Wrap-Ups and Their Inevitable Termination
April 2011
Having touched on many wrap-up topics over
the years, it is now time to tackle an issue that has numerous moving pieces
and presents many a challenge even to the best wrap-up professional. The
wrap-up termination—with all its twists and turns—is not the time to take
your eye off the ball.
by Richard
Resnick
Aon Construction Services Group
Think about it; you have stayed with the project for maybe 3 to 5 years,
and now the end is in sight. Now what? This article examines some critical
steps in the termination process and what you need to watch for.
First things first, let us get our definitions in line. Many folks use
"termination" and "closeout" interchangeably. While a few may accuse me of
dealing with semantics, I do believe there is a line to be drawn between the
two. A closeout refers to the point in time in a "wrap-up" insurance program
when all claims have been settled (or a buyout has been negotiated by the
insured), and final audits have been paid and accounted for. Some
noninsurance people refer to this as a "closeout" of the construction
accounting books.
On the other hand, a wrap-up termination, which is the focus of this
article, deals with the end of the wrap-up policies, after which time all
on-site contractors will be responsible to use their own insurance coverage
for as long as they are on the site (except for extended completed
operations—more on that later). Policies will no longer be in effect for the
wrap-up designated location, so all parties involved in the program will
need to look elsewhere for coverage. Just to reiterate, while the policies
may be canceled, the financial aspect of the
program continues, including claim payments from previous losses, losses
incurred but not reported, premium payments arising from the final audit,
and, of course, collateral obligations.
So, please note, when you are speaking with the wrap-up sponsor's project
team, be careful when you use these terms to make sure everyone understands
what is actually meant.
When To Terminate the Wrap-Up
If you queried 10 people and asked, "When is the best time to terminate
the wrap-up," you would likely get 10 different answers. Perhaps this is due
to the fact that the only place in the policy where we address anything
close to defining a termination point is the trigger for the extended
completed operations coverage. That trigger generally commences at the time
the project is put to its intended use (much more on this later).
There is no mandate that advises when to terminate the wrap-up. Rather
than being driven by policy terms, it has been customary to conclude upon
substantial completion/intended use (perhaps with a temporary certificate of
occupancy or perhaps a permanent certificate of occupancy) or simply wait
until the punch list work is completed. At times, we encourage wrap-up
sponsors to hold off owner-controlled insurance program (OCIP) terminations
as long as possible to avoid the contractor policy wrap exclusions that may
apply on warranty and punch list work. Having noted these concerns, it's
also important to recognize that the longer the wrap-up is kept open, the
greater the potential for new claims. In short, when to terminate a wrap-up
is more a matter of preference than a dictate of policy terms and
conditions.
No matter what method is utilized to determine wrap-up termination, it is
strongly recommended that you confer closely with the client and their
project team as to where they are in the construction time line. It is very
helpful, for example, to review the requisition reports with the project
team to get the best understanding of percentage completion and what the
next 30–60 day "look ahead" reveals.
Contractual Issues
It is customary for a wrap-up insurance addendum to replace the standard
insurance requirements of the construction contract. As it relates to our
subject at hand, there is a contract clause that addresses the issue of an
"owner's election to modify or discontinue the wrap-up." The sponsor cannot
arbitrarily decide on a Friday to terminate the wrap-up on Monday when it is
contrary to the contract document. Here is typical wording that dictates the
terms of the wrap-up termination.
Owner may, for any reason, modify the OCIP Coverages,
discontinue the OCIP, or request that Contractor or any of its
subcontractors withdraw from the OCIP upon thirty (30) days' written notice.
Upon such notice, Contractor and/or one or more of its subcontractors, as
specified by Owner in such notice, shall obtain all (or a portion thereof as
specified by Owner) of the insurance coverage previously provided by the
OCIP. The reasonable cost of obtaining such insurance shall be reimbursable
to Contractor by Owner. The form, content, limits of liability, cost, and
the insurer issuing such replacement insurance shall be subject to Owner's
approval.
No need to get into a breach of contract dispute at this juncture of the
project. Let the contract terms dictate. This is another reason that the
30–60 day look ahead is critical when determining a point in time to
discontinue the wrap-up, especially in light of the notification
requirement.
Trigger for Extended Completed Operations
Entire articles have been devoted to this subject alone, but in our
discussion here, it will suffice to point out the highlights as respects the
thought process for program termination. As mentioned, once the wrap-up
terminates, all insurance policies are canceled as of that date. This
presents a significant problem as respects completed operations claims that
arise after the program termination and, more specifically, after the
project is put to its intended use. If there were a completed
operations loss at that point, there would be no wrap-up policy in place to cover
that claim. It should be noted that, in many states,
statutes of repose govern the time period after work concludes when
suits may be commenced.
Accordingly, wrap-up insurers will provide an "extended completed
operations" endorsement. It is important to note that the terms of this
endorsement are included in the general liability wrap-up policy. There is
no separate or subsequent wrap-up policy issued postconstruction to cover a
completed operations claim. Therefore, it is important to understand the
implications of this endorsement and how it impacts the wrap-up after
termination.
