Avoiding pitfalls

If you regularly perform public or private new construction work, you likely will encounter a project where insurance is being provided through a controlled or consolidated insurance program known as a CIP or "wrap-up." Although CIPs have been used for nearly 50 years in the construction industry to procure insurance, they recently have been used with increasing frequency and for a wider range of construction projects.

What are they?

A CIP is used to provide insurance coverage for an entire construction project under the umbrella of a single insurance policy. A CIP is used to procure and administer designated lines of insurance covering most contractors working at the project site in lieu of each contractor and subcontractor being responsible for purchasing and maintaining his or her own insurance and being required to name the owner and others as additional insureds under liability policies. Most CIPs are site-specific and established for a single large construction project with insurance coverage extending for several years but with a fixed duration. There also are "rolling" wrap-ups that are used for a series of projects. For instance, a general contractor might establish a rolling CIP that might cover three projects to be built over a five-year period.

Historically used almost exclusively for large new industrial, institutional and commercial construction projects, CIPs increasingly have been used in recent years for modestly sized residential projects, particularly condominiums and multifamily projects, and in states suffering from a high number of construction defects suits where smaller contractors have had difficulty obtaining insurance and whose policies may contain a multifamily exclusion. In fact, much condominium, multifamily and townhouse work in some states is performed with CIPs because of the difficulty contractors face when obtaining insurance for this work.

As a result, a cottage industry promoting and administering CIPs has developed. In addition to surplus and excess insurers, AIG, Arch, Chartis, Chubb, Liberty Mutual, Old Republic Insurance Co., The Hartford, The Travelers Cos. and Zurich Insurance Group have been active in the CIP market as have most of the major national insurance brokerage houses. Many local and regional firms also have developed a niche for CIPs. CIPs for residential projects have been written primarily by excess and surplus line insurers.

If you enroll in a CIP for a project without knowledge of the intricacies of CIPs or the assistance of an experienced insurance adviser with expertise in CIPs and construction insurance, you run the risk of finding what you expected to be a profitable job turns out to be unprofitable. On the other hand, with careful bidding and proper planning, you can participate profitably in a market that might not otherwise be open to you.

There are two common types of CIPs used in the construction industry: owner-controlled insurance programs (OCIPs) and contractor-controlled insurance programs (CCIPs). For an OCIP, the project owner is the sponsor and purchases and controls the insurance. For a CCIP, the general contractor, construction manager at-risk or prime contractor selects the insurance coverage, pays the premium and is the sponsor.

Purpose of OCIPs

The primary purposes of an OCIP are for the owner to reduce overall construction costs and provide coverage certainty. By buying insurance in bulk, the owner, in theory, will save money compared with each contractor buying his or her own insurance and passing that cost, and presumably markup, onto the owner. Through economies of scale in purchasing insurance, the owner might reduce overall project costs by 0.5 to 2 percent.

When evaluating whether a project is well-suited for an OCIP, the initial determination depends on whether the project's size creates sufficient economies of scale for purchasing insurance.

Although an OCIP might be used for a project where the total construction costs are as low as $50 million, insurance brokers commonly report it makes economic sense to use an OCIP when total construction costs are in excess of $100 million, and some insurance brokers look at $200 million as the point where an owner will receive enough benefit to justify purchasing an OCIP.

An OCIP may be used to procure CGL insurance on much smaller residential projects where contractors have difficulty obtaining liability insurance applicable to condominiums, multifamily projects and townhouses.

An OCIP could be either a guaranteed-cost/fixed-rate program or loss-sensitive program. An OCIP may include a retrospective rating feature so the premium and total OCIP cost depends on the actual incurred losses with the premium being adjusted based on loss experience.

Alaska, Arizona, California, Connecticut, Florida, Kansas, Michigan, Nevada, New Jersey, New Mexico, North Carolina, Texas and Virginia have enacted statutes pertaining to OCIPs, particularly for public works projects. These statutes usually define what projects are eligible for CIPs.

