stages of the OCIP design and implementation. However, once the OCIP is up and running, the time and level of effort required for administration will be minimal. It will consist mostly for responding to coordination questions and reviewing periodic OCIP status reports with the insurance broker, OCIP administrator, and the insurers.
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Q.?Is a Project Owner’s cost for the OCIP premium plus related expenses less than the cost under a non-OCIP project?
A.??That depends! Maybe yes, if the OCIP insurance program structure is designed and managed properly. But, it also depends on the market condition at the time of the OCIP insurance coverage(s) are marketed and procured. Typically, eliminating the insurance costs from contractor bids, combined with the potential savings related to maintaining a safer worksite, plus any dividends received for reduced frequency of jobsite accidents, could compensate for the project owner’s direct cost for OCIP premiums and expenses. A good rule-of-thumb that has been used over the years, is that a project owner could expect to save approximately 10% to 25% of contractor-provided-insurance costs, or 1% to 3% of the total construction cost. (this is an approximation is for a typical OCIP with workers’ compensation, general liability, and excess liability insurance coverages. The margins for a GL-only OCIP would be significantly less. More like, .5% to 1.5% of TCV.)?
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Q.?Are OCIP insurance premiums less than a General Contractor’s insurance premiums plus mark-up?
A.??There are no finite answers; yes, that depends, sometimes. Many large national and regional contractors pay very small increases for their existing insurance premiums to add incremental coverage for including one more project onto their annual policy(s). Based on this reality, even if a GC’s premiums are marked-up for the GC’s overhead and profit, the insurance cost included in a large GC’s contract bid on a non-OCIP project could be less than a small contractor’s bid with insurance costs on the same project.
As we have discussed, the economies of scale from the volume purchasing of the OCIP insurance coverage(s) typically are more financially viable for a project owner. However, for large GCs, the cost of insurance could be comparable depending, how much leverage the GC has in the insurance marketplace. Another consideration is if losses are kept to a minimum, and the OCIP administration processes are efficient to control expenses, the cost of the OCIP can be less for a project owner than just insurance premiums alone.
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Q.?If a Project Owner commits to an OCIP, can they switch back to a traditional insurance program?
A.??What’s the saying, “an ounce of prevention is worth a pound of cure.” It’s a difficult process, but it can be done, at times. There are several reasons why a project owner may want to dissolve an OCIP. The main reason is usually driven by economic factors that result from changes in the insurance market conditions. For example: If an OCIP is implemented in a hard market, then the market softens, the OCIP will cost less than projected. Conversely, if an OCIP is implemented in a soft insurance market, then the market hardens, the OCIP cost will increase, coverage may also be reduced, and limits could be lowered. (Note: It is recommended that you request the broker to specify to insurers to include an annual pre-established “reinstatement of limits” provision, a “non-cancellation” provision, and a “break & review” provision, in the insurance coverage policies, if the insurers are agreeable to these terms.)
Given potential market swings and economic-cycle volatility, it can make it difficult for a project owner to provide the necessary OCIP insurance coverage, which is contractually stipulated as a requirement on all construction projects. In the event the OCIP insurance is compromised, or coverage becomes unavailable or unaffordable, the OCIP may need to be dissolved. Consequently, this entails the negotiation of contract cost adjustments, including change order increases, with all enrolled contractors and subcontractors. The magnitude of these increased construction costs could have a negative financial impact on the project’s overall potential profitability.
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Q.?Do all Contractors and Subcontractors who perform work on the project need to be enrolled in the OCIP?
A.??Contractors or subcontractors who perform the majority of their work away from the project site may be excluded from an OCIP. The primary reason for this exclusion is that their limited project site exposure results in limited risk and exposure to jobsite injuries, claims, and liability.
In addition, contractors and subcontractors may also be excluded due to consideration of practicality from an administrative standpoint, if their contract value is less than a certain amount, or their scope of work is minimal or of short duration. Depending on the total construction cost of a project, a rule of thumb that has been used is to exclude contractors and subcontractors with contract values less than $25,000 to 50,000. Although, these figures are examples. Being selective of who is in and who is out of an OCIP is basically at the discretion of the project owner, and the OCIP administrator.
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Q.?What Contractors are ineligible for an OCIP?
A.??Most contractors in all trades performing work on the project jobsite are eligible to be included in an OCIP, except those involved in certain activities, such as the following:
Even contractors who would typically be eligible (if work was done on the project site) are not covered for their offsite activities, such as shop work, office support, etc.
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Q.?Can architects and engineers be covered under an OCIP?
A.??Typically, architects and engineers are excluded due to their limited time on the project jobsite. In addition, the minimal bid reduction (in lieu of the high claim potential), for architects and engineers, is another factor. However, architects and engineers can be included in the basic OCIP coverages (e.g. workers’ compensation, general liability, and excess liability) if required. Although, the OCIP does not provide coverage for claims resulting from an architects’ and engineers’ errors or omissions. If A&E E&O coverage is required, a separate project professional liability program could be designed to be incorporated into the OCIP to cover architects and engineers E&O exposures, but this is at the discretion of the project owner and project requirements.
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Q.?What insurance coverages are not included in an OCIP?
