Wrap-Ups and the Balance Sheet Effect
October 2004
Wrap-ups can be looked at as one big balance
sheet. Those that have read previous articles in this column have a sense of
what wrap-ups are and their benefits to owners, developers, construction managers,
etc. It is time to dig somewhat deeper into the world of wrap-ups and see what
components make up the savings potential of these programs, and what control
we have on some of these variables.
by Richard
Resnick
Tanenbaum Harber
Co., Inc.
The ultimate cash savings (and remember, that is not the only reason to do
a wrap-up) associated with wrap-up insurance programs are simple to illustrate.
If I were to put it in a formula, it would look as such:
Subcontractor Deducts (or Alternate Adds) – Cost
of Wrap-up Insurance Program = SAVINGS or (LOSS)
Hopefully, at the end of the day, you will realize a savings. Keep in mind
this is not a guarantee. To get the program off to a good start, it takes being
involved at an early stage, in particular during the bidding process. It is
at this time that you will be able to examine the potential "deducts" or assets
as we call them. This is an important task that needs to be understood as respects
the particulars that go into the analysis. Therefore, we will focus on the asset
side of the balance sheet for this article.
If we are not diligent in obtaining the proper insurance credits from the
subcontractors, we will have "under-funded" our program. Let’s start there and
take some of the mystery out of this process.
Insurance Credits
A subcontractor will normally include their maximum cost of insurance in
their bid when estimating the cost of a project. When a contractor enters a
wrap-up program, the owner provides and pays for the insurance through the wrap-up.
Therefore, there is no need to include the cost of insurance in the contractors
bid. Henceforth, a "credit" (sometimes referred to as a deduct or alternate
add) is given back to the owner.
This exercise can be accomplished in two ways. Knowing that a wrap-up will
most likely be implemented, the owner requires the contractor to bid the job
"ex insurance" and then will ask for an alternate bid price from the contractor
for the inclusion of their insurance costs. This accomplishes two things. First,
in the event the wrap-up is not implemented, the owner knows what to add to
the contractor’s bid for the cost of the contractor's insurance. Second, we
have an insurance cost (an asset) we can verify and use in our balance sheets.
Other times, the owner may require a dual bid—with and without insurance
to determine the "credits." This is more commonly known as a deduct. In other
words, the contractor must deduct the cost of the insurance from the bid and
provide dollars back to the owner as a credit. Following are some pros and cons
of both methods.
| Advantages |
Disadvantages |
- Less threatening to the contractor
- Levels the playing field as respects impact of experience modifiers
- Better able to authenticate "credit"
- Simplifies bidding process
|
- In the event wrap-up is not selected, contractors may be noncompetitive
based on "gross" bid
- Takes away negotiating tactic from the "buy"
|
| Advantages |
Disadvantages |
- Can be used as a negotiating ploy during the bidding process
- Deducts are real dollars back to the sponsor in the form of
a credit
|
- Once the insurance number is in, it is difficult to get out
- A threat to contractor
- Deducts take additional time to negotiate ("Dialing for Dollars")
- A high deduct could be due to a high experience modification
- Low bidder could be the most unsafe bidder
|
Alternate adds can provide the fairest and best way to substantiate the reduction
of contractors’ insurance costs during the bidding process. However, with respects
to the deduct method, one must confirm that the contract language facilitates
a similar insurance form outlining the insurance cost that makes up the actual
deduct. This must occur during the bidding process to obtain the truest insurance
credit.
The Contractor Insurance Cost Worksheet
No matter what methodology is selected, it is critical to properly verify
the bid deducts or alternate adds provided by the contractor. To accomplish
this task, we utilize a detailed worksheet titled the "Contractor Insurance
Cost Worksheet." A brief overview of the information required will help to explain
the detailed nature of this process.
There are usually three elements of cost that make up a contractor's cost
of insurance included in a bid. There may be exceptions at times based on the
particular insurance requirements of a project such as environmental insurance,
marine coverage, and professional liability. The three most common forms of
coverage for which an owner needs to obtain credits when implementing a wrap-up
are workers compensation, general liability, and umbrella insurance.
Workers Compensation
Following are some of the items required to best verify the true cost of
insurance from the worksheet.
-
WC Class Code—This is necessary in order
to verify that the trade contractor is using the proper coding for the particular
project. A contractor using a code that may not reflect the actual job scope
could be (although not intentionally) understating their insurance credit.
-
Estimated Payroll—This is the most critical
information asked for. Just as a miscoding can understate the contractor's
cost of insurance; an understatement of payroll has the same effect. Because
a contractor's insurance cost is usually based on labor, one can see how
important it becomes. Even more so, in certain jurisdictions there are questions
as to the ability of the owner to obtain additional credits from the subcontractor
at the end of the project when the payrolls are audited.
-
Experience Modification—A contractor deserves
to lower its estimated insurance cost by the utilization of an experience
credit obtained from the Compensation Rating Board. In turn however, the
contractor's insurance credit back to the owner will be higher with a debit
experience modification. The experience modifications can be verified by
the Rating Board with a simple letter of authorization that allows the user
a right to the data.
-
State Assessments—Many states have insurance
assessments that are applied to premiums. It is only right that the owner
have an opportunity to recapture these amounts in the insurance credits.
To the owner, this really becomes a trade off because the owner will also
be assessed by the insurance company underwriting the wrap-up.
General Liability
As respects general liability insurance, the key elements are the rates and
payroll information. Without actually seeing the contractor’s insurance policy,
it is somewhat difficult to verify the general liability information. Workers
compensation is simpler to verify with the given data because it is statutory
as prescribed by the state. For example, all steel workers in a given state
start out with the same rate. General liability rating is more subjective and
judgment rated by the underwriter. The same goes for the umbrella. This again
is a judgment rate and is usually based off the general liability premium. It
is not uncommon for the owner to request a copy of the rating page from the
contractors’ general liability policy in order to verify the worksheet.
This process goes on throughout the term of the construction period. Contractors
come and go throughout the project. There is much more to this process then
most people realize. It takes time to review, verify, and sign off on these
insurance costs. However, by being so diligent, the owner will benefit by having
a more profitable program.
The insurance credits we have discussed accumulate and are eventually finalized
and compared to the cost of the wrap-up program. These liabilities will be the
subject of my next article.
Opinions expressed in Expert Commentary articles are those of the author and are
not necessarily held by the author’s employer or IRMI. This article does not purport
to provide legal, accounting, or other professional advice or opinion. If such advice
is needed, consult with your attorney, accountant, or other qualified adviser.