Five of these states (Alaska, Kansas, Michigan, Nevada and New Mexico) have statutes that directly address the use of OCIPs on private projects. Alaska, Arizona and North Carolina have statutes requiring a minimum total project cost of $50 million for an OCIP to be used. Nevada requires an estimated total project cost of at least $150 million. Michigan does not allow workers' compensation insurance to be provided through a CIP unless construction costs exceed $65 million and authorization is given by Michigan's insurance director. New Mexico does not allow rolling CIPs and requires a $150 million minimum in construction costs at a single site within five years. California and Texas have enacted legislation requiring disclosure to subcontractors of key CIP provisions in bid and contract documents.

Lines of insurance

OCIPs typically cover commercial general liability (CGL) and umbrella or excess liability insurance, workers' compensation insurance and employer's liability coverage, but sometimes an OCIP covers only general and excess liability insurance. When an OCIP is in place, the developer/owner, general contractor and subcontractors are named insureds under the same CGL, excess liability, and/or workers' compensation employer's liability policies depending on which lines of insurance the owner has chosen to include in the OCIP.

Commercial automobile liability insurance customarily is not included in an OCIP. Pollution liability, which is excluded from standard CGL policies, and professional liability, if the owner wants to include coverage for design professionals, also might be included in an OCIP. Builder's risk insurance coverage typically is not included in OCIPs, but is commonly purchased by the owner.

Most OCIPs cover all contractors while working at the construction site. The sponsor or insurance underwriter determines which contractors are to be provided insurance through the OCIP. Contractors engaged in demolition or handling hazardous materials or waste, architects, surveyors, engineers, vendors, suppliers, fabricators, material haulers, subcontractors not performing on-site labor and subcontractors with contracts under $5,000 typically are excluded from OCIP participation.

OCIP advantages

Although a reduction in overall insurance costs and, in turn, total construction costs, is the primary reason for OCIPs, OCIPs also ensure all contractors working at a site are insured and may have better and broader uniform coverage with much higher limits than if each contractor and subcontractor purchased separate policies. An individual subcontractor policy may have liability limits of $5 million, but a typical OCIP will have much higher limits of perhaps $100 million or more depending on a project's value.

With an OCIP in place, owners do not need to be concerned about unusual exclusions or provisions in a subcontractor's liability policy or whether a subcontractor's policy has lapsed because of a failure to pay a premium or policy expiration. An OCIP also allows hiring of smaller subcontractors who might be unable to meet the project's insurance requirements if each subcontractor were required to purchase his or her own liability insurance.

Reducing cross-claims between parties working on a project is another advantage of an OCIP. Because the OCIP insurer covers almost all trades working at a job site as well as the owner, litigation among project participants for accidents, losses and damages covered by liability insurance should be eliminated.

OCIPs are touted for reducing and avoiding adversarial claims, lowering legal costs and expert fees, streamlining the claims handling process and causing faster resolution of claims.

OCIP and CIP proponents also assert CIPs result in safer job sites because of more comprehensive and coordinated safety programs. Well-run CIPs will include an effective, integrated project-wide safety program in addition to each contractor having his or her own safety program.

Effects on subcontractors

Keep in mind OCIPs are designed to benefit owners, and CCIPs are designed to benefit general contractors. The owner's objective is to maximize insurance deductions, known as insurance credits, obtained from contractors and subcontractors working on a project. The total savings realized by the owner resulting from each contractor and subcontractor excluding insurance costs from their contract prices should be greater than the costs incurred by the owner to purchase and administer the OCIP coupled with losses the owner may be required to pay. When negotiating a final contract price, the owner will seek to maximize the insurance credit obtained from each party covered by the OCIP.

OCIPs are not intended to result in subcontractors saving money. To the contrary, an OCIP easily can result in you having greater insurance costs and/or more uninsured liability exposure if you are not vigilant and knowledgeable when calculating the insurance credit the owner seeks and making sure there are no insurance gaps that could prove costly.

Your due diligence when undertaking a job that will be covered by an OCIP begins during the bidding process. If the project is to be insured through an OCIP, an OCIP project manual, prepared by the OCIP administrator retained by the owner, should be distributed to all potential OCIP participants. At a minimum, the OCIP manual should describe the insurance policies, limits and deductibles included in the OCIP, claims management procedures and contact information.

