Contemplating a Controlled Insurance Program

6. What Are the Current Insurance Market Conditions?

A potential sponsor should consider current insurance market conditions, coverage availability, pricing, collateral requirements if applicable, and the required timeline for securing a program. Combined line programs—including workers compensation, general liability, and excess liability—are typically procured from standard markets. General liability only ("GL only") programs, especially for for-sale residential projects, are usually written by surplus lines markets. Some standard markets write GL only programs; however, their deductibles are typically much higher than in the excess and surplus markets, for example, $250,000 or $500,000 versus $10,000 or $25,000.

The sponsor's broker should have a complete understanding of the current CIP marketplace. An experienced broker's knowledge about each insurer's terms, conditions, and requirements for writing coverage is important as these factors may aid in a more accurate determination of feasibility. Some CIP insurers have mandatory safety requirements, such as requirements for a full-time site safety representative, drug screening, or 6-foot tie-off, which can add cost to a program. These additional costs, if not identified, can make a borderline program (a program with no or minimal savings projected) no longer feasible for a sponsor with the primary goal of savings.

It generally takes longer to market a combined line program than a GL only program. A rolling combined line program will usually take more time to arrange than a project for a single site. Currently, depending on the project, there may be as many as eight potential standard market insurers. A combined line program can take 8 to 12 weeks to market and place, which includes putting together a comprehensive submission, arranging for insurer site visits, obtaining quotations, reviewing and negotiating primary coverage terms, and agreeing on final pricing. It also takes additional time to approach excess markets once the primary program terms and pricing are finalized.

A GL only program, though simpler, can take 2 to 6 weeks to put together, especially for a program with high limits. An experienced broker can always arrange a program on a fast-track basis if needed; however, that approach is not ideal, as a CIP is a long-term engagement that should be carefully constructed because it affects multiple insureds.

7. What Other Risk Financing Options Are Available?

Even with a capable broker and administrator, a combined line CIP can be administratively burdensome for an inexperienced sponsor over an extended period of time. There are usually other viable risk financing options available to an owner-sponsor in addition to the traditional approach (where contractors provide their own insurance) and an owner-controlled insurance program (OCIP). The sponsor and the broker should consider the sponsor's primary goals and its ability or inclination to manage a CIP over a long term.

For example, if the owners are considering an OCIP, their internal team is minimal, and they are primarily concerned about liability coverage and limits, a GL only OCIP, GL only contractor-controlled insurance program (CCIP), or a combined line CCIP may be a better choice than a combined line OCIP. CCIP sponsors also should consider their goals for implementing a program. A general contractor (GC) sponsor may wish to initially implement a GL only program that meets its coverage needs before diving into a combined line program that may require additional training of personnel and changes to internal procedures.

8. How Likely Is Each Option To Meet the Sponsor's Goals?

The party performing the feasibility analysis should always understand the sponsor's goals for the program and not make an assumption that the primary or only goal is savings, though that may sometimes be the case. All potential risk financing options should be explored, and an exercise like the following can ensure that goals are understood, promote discussion, and help a sponsor select a program that best meets its needs. It is also useful to prioritize objectives. This example is for a potential owner-sponsor.

#	Risk Financing Objective	Traditional	Combined Line OCIP	GL Only OCIP	CCIP
1	Provides adequate coverage and high limits through statute of repose	Perhaps, depends on the GC	Yes	Yes	Yes
2	Provides opportunity for savings over traditional method	No	Yes, depends on adequacy of savings projections and program losses	Perhaps, not likely to be significant if high limits are purchased	Perhaps, if GC is willing to share, but not likely to be significant
3	Requires minimal administration duties of owner team	Yes	Perhaps, if OCIP administrator is capable and dedicated and there are minimal losses	Yes	Yes

As shown in the above example, even without detailed financial data, each of the options has the potential to meet some or all of the sponsor's goals. A CCIP is not always available to an owner-sponsor, but the party performing the feasibility study should ask whether the GC is able to offer a CCIP and, if so, obtain the details for review. This step will ensure that the feasibility analysis is comprehensive. Such analysis, as shown above, may point out that the owner-sponsor should fully examine and understand their own administrative requirements in an OCIP and the potential administrator's capabilities, the scope of services, and ability to perform those duties over the life of the program.

9. What Is the Likely Financial Outcome for Each Option?

A CIP pro forma, which is a projection of the expected financial outcome of a CIP using data estimated for the project and assuming the underlying assumptions will hold true, is usually the primary focus of a typical feasibility analysis. This topic is too comprehensive to be addressed in full here, and a more detailed discussion about how to understand, analyze, or best develop pro forma models will be addressed in a subsequent article. For this discussion, we'll look at how most pro formas are presented and the major pro forma components.

Combined line CIPs are not always presented or sold on the program cost alone. Raw cost numbers are not typically emphasized in a pro forma. Rather, the difference between traditional cost and CIP estimates are highlighted. To illustrate, imagine a scenario where a broker quotes a combined line CIP, for a $350,000,000 commercial project, with a $250,000 deductible, completed operations coverage through the statute of repose, and total limits of $100,000,000, for a cost of $8,000,000*. There would be some sticker shock associated with that cost number alone as contractor insurance cost is typically imbedded in the total cost of the work, and contractors do not typically identify their insurance costs in lump-sum bids. Because of this, CIP cost is almost always shown in a pro forma compared to the estimated cost of traditional insurance as shown in the highly simplified example below.

