There is a choice that the parties to a construction project have when it comes to the purchase of the wrap-up program—assuming the project is large enough and other particular criteria are met. Does the owner elect to be responsible for the procurement of the insurance, or does the owner leave it up to the contractor to handle? There are compelling reasons for both. As an editorial comment, let me start off by stating what you will read is not an endorsement of one method over the other. It is simply a "101" on the basics of a recently popular movement toward contractor controlled programs.
Welcome back to my most trusted readers. My latest article deals with a trend I initially mentioned about a year ago—the rising popularity of contractor controlled insurance programs (CCIPs). All technical issues discussed previously are equally applicable to different types of wrap-ups; i.e., those that an owner may secure, a contractor may secure, and even a financial institution may purchase.
First of all let me explain what we mean by "contractor." We are referring usually to a construction manager at risk, a general contractor, or what may be referred to as a prime contractor. Generally, these will be the parties that have privity of contract with the trade contractors. Which brings us to the first question of "Why are CCIPs so popular now?" The contracting community has made a very compelling case to the owners that they (the contractors) are simply in a better position to control the procurement process because they are contractually controlling the subcontracting process. Makes sense, does it not?
In previous articles, we discussed how the sponsor of the wrap-up can save money by the wrap-up method. Because most wrap-up insurance programs are loss sensitive (the sponsor is responsible for the deductible losses), safety becomes priority number one. Although still contractually obligated to provide a safe site—wrap-up or no wrap-up—the contractors have opined that they are best able to control the claims through a safe work environment. If that is the case, then they should be rewarded with the savings. In other words, logically thinking, the procurement of a CCIP simply is nothing more than an extension of the contractors' scope of work responsibilities.
Not only will an excellent safety culture result in monetary rewards, so will the ability to extract the highest level of "deducts" from the trades. Remember, the final cost of the wrap-up insurance program will be compared to the final collected insurance deducts. The contractor is in a wonderful contractual position to control this process. By having a privity of contract with the trades, contractors are in the best position to negotiate the highest level of deducts.
One of the more critical differences between a CCIP and OCIP has to do with the completed-operations exposure. Completed-operations coverage extends typically 3 years beyond the construction period and quite often beyond the closing of the developer's/owner's construction loan. Although, coverage continues to be in place to protect all insureds in the event of a completed-operations claim, this coverage continues with the large deductible in place, which is the responsibility of the sponsor. Under an OCIP, the owner is the sponsor and remains exposed to the deductible for the completed-operations extension period. This exposure makes it difficult for owners to ultimately cap their project costs and close their construction loans within a year or so of the project completion. In addition, unlike an OCIP, owners need not concern themselves in a CCIP with the overall CCIP administration that can include:
Furthermore, insurance companies that write wrap-up programs are usually the same insurers that write the insurance programs for large construction managers and general contractors. These insurers have a high comfort level in writing CCIPs. Unlike most owners, the construction manager usually has significant critical mass in the insurance marketplace and can generate cost efficiencies for the mutual benefit of the owner and the manager.
As respects the loss-sensitive nature of wrap-ups, owners may not have an appetite for deductible reimbursement in controlled insurance programs; especially with deductibles in the range of $250,000 to $500,000. Moreover, the days of guaranteed cost CIP's (i.e., no deductibles) are gone.
Depending on program design, sponsors of wrap-up programs may elect not to pre-fund the losses in the premium payments. This deferral of loss payments means that the sponsor must provide some form of collateral to the insurance company guaranteeing that the losses will be paid when due. Owners have demonstrated less enthusiasm about providing letters of credit, collateral requirements, or surety instruments required by underwriters for future OCIP claims (i.e., actuarially projected and developed claims).
Contractors with large asset bases and substantial surety programs have more capacity to deal with insurer collateral requirements in CCIPs. Similar to the completed-operations issue noted above, the sponsor in an OCIP must bear the claims exposure until all claims are closed or a buyout is negotiated with the insurer. It may take upward of 3 to 5 years to close all claims and buyouts do not begin to be feasible until 18 to 24 months following project completion. Construction managers are familiar and stay involved with the ongoing claims management process well beyond project closure. Development firms contemplate operational concerns and, up until recently, were not very involved with construction claims. The due diligence and overall approach are different due to the nature of the contractor's operations. A CCIP is in many ways a natural extension of the construction manager's master risk management program and can add value by applying a more sophisticated insurance claims management process.
This is not to say that in every instance a CCIP is favorable over the OCIP. In the spirit of partnership, all parties should decide beforehand, which is the best way to proceed. Many owners may be quite comfortable assuming the risks inherent in procuring the wrap-up. They might even be willing to share a portion of the savings with the contractors for a job well done. By the same token, the contractor may be willing to do the same under a CCIP. Regardless, this does not have to be adversarial. Pick the most logical approach given the specifics of the project. It can be a win-win for all parties.
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