Most insurers use manuscript endorsements for the extended
completed operations coverage. The first point to understand is that there
is no additional coverage for any new construction that may take place on
the project site after the policy terminates. However, under the Insurance
Services Office, Inc. (ISO), commercial general liability form, Section
V—Definitions: 16. "Products-completed operations hazard" ...
"work that may
need service, maintenance, correction, repair or replacement, but which is
otherwise complete, will be treated as completed."
We
will come back to this point when we address "contractor warranty work."
The extension endorsement must be read very carefully because no two
endorsements look exactly alike. However, there are some similarities. It is
customary that the aggregate limit as stated in the endorsement remains the
same for the term of the extension period. If you have a 10-year extension
period, the aggregate does not reinstate annually. It is a single aggregate
for the entire term. Also, the wording in the endorsement needs to track the
type of wrap-up, that is, single project versus multi project.
Questions
can present and are best anticipated in clear policy language. In other
words, do all the projects (in a multi project wrap-up) need to first be
competed for the trigger to take effect? Or, does each project in the
program stand on its own as respects the trigger? The endorsement should be
very clear and specific. If not properly endorsed, the aggregate may be
fully exhausted before most of the projects have been competed. While it is
true that potentially the excess could drop down, the excess policies must
also follow form with the primary program. Needless to say, there is some
homework that needs to be done up front in negotiations prior to binding.
In addition, the trigger itself needs to be clear as to its intent to step
in and pay an extended competed operations claim. While, again, not all
endorsements are alike, typical trigger wording states
"when that portion of
the project is put to its intended use or a temporary or permanent
certificate of occupancy is issued."
Parties have
litigated the interpretation of this language, but it is important to note
that the trigger needs to correspond to the type of project that is being
covered. How would it work for a single high-rise office project? For
example, if the first two floors (of a 50-story building) were occupied and
put to their intended use as offices, would the endorsement trigger an
extended completed operations claim? Keep in mind that if construction was
continuing on the upper floors, and the policy was still in effect, there is
a question as to whether the extension provides coverage to all the floors.
Would two completed operations aggregates exist—one for the extension and
one for the ongoing construction? Clearly, the wording needs to be reviewed
carefully to match the project's scope.
It is also important to note that
some insurers place the following clause in their extension endorsements:
"Failure to protect or maintain completed portions of the project by the
owner or the contractor will invalidate coverage." How
long does the contractor need to protect or maintain the completed work?
Once the contractor's work is complete, and once the warranty period is
over, is it realistic to believe that the contractor will always be able to
maintain the completed portions? Or does this language mean that, while
still on the project site, the contractor needs to "protect or maintain,"
and then the burden falls on the owner? The point to emphasize here is that
it is important to ask—and answer—these questions. Do not be shy!
Contractor Warranty Work
You cannot have a wrap-up termination
discussion without talking about the particular "hot topic" of coverage for
warranty work. This has been getting much attention in the contracting
community as many wrap-up projects begin phasing out. This is part and
parcel of a much wider issue, the contractor's wrap-up exclusion, which is
beyond the scope of this discussion but may find its way into a future
article. In short (and without getting into the technical differences
between such endorsements), most contactors have such provisions on their
policies. The problem arises when a wrap-up terminates and the contractor
needs to return to the site to do repair/warranty work.
We know that the
"premises-operations" exposure (i.e., a tool injuring a passing
pedestrian) for the returning contactor will not be covered because the
wrap-up policy has terminated. As for the contractor's own insurance, many
wrap-up exclusionary endorsements are very broad in nature and may not
intend to cover the contractor when they go back to the site in the given
example. That leaves the contractor in a very precarious situation.
There
is good news on both the contracting and the wrap-up side. As for the
wrap-ups, insurers are beginning to address the issue by amending their
policies to pick up the extended premises-operations exposure. But, as with
any insurance endorsement, it should be read carefully because there are
differences. Some of the endorsements address the issue of a contractor
returning to do warranty work while the wrap-up is still in effect. There is
a school of thought whereby, in the case of a contractor returning to the
site while the wrap-up policies are still in effect, there should be
coverage available under the wrap-up policy even without an endorsement.
Some insurers may simply require "reenrollment" to trigger the coverage.
Eventually, wrap-up insurers may issue an endorsement similar to the
completed operations extension. It can be called a "premises operations"
extension. This would apply once the policy terminates just as completed
operations does. It would also designate a specific number of years; 2 years
should be sufficient to pick up the warranty work.
Lastly, there is the
issue of completed operations work done during the warranty period. As
discussed above, the ISO form considers repair and warranty work on previous
wrap-up construction at the site as part of the completed operations
definition. Contractors need not worry about that coverage because they are
still protected by the wrap-up for the completed operations extension term.
The only concern therefore remains the premises-operations exposure.
Conclusion
In conclusion, there is much to think about in the
"termination" process. Hopefully, this discussion has provided some insight
into some of the issues to consider when dealing with termination of a
wrap-up.
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