If you are a part of an OCIP project, become familiar with the contents of the OCIP manual and provide a copy to your insurance broker or adviser before preparing your bid. You will need to know which insurance coverages are to be provided through the OCIP and whether you are to prepare your bid or proposal with or without insurance costs.

Bidding OCIP jobs

Bidding an OCIP project is more complicated than other projects because of the need to calculate the insurance credit to be extended to the owner, reflecting the deduction from your contract price as a result of you not providing the insurance coverages that will be provided through the OCIP. Assuming the OCIP provides CGL and workers' compensation insurance, your subcontract price will be determined by deducting your costs of these coverages from your bid. You will need to be able to prove the insurance costs have been removed.

The bid instructions will indicate whether you are to exclude insurance costs for OCIP coverages from your bid, submit a bid including insurance costs and/or state the amount of the insurance credit. At some point before finalizing the contract price, you will be required to complete a worksheet, usually prescribed by the OCIP administrator, to be used to calculate the insurance credit/deduction. Because each subcontractor is required to exclude the cost of insurance provided by the OCIP, you need to be prepared to show that amount separately. You also will need to make sure any sub-subcontractors you retain have similarly excluded insurance costs covered by the OCIP.

Calculating the insurance credit is not simple. You will need to work closely with your insurance adviser to determine how the insurance credit will be calculated for each line of insurance to be provided by the OCIP, comparing the coverages provided through the OCIP to your own policies, and identifying and filling insurance gaps that could leave you exposed.

Excess or umbrella liability coverage is typically "flat-rated," meaning you pay a flat rate or fixed premium when purchasing it regardless of your total payroll or volume. So you may not have any premium savings when an OCIP includes excess or umbrella coverage; yet, the owner is expecting the insurance credit to take into account excess coverage is being provided by the OCIP. Before reaching an agreement on a contract price, you need to know how the insurance credit/deduction will be calculated when you pay a flat premium. You do not want to find yourself in the position of extending an insurance credit when you have no premium savings.

After you have reached an agreement on the amount of the insurance credit, you will be asked to complete an enrollment form. You need to be sure your completed enrollment form has been received by the OCIP administrator and you have been formally enrolled in the OCIP. Make sure to keep copies of the paperwork. There have been several lawsuits where subcontractors thought they were covered by an OCIP but were never formally enrolled. Do not start any work until you have confirmation you are enrolled in the OCIP. You should receive a certificate of insurance showing the coverages provided by the OCIP.

OCIPs and CCIPs are not uniform. You and your insurance adviser need to closely examine the policies provided under the OCIP, compare the OCIP coverage to your policies that are being replaced by the OCIP and identify gaps in coverage you will want to have covered by your own insurance.

What about existing insurance?

Your liability policy is likely to include a "wrap-up exclusion," which means if a job is covered by an OCIP or CCIP, your insurance will not apply. OCIP coverage may not be as broad as your own insurance or may differ from what you arranged when you purchased your policy. The wrap-up exclusion exposes contractors to gaps between what is covered by the CIP and what would otherwise have been covered by your policy.

To address this potential problem, you will want to have difference in conditions, or DIC, coverage provided in what is commonly referred to as a DIC endorsement. Rather than your policy having no applicability to a job covered by an OCIP or CIP, you want your policy to apply on an excess and DIC basis so you can rely on your insurance if the CIP does not respond. The cost of obtaining DIC coverage should be included in the insurance credit worksheet to reflect the cost you incurred to maintain this coverage.

The International Risk Management Institute (IRMI), Dallas, recommends contractors not exclude OCIP exposure from their CGL and umbrella policies but endorse those policies to provide coverage in excess of the OCIP coverage and where differences in conditions would apply. IRMI recommends an OCIP state all its coverages are primary and contractors and subcontractors arrange their CGL and umbrella policies to provide only excess coverage and for differences in conditions.

When planning for an OCIP project, modify your insurance to provide excess coverage when the limits of all applicable OCIP policies have been reached and to cover any differences in conditions covered by your policy but not the OCIP. The owner obviously will not want to pay for duplicate coverage for you to keep your policies in effect. Your insurance policies should be endorsed to exclude exposures covered by the OCIP with a concomitant reduction in your premium. The Insurance Services Office and National Council on Compensation Insurance have promulgated endorsement forms for this purpose and include them in their manuals.

