Expert Commentary

Wrap-Ups and the Issue of Critical Mass

How big does a project need to be to begin thinking wrap-up? What's the differences between what a "project budget" and a budget used for determining wrap-up qualifications? What are the advantages when compared with a traditional insurance program? What are the "control" issues?

Wrap-Up Programs
March 2000

Has this ever happened to you? A risk manager is sitting comfortably in her office, admiring the beautiful scenery outside her spacious window while contemplating how easy the upcoming week will be. She recently completed a major assignment and will finally have time to clean off her desk. Sounds great, doesn't it? Well, welcome to Act I Scene I of the Wonderful World of Wrap-Ups.

You're about to embark on a wonderful journey into a fascinating area of insurance that at times appears more complicated then it really is. Oh sure, you need to know a few things before you can consider yourself well-versed in the technicalities of wrap-ups. My job in this column is to take some of the mystery out of wrap-ups (done with a sense of humor of course) and in doing so give you an opportunity to utilize this knowledge in your own job.

Before I forget, I should clear up something about the term "wrap-up." There are several different names for a "wrap-up": an Owner Controlled Insurance Program, a Consolidated Insurance Program, or a Contractor Controlled Insurance Program when the sponsor happens to be a contractor. However, at the end of the day, they all mean the same thing-potential for substantial dollar savings. In short, what's in a name anyway?

Back to our story. Our risk manager has been shaken from her reverie by a phone call from the vice president of Operations who informs her that the beautiful scene outside her office will become the new production facility for the company's newspaper printing operations. The approximate cost of the project is $175,000,000.

Obviously, she is concerned not just because she will be losing her scenic view but, as the firm's risk manager, she will need to learn everything about construction insurance and, in particular, something about wrap-ups. She remembers that a wrap-up is a single insurance program procured by the sponsor that will cover the job site risks for workers compensation, general liability, and umbrella liability. In turn, because the subcontractors are covered by the wrap-up, the cost of insurance will be eliminated from their bids. She also recalls, with some trepidation, other risk managers advising her about the pitfalls of wrap-ups a couple of years ago when there was talk of a new corporate headquarters building. This sounds intriguing.

An issue often heard in wrap-up discussions is critical mass. In simplistic terms, how big does the project need to be to begin thinking wrap-up? In our story, the risk manager has just been told that the approximate project cost will be $175,000,000. It took a few moments, but she has gotten over her initial concerns and is now ready to tackle the problem head on.

First, let's review very quickly why our risk manager should be thinking wrap-up in the first place. What are the advantages? A wrap-up should provide the sponsor of the program with a savings as compared to the traditional way insurance is procured for a construction project (i.e., the contractors provide their own coverage and include a fixed cost for insurance in their bids). Without going into a long dissertation on how wrap-ups can save money, let's just say for now that there is an economy of scale for the sponsor to purchase the coverage as a group. In addition the sponsor can save premium dollars by purchasing a loss-sensitive (i.e., deductible) program as compared to the fixed costs the contractors will place in their bids.

There is also an issue of control. There are those that utilize wrap-ups even if the potential savings are minimal just to be able to control the insurance functions: coverage limits, coverage enhancements, and control of the safety and claims process. (More on all this in a later article). Additionally, many public projects seek to implement wrap-ups in order to support Minority Business and Woman Business participation.

Now to the issue at hand-critical mass. No, we are not referring to the size of the universe, but the size of the project. You can ask a dozen people their opinion on this issue and get a dozen different answers. Qualifying a wrap-up as to the project size can be considered a function of several key factors. For the purpose of this article, we will focus on what factors effect project size for a wrap-up. In upcoming articles, we will address other factors such as why the insurance company cares about critical mass and the influence it has on underwriting decisions.

I am almost afraid to say this, but a simple rule of thumb, as we enter the new millennium is-always consider any project in excess of $100,000,000 as a candidate for a wrap-up. This is only a guide and should not be considered the gospel according to Resnick. There are circumstances when you might consider wrap-ups on much smaller projects for some particular reason.

When our fictional risk manager is told the project size, she immediately reviews some wrap-up basics and begins selling the idea to everyone that a wrap-up is the way to go. However, she might have been be wise to slow it down a bit. For the purpose of determining a true project cost for wrap-up consideration, the risk manager needs to figure out whether the cost of the project is really $175,000,000.

The reason we are so focused on quantifying the proper cost is that our anticipated on-site labor will become a factor of that figure. Miscalculate the project cost, and obviously you have a problem with the payroll calculation. As a side note, when I discuss on-site labor, I am only referring to the unburdened payroll or, in other words, W-2 wage rates.

Another rule of thumb (here we go again) is that on-site labor should approximate anywhere from 18-25 percent of hard construction dollars. As usual, depending on certain factors, some projects could be higher or lower then the given range. If we did not know any better, we might take 20 percent of the $175,000,000 and say that the payroll will be about $35,000,000. Take this a step further. To make matters worse, our fictional risk manager has made representations to her management of significant dollar savings based on these parameters. Houston, we have a problem!

We need to first consider what cost items in the construction budget will have a payroll element assigned to them. Wrap-ups traditionally do not include any off-site work, such as fabrication of steel or manufacturing of special machinery. So, our risk manager needs to determine whether there is anything special about a printing facility that makes it unique for wrap-up purposes.

The cost of the printing presses will certainly skew the analysis. The construction budget will have a line item for the cost of the presses. Let's say, for example, that the new facility will require five presses. The budget line item is $75,000,000. What has started as a $175,000,000 project has been reduced to $100,000,000. Still within the range for a potential wrap-up, but there is more to consider.

We need to take this analysis even further by understanding the simple differences between what some would call a "project budget" and a budget we use for wrap-up qualifications. The project budget will generally include cost items for both hard and soft costs, as well as special purchased items, such as printing presses. Hard costs can be defined as "bricks and mortar" or subcontractor trade costs. Soft costs include costs such as architectural, engineering and legal fees. Unless we can put a payroll number to a cost, chances are we will not consider soft costs in the wrap-up budget.

The following chart illustrates what the project budget might look like as compared to the wrap-up budget when the soft costs are eliminated. All the trade costs remain as is, but soft cost items, which are primarily fees, are not included. Also note that we did not carry over the cost of the printing presses. Any labor associated with installation of the presses will be in the trade costs.

Project Budget Wrap-up Budget
Description Contract Value Contract Value
Site Work $ 4,000,000 $ 4,000,000
Excavation & Foundation 5,000,000 5,000,000
Structural Steel 25,000,000 25,000,000
Plumbing 8,000,000 8,000,000
HVAC 14,000,000 14,000,000
Electrical 14,000,000 14,000,000
Architectural Fees 8,500,000 -
Consultants 500,000 -
Legal Fees 500,000 -
Presses 75,000,000 -
General Conditions 11,500,000 11,500,000
CM Fee 9,000,000 -
TOTAL 175,000,000 81,500,000

As a result, we are now looking at a project that is close to $80,000,000, and its feasibility for a wrap-up is questionable. Our risk manager might need to find some very compelling reason why she should proceed at this point.

The lesson here is that one person's definition of "project cost" may not necessarily be the required definition for wrap-up consideration. It is a good idea to take the extra time to review carefully the construction budget, and separate hard costs from the soft costs. Only by doing will you be assured of a realistic project cost and thereby establish proper cost parameters for the wrap-up.

Have a good winter. You'll be hearing from me again in the spring.

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.

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