Item	Estimated Cost
Contractor insurance cost (traditional insurance procurement)	$9,000,000^A
Minus
CIP program cost	$8,000,000^A
CIP financial result (savings or CIP benefit)	$1,000,000
^A These numbers are for illustration purposes only. Program and contractor insurance costs vary by jurisdiction, program, and project type.

In the above example, which compares the estimated cost of traditional insurance to the estimated cost of a CIP, the benefit of implementing a CIP is shown as a savings of $1,000,000. Potential or expected savings are typically emphasized in a pro forma. However, it is important for a potential sponsor to understand that contractor insurance cost and CIP program cost figures are always "estimates based on estimates." These main components of the simplified pro forma formula, shown above, are based on an estimate of unburdened payroll. The following are descriptions of these key components of a pro forma.

Contractor insurance cost. This is the amount of insurance cost contractors will include in their bids for the lines of insurance to be provided by the CIP if the CIP is not implemented. This is sometimes referred to as traditional cost. These costs are usually a function of an estimate of unburdened payroll.
CIP program cost. This is what the CIP sponsor will pay for the program and includes fixed cost, taxes, assessments, claim service fees, all deductible or self-insured retention costs (loss cost), overhead, administration expense (CIP administration, safety, risk management information system, consultants, vendors, etc.), and cost of collateral. Fixed costs for combined line programs are usually based on the application of an assumed rate applied to an estimate of unburdened payroll.
Unburdened payroll. This is the amount of payroll (base hourly pay rate not including taxes, benefits, etc.) that contractors enrolled in the CIP will expend to construct the project and report to the CIP administrator. Unburdened payroll can be difficult to estimate. Most practitioners constructing CIP pro formas use an estimated percentage of contract value to estimate unburdened payroll value.

When preparing, reviewing, or evaluating a pro forma, it is important to remember that there are three highly variable components that can affect the overall result: contractor insurance cost rates, unburdened payroll, and loss costs. None of these items are easy to predict, even with reliable data from previous projects, since there are many differences among projects. The best approach is to look at multiple scenarios for each variable. Many pro formas adequately address the loss-cost variable, presenting estimated financial results at various loss levels. Pro formas that show outcomes at various contractor insurance cost rates or alternative payroll estimates are less common. Although Monte Carlo simulations (providing multiple estimates, instead of a single estimate, for each component) may be useful to show a wider range of outcomes to a potential sponsor, such methods are not common.

10. What Are the Potential Advantages and Disadvantages of Each?

Question number 8 above looks at how likely it is that an option will meet the sponsor's overall risk financing goals. For this last step, after considering potential financial outcomes and selection of the most viable or recommended option(s), we examine the advantages and disadvantages of each. It is important to be fully transparent about the potential downside(s) of each risk financing option. It is also important to realize that advantages and disadvantages will be interpreted from the perspectives of sponsor orientation, sponsor goals, and the attributes of the option itself. It is more common to find examples of the advantages of implementing a CIP in a feasibility study. The following are examples of some potential disadvantages of an OCIP that may be disclosed in a feasibility analysis and whose significance will be interpreted by the analyst and the sponsor.

Potential Disadvantages of an OCIP

Financial:

Uncertainty of financial outcome
- Uncertainty as respects contractor insurance costs
- Variable program cost to the owner due to:
  - Final program audit (payroll or contract value)
  - Claims activity
Cash flow
- Upfront cash outlay requirement prior to receiving insurance cost credits
- Deductible reimbursement obligation—when loss fund is not pre-paid
- Long-term claim liability

Administrative Burden Due to:

Procurement of program
Meetings with program administrator/team
Potential conflicts with contractors regarding insurance cost negotiations
Claim activity review
Deductible payment review/replenish
Safety involvement to ensure successful program
Safety meetings
Safety awareness efforts
Training /orientation efforts
Potential Occupational Safety and Health Administration involvement

Risk Management/Other:

Change to established procedure for pursuing claims against contractors
Possible effect on sponsor's ability to be an advocate for third-party claimants against contractor
Potential for increased responsibility/liability to contractors as respects the program coverage terms and conditions

Conclusions

There are many methods for conducting a thorough feasibility analysis. In this two-part article, we have discussed one process for feasibility analysis that takes place on a continuum that starts with consideration of the CIP concept and extends through to closure of the CIP. Unfortunately, we do not always have the opportunity to work on the entirety of a project from beginning to end, from concept to ultimate completion, for up to 10 or more years (after the completed operations extension has exhausted), after all claims have been closed, and collateral, if applicable, is returned.

It would be highly informative to know the goals and aspirations of a sponsor at the beginning of a CIP, on what basis they were developed, and then be able to compare them to the result developed from real data at the end. If all parties with that kind of full knowledge and credible financial data got together to share and compare results in order to improve the feasibility analysis process, that would be CIP nirvana.

Contemplating a Controlled Insurance Program—Part Two