A.??The basic insurance coverages typically included in an OCIP do not include and provide for environmental/pollution liability or professional liability coverage for any A&E E&O exposures. However, it is not uncommon to include these types of coverage with a separate CPL and/or project-specific PL insurance policies on an OCIP project.
The insurance coverages that should never be included in an OCIP are automobile liability and auto physical damage coverage. In addition, an OCIP should not provide any coverage for certain off-site activities. But remember, contractors are still required to provide their own workers’ compensation and general liability protection for their automobile liability and auto physical damage exposures. The project owner should also be named as an additional insured on the contractor’s auto policy(s).
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Q.?Are Surety Bonds included in an OCIP?
A.??Not recommended. There are several reasons why surety bonds are not typically included with the OCIP coverages, including additional cost to the project owner and the administrative requirements for the project owner and the surety. ?Sureties, (i.e. surety bond issuers) do not pay losses. Sureties guarantee contract completion and then seek recovery from any defaulting contractor(s). This is very different than the coverage that insurance carriers provide that are associated with the actual project work. As an alternative to surety bonds, subcontractor’s default insurance (SDI) can be designed within the insurance program structure to work in conjunction with an OCIP. ?
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Q.?Do OCIPs provide an unfair advantage to Contractors with poor safety records and loss experience when bidding against Contractors with good safety records?
A.?Logically, it would seem that contractors who have poor loss experience would expend a greater percentage of their revenue on the cost of insurance than contractors who have good safety performance and low loss experience. Therefore, contractors with poor loss experience should have higher insurance costs, higher total costs, and this would result in higher contract bids than contractors with favorable loss experience.
By removing the insurance costs from construction bids, contractors with favorable loss experience may lose a cost advantage. However, the difference in the contractors’ bids created by differences in loss experience is marginal when measured as a percentage of the total construction bid. The logic behind this thinking is by making the insurance cost a neutral factor, the bid competition is focused on more substantive issues such as the project management operations performance, quality of workmanship, as well as safety.
Furthermore, a contractor develops the lowest bid because of lower labor, material, or other costs. Not because of having lower insurance costs. This should be an advantage to a project owner. To eliminate any advantage to contractors or subcontractors who have poor safety records or poor loss experience, some project owners will not accept bids when workers’ compensation experience modification rates (EMRs) that exceed a set level (e.g. an EMR of 125%). Eliminating this unfair advantage can also be achieved by using an alternate deduct or straight deduct (bid deduct) methodology for the insurance cost extraction approach on the OCIP project.?
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Q.?How can OCIPs improve Safety on a construction project when the Contractors and Subcontractors don’t directly pay for this insurance?
A.??Safety is a key attribute for a successful OCIP. There are several methods used to control jobsite losses. Contractors are contractually required to comply with the site safety program. An onsite construction safety representative also provides additional resources to supplement the general contractor’s (GC) or construction manager’s (CM) basic safety program to ensure project safety compliance. On many large construction projects that utilize OCIPs, contractors complete OSHA 10-hour training and attend jobsite safety seminars prior to starting their contract work. This ensures that enrolled contractors receive the proper safety training and education necessary to prevent jobsite injuries and lost time accidents. Safety and loss prevention is important on all OCIPs.?
In addition, for workers’ compensation insurance coverage, contractors’ individual loss experience is reported to the compensation bureau (in the same manner a contractor’s non-OCIP losses are reported). These loss reports are used to calculate a contractor’s experience modifier rating (EMR). It should be stipulated on all bid documents that the loss experience incurred by each contractor or subcontractor of any tier on the OCIP will be retained and reported to the National Council on Compensation Insurance (NCCI), which is the normal process used to calculate contractor EMRs. Poor loss experience will result in a higher EMR, which directly impacts contractor’s workers’ compensation costs. In addition, high EMRs may result in a contractor being precluded from bidding construction contract work for project owners or general contractors on future projects.
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Q.?Are contractors’ loss-sensitive insurance programs impaired by an OCIP? (i.e. Will an OCIP negatively affect a Contractor’s leverage with their own insurance carriers?)
A.??Loss-sensitive insurance programs, such as dividend plans and retrospective rating plans, have two components: 1) a fixed charge and, 2) a variable charge, which is based on the frequency and severity of losses.
When a contractor’s or subcontractor’s projected payroll (i.e., the predominant rating basis used by workers’ compensation underwriters for determining premium) is moved from its own insurance program to an OCIP, the fixed charge may increase marginally as a percentage of premium because of this reduction in payroll. If a substantial portion of the premium is moved to an OCIP, the effect on a contractor’s or subcontractor’s own insurance premium may ultimately result in a slight increase in premium, depending on the size of the contractor’s or subcontractor’s account and whether the insurers minimum premium threshold has been met for certain lines of coverage.
As we noted at the beginning of this section on FAQs about OCIPs, this list of questions and answers are not exhaustive, but will provide you will some examples of the FAQs that have been addressed. More importantly, I hope they provide you with a better perspective about OCIPs and for building a better wrap-up.
This is the final section in the series: OCIP 2.0 – Building a Better Wrap-Up.
It’s a Wrap!?
Hope you enjoyed this post.
Until next time…
Best,
David
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David Grenier, MBA | Principal / Director at C-RISK, LLC
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