Expert Commentary

The State of Wrap-Ups 2009

A little less than a year ago I presented my wrap-up "state of the union" article. In the spirit of our recent Presidential inauguration, I think this is an appropriate time for this year's state of the wrap-ups.


Wrap-Up Programs
February 2009

What a difference a few months make. Starting in mid-September we saw an already difficult economic picture turn even worse. But if you were to revisit The State of Wrap-Ups 2008, you might say, "The more things change, the more they seem to stay the same."

We began 2008 with a sub-prime crisis that quite certainly had an impact on the construction forecast and, in turn, wrap-up predictions. We ended 2008 in the midst of one of the most severe economic downturns since the "Great Depression." The seeds for this were growing throughout 2008. Led originally by the sub-prime crisis, it eventually seeped into every corner of our economic system: banking, retail, automotive, and insurance. While one might think that the recent financial challenges of a major insurance company, active in the construction industry, would have had a devastating impact, we are happy to report this has not occurred.

As we progress further into 2009, let us review what this latest economic crisis will mean to those of us who dedicate our time and resources to the construction industry—and wrap-ups more specifically.

Availability of Projects

2009 will definitely be a very challenging year to keep the "pipeline" of projects full. The credit crisis has caused major developers to rethink their plans. At one time developers were able to easily obtain competitive financing terms, now they have seen restrictive terms in the best cases. In many instances the financing is just not available. Where at one time developers were able to finance 65-75 percent of a project's value, now they have seen these same banks agreeable to financing only 25-35 percent of the project. This obviously has had a dramatic impact on development portfolios for residential and retail construction (to name a few). With still higher unemployment rates expected, the impact on home buying, retail purchasing, and therefore construction within those venues will be greatly affected.

The residential crisis, which began to impact wrap-ups early in 2008, has now grown into a major phenomenon whereby housing starts are down dramatically as foreclosures appear in the headlines more often then new construction.

As the economy heads into 2009 with the expectation that we may not see improvements until 2010, what "silver linings" can we look forward to? The good news is that if the proposed stimulus package does "kick start" our economy, then we could see more infrastructure projects and a renewed emphasis on upgrading our educational facilities and hospitals.

The Marketplace

It is encouraging to note that the marketplace has actually expanded beyond last year. These few new players entered the marketplace prior to the September headlines, but they, as all the other players, still remain committed to wrap-ups as an underwriting platform. Similar to what was expressed in 2008, these potential insurers all have different project appetites. We have our traditional group that will write just about all types, whether owner controlled or contractor controlled. Others prefer to concentrate on contractor controlled wrap-ups, and quite often only for their own property-casualty clients.

One new player—Hartford—(we are very happy to say) is actually reentering the marketplace after a several year absence and will initially be selective as to which jurisdiction they write in. Another newer player—Seabright—has a specialty in "collective bargained" workers compensation. This underwriter (who also writes general liability) can become a critical player when projects fall under "project labor agreements."

While the number of insurers has dramatically been reduced over the past 10 years, we can be thankful that we have had some consistency in the marketplace for a few years now. In addition, capacity for the higher limits usually required in wrap-up programs is available. The simple issue is that we will most probably have more insurance companies chasing far fewer wrap-ups.

The line-up of players (with all differing appetites and tolerance for wrap-up risks) that have considered traditional Workers Compensation and General Liability wrap-ups as part of their underwriting portfolio are: ACE, AIG, ARCH, Hartford, Liberty, Old Republic, Seabright, Travelers, and Zurich.

So, as we enter 2009, the three most compelling reasons to do a wrap-up remain the same; control of coverage, control of limits and potential cost savings. However, we will certainly see a drop off in the number of wrap-ups. Simultaneously, we need to be aware of several underwriting forces working against us. Some key issues will take precedence as to how insurance companies perceive the wrap-up risks they are underwriting. As a result of the tenuous economic conditions, underwriters may not be as willing to provide such favorable cash flow terms. More sensitive will be the critical issue of collateral. Underwriters will apply much stricter guidelines to their financial due diligence. Whereas in the past, some insurance companies would be more flexible as respect securing the wrap-up’s potential losses, we may now see a tightening of requirements resulting in higher collateral amounts.

Additionally, continued adherence to rigid guidelines as respects safety will be critical to the underwriting process. Developers will need to demonstrate an "engaged" culture toward safety. To simply obligate the general contractor contractually may not be enough. The underwriting submission must include a detailed section on the proposed project Safety Plan. Providing a "safety comfort" to the insurer will result in a more favorable underwriting response.

Challenges

As underwriters have become more comfortable with their pricing models, and wrap-up rates have stabilized, we are also beginning to feel the impact of contractors' "practice policy" rates reducing at a somewhat quicker pace. Therefore the reduced bid prices we expect from the subcontractors may not be as attractive as previously seen. Those "bid credits" that fund our wrap-ups will be below our expectations. This will put more pressure on safety and obtaining wrap-up savings from good loss experience. We should also mention, as some are predicting, this can turn quickly in the other direction as underwriters take a more cautious approach to their "practice policy" pricing.

From California to New York, we have been witness to a dramatic reduction in workers compensation rates for contractors. While we have seen pressure by workers compensation state rating agencies to recommend rate increases, these increases will not nearly be enough to bring those rates to an adequate level.

A continuing rating burden we face, which impacts greatly the bid credit management process, is the estimation of contractor’s workers compensation rates when we are dealing with a "loss cost" state rating structure. Where previously we had the advantage of state "manual rates" (loss costs and expenses), now we will only be provided with loss costs rates in states subscribing to that rating model. Imagine the further challenges when creating bid credit projections for our wrap-up projects.

Conclusion

In 2008 we said that the "state of wrap-ups" was very good. I wish in 2009 we could be as optimistic. It will be a very challenging year but opportunities still exist. We started off by saying "the more things change they stay the same." My summation from 2008 is a good case in point.

In summary what are the challenges?

  • Underwriters need to be cognizant of the rating environment of the contracting community while still adhering to sound underwriting guidelines.
  • Brokers need to be realistic in their assessment of wrap-up opportunities.
  • Sponsors need to understand their motivation in procuring wrap-ups. It is not all about savings.

Happy New Year.


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