As a contractor, imagine getting a bill from an insurance company for an additional premium 30–120 days after project closeout—on a project with no losses! Who will make that additional payment, you or the owner?
The answer is based not only on whose name appears on the policies but also terms of the construction agreement. Were insurance premiums a pass-through, or were they embedded in the project price? Were they represented as a fixed cost/dollar amount, or were they meant to float as a percentage of other costs? Bottom line, will all project costs be allocated to the job and the project owner, or will you—as the contractor—eat the additional insurance premium?
Rising Costs Mean Additional Premiums
A lot has been said about the impact of material price increases on the project cost. The difficult economic conditions of the last couple of years have prompted project owners and contractors alike to look for ways to complete projects and still maintain their profit along the way. Most contractors have moved away from bidding jobs on a lump-sum basis for all but the shortest jobs. One alternative has been to implement a mechanism that allows for contract price increases as material prices increase. However, many contractors fail to take into consideration the impact of soaring material costs on the cost of their insurance policies.
The price paid for most insurance policies is based on estimated costs. As an example, the cost basis for workers compensation is payroll, broken down by worker classification. Most contractors do factor in increases in the cost of labor and the impact of change orders on the expected premiums for their workers compensation, general liability, and even their excess or umbrella policies (although they may overlook the possibility of increases in insurance rates). Where a surprise is most likely to happen is with the builders risk policy premium.
Builders risk policy premiums are based on the completed cost of the project. These policies are sold with the condition that a change in project cost must be reported to the insurance company. The insurance company has the right to adjust the final premium based on the revised total, which is determined by an audit of the project upon completion. If the project comes in at 20 percent over budget, the builders risk policy will generally cost an extra 20 percent over the initial premium. The timing of this final billing may be anywhere from 30 to 120 days after project completion. A diligent follow-up helps to minimize the length of this time period.
Construction Delays Mean Additional Premiums
Another important point to keep in mind about builders risk policies is that they are issued with an expected period of construction in mind. With change orders, supply chain issues, weather delays, and other factors, the project may not be completed by the time the policy expires. Under most builders risk policies, the insurance company is not obligated to extend the policy term. Trying to insure a partially completed project is difficult and expensive. Even if the insurer agrees to an extension, the original rate is not guaranteed. Imagine asking for a policy extension during hurricane season or after the insurance company just paid out a sizable loss!
Fortunately, these problems can be minimized or even avoided. Policies can be written to absorb reasonable cost escalation. Extensions of the policy period can be built into the policy. In some cases, the automatic extension may include up-front guaranteed rates that will apply to the policy period extension if one is needed. A detail-oriented agency that is focused on the construction industry can review the job and your construction agreement and negotiate policy terms and conditions to take these issues into account.
Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do 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.