Equitable Risk Sharing by Wrap-Up Insurance Program Participants

Background of Wrap-Up Policies

Wrap-up policies typically have a deductible or self-insured retention (both referred to as a "deductible" in this article) that is a cost borne by the wrap-up sponsor. If the wrap-up contains workers compensation coverage, the deductible is typically $250,000 for each occurrence. General liability coverage often contains a deductible of $25,000–$250,000 for each occurrence or each claim. Larger rolling wrap-up programs may carry deductibles up to $1 million for workers compensation and/or general liability.

The deductible serves several purposes: For the insurer, the deductible incentivizes safe practices and reduces the claims administration associated with a frequency of smaller claims. ¹ For the sponsor, the deductible reduces the amount of premium and offers the ability to lower the total cost of risk by managing safety and claims below an expected loss level.

It is common for sponsors to attempt to transfer some of the deductible risk to the contractors enrolled and insured by a wrap-up program. ² The motivations for sharing the deductible risk can include the following.

• Provide an incentive for the insured contractors to perform their work safely
• Reduce the administration associated with a frequency of smaller claims
• Fund a portion of the deductible obligation of the sponsor if the loss is caused by a contractor
• Mirror the deductible on the contractor practice program on which the insurance credit or deduction was based

The Issue: The Deductible

The issue arises when a sponsor seeks to impose a deductible larger than that carried by the contractor under their practice program. There have been some egregious obligations, including requiring each enrolled contractor to pay the first $250,000 for workers compensation and/or $100,000 or even $250,000 for general liability.

Many trade contractors have no deductible on their workers compensation and a minimal deductible ($1,000–$5,000) on their general liability program. Imposing a higher deductible can create financial risk to the subcontractors who are faced with either self-insuring the higher deductible risk or adding additional cost into their contract cost to fund the additional risk. If the subcontractors start loading additional costs into their bids and this is compounded over 50-plus subcontractors on a typical job, then the project cost can increase dramatically to the detriment of the wrap-up sponsor.

Another issue arises where a wrap-up program is used to increase the participation of disadvantaged or small contractors by utilizing the wrap-up coverage limits to satisfy contractually required limits. If a subcontractor is required to take on significant deductible risk or it adds the cost of the additional risk to their bids, it essentially nullifies the participation advantage of a wrap-up program.

Alternatively, the sponsor is benefiting from a reduction in the cost of the work (insurance credit) as an offset for providing the wrap-up coverage. The insurance credit is based on the anticipated exposure for the project and premium rates the contractor would have paid on their corporate insurance program. Because most contractors will have a deductible on their corporate general liability policy, ³ the insurance credit reflects the applicable level of deductible, and the sponsor is not achieving an insurance credit equivalent to a $0 deductible.

Furthermore, the sponsor may impose a deductible obligation to avoid the administration associated with a frequency of smaller claims. The sponsor may also seek to have the contractors bear some of the deductible risk to incentivize them to perform the work safely and cautiously.

The Wrap-Up Participant Deductible Obligation

The deductible obligation of enrolled contractors is identified in either the wrap-up manual and/or in a wrap-up contractual addendum to the construction agreement or subcontract agreement. A typical obligation often includes the amount of the obligation, the trigger of the obligation (typically when it is determined the construction manager/general contractor (CM/GC) or insured subcontractors caused the loss), and who determines if the obligation will be imposed. A sample deductible obligation is as follows.

There are several variations of the deductible obligation.

• The general liability obligation applies to bodily injury, property damage, or both.
• The deductible obligation equals the amount of the deductible the at-fault contractor carries on their corporate program.
• Stair-step the deductible based on the size of the subcontract value (lower subcontract values have lower deductibles).
• There is no deductible obligation.

In addition to the level of the deductible obligation, there are a few issues worth noting. First, the sponsor will impose the deductible obligation onto the party with which they have contractual privity. In the case of an OCIP, the owner will impose the obligation on the CM/GC, who will then be responsible for collecting the obligation from any at-fault downstream subcontractors.

Second, quite often the deductible obligation is determined at the sole discretion of the sponsor to assess the amount and party responsible for the claim. The language typically doesn't address the methodology for the sponsor's assessment nor is it common that the language delineates between claims paid by the sponsor versus incurred by the sponsor.

Lastly, the deductible obligation applies to the specified policies. In the instance of a general liability wrap-up, coverage typically extends the products/completed operations coverage through the state statute of repose. Thus, the deductible obligation can expose the wrap-up participants to financial risk many years after the project is complete.

Statutory Implications

The ability or amount of the obligation can be limited based on state statutes, which is typically found in the wrap-up or controlled insurance program statutes. For example, the Kansas Statute § 40–4503 (2021) states that controlled insurance programs shall not charge enrolled participants who are not the sponsoring participants, a deductible in excess of $2,500 per occurrence or a per-claim assessment by the sponsor.

Another example is California Civil Code—CIV § 2782.9, which relates to wrap-up programs on residential construction projects. The code specifies that the sponsor is allowed to collect a self-insured retention or deductible:

If the maximum amount and method of collection of the participant's contribution is disclosed in the contract with the participant and the contribution is reasonably limited so that each participant may have some financial obligation in the event of a claim alleged to be caused by that participant's scope of work. The contribution shall only be collected when and as any such self-insured retention or deductible is incurred by the builder or general contractor and in an amount that bears a reasonable and proportionate relationship to the alleged liability arising from the claim or claims alleged to be caused by the participant's scope of work, when viewed in the context of the entirety of the alleged claim or claims. Any contribution shall only be collected from a participant after written notice to the participant of the amount of and basis for the contribution. In no event shall the total amount of contributions collected from participants exceed the amount of any self-insured retention or deductible due and payable by the builder or general contractor for the claim or claims.

Conclusion

So, what is equitable risk sharing by the wrap-up participants?

First, one must acknowledge that the sponsor is responsible for the policy deductibles and is obtaining a premium reduction as consideration for bearing a deductible. Even if the insurance credit or insurance deduction received in the bid price does not reflect a guaranteed cost equivalent, the benefits of wrap-up insurance protection should be the primary goal and balance the economics of any nominal insurance credit not obtained during the bid process.

Second, given that many of the workers compensation policies of the subcontractors are on a guaranteed cost basis, and they tend to be smaller firms, this author cannot rationalize how a deductible obligation on workers compensation is equitable.

Third, the wrap-up policies are intended to insure and protect the interests of all insured parties on the project. Therefore, imposing a deductible obligation that imposes undue risk on the project participants does not seem equitable. Potential wrap-up sponsors should be cautious of any sales pitch that obligates the sponsor only to the premium responsibility while passing along all of the deductible obligation to the contractors.

However, one could rationalize that imposing a larger deductible obligation than the practice program deductible is equitable as the enrolled contractor may have access to broader coverage terms or higher limits afforded by the wrap-up program.

The sponsor is equally justified in providing an incentive for the participants to have "skin in the game," and avoiding the administration of a frequency of smaller claims has merit if the obligation is at a sufficient level (typically $2,500–$10,000) to prevent contractors from either bearing an unfair risk or loading additional dollars into the cost of the work.