You also will want to ensure your liability insurance will not be primary and only would come into play on an excess basis if the limits of the OCIP policy have been exhausted or the DIC coverage is applied. You will want to make sure only the net reduction in your liability insurance costs is counted toward the insurance credit extended to the owner, taking into account the premium paid for DICs; tail coverage (which extends completed operations coverage beyond the expiration of the OCIP policy); and for your policy to remain in effect as excess coverage.

When calculating the insurance credit, the owner's representative administering the OCIP may seek to calculate the insurance credit based on the entire cost of your liability insurance without offsetting costs to maintain your own liability insurance on an excess and DIC basis.

There are numerous differences among OCIP coverage and policies maintained by subcontractors. First, remember OCIPs provide coverage only for on-site risks. For an accident, loss or damage to be covered by an OCIP policy, the claim must arise at the construction site. If a worker is injured when fabricating sheet metal for the job at your shop or when loading a truck for the job, the OCIP will not cover the claim.

Self-insured issues

Self-insured retentions (SIRs) and deductibles in OCIPs also present problems. A SIR typically is required to be paid at a claim's outset, and deductibles are paid when a claim is finalized. The SIR deductible could be $50,000, $100,000, $250,000 or more per occurrence. On an OCIP project, who pays the SIR or deductible? Will the owner pay the entire SIR or deductible, or will the owner be entitled to pass along at least a portion of the SIR or deductible to subcontractors? Will it make a difference whether a subcontractor's negligence caused the loss versus an injury or loss arising from the subcontractor's work without negligence? If the payment of a SIR or deductible depends on fault, who determines whether there was negligence, who was negligent and to what extent? And if the initial determination of negligence is made by the OCIP sponsor or administrator, is there a procedure for the subcontractor to challenge the decision?

Unlike liability claims, workers' compensation and builder's risk insurance are no-fault insurance policies not based on negligence by a particular party unlike a liability claim. An OCIP that imposes payment of SIRs or deductibles based on negligence does away with the no-fault feature of these coverages.

Before calculating the insurance credit and executing a contract, know how SIRs and deductibles are to be handled under the OCIP and whether you may be liable to pay the SIR, deductible or portions of the deductible. OCIPs customarily carry SIRs or deductibles much higher than those in subcontractors' individual policies.

Deductibles associated with builder's risk or installation floater policies carried by subcontractors typically do not exceed $5,000. If builder's risk coverage is obtained by the owner, the deductible may be higher. If the OCIP payment of the builder's risk deductible is based on negligence, a subcontractor faces a much greater potential exposure if, for instance, there is a job-site fire (allegedly caused by the subcontractor's negligence) before the owner's acceptance of the project. The risk and cost to the subcontractor for obtaining his or her own insurance to cover the exposure of higher deductibles and SIRs should be taken into account during bidding when determining the insurance credit.

Completed operations coverage

Roofing contractors face potential warranty liability for more post-construction years than other trades. As a result, the duration of OCIP coverage presents another potential gap in coverage. OCIPs often do not cover claims that arise in connection with warranty work because the OCIP policy may have expired by the time a roofing contractor is called upon to perform warranty work. You need to address this potential gap in insurance coverage so coverage is provided by either the OCIP or your policies. Be sure you have workers' compensation and general liability insurance applicable to warranty work and repairs. You may need to obtain a repair work endorsement.

OCIPs usually provide completed operations coverage anywhere from two to 10 years following project completion. You will want to be certain you have liability coverage and workers' compensation coverage for employees who return to the job site to perform warranty work or respond to leak calls at least until expiration of your warranty and applicable statutes of limitation and repose. You may need to obtain tail coverage and endorse your own policies to include exposures beyond the period covered by the OCIP. Again, your cost to have this coverage in place should be taken into account when determining the appropriate insurance credit.

Carefully review the OCIP excess coverage and particularly the "other insurance" provisions in the OCIP's excess policy. You will want to make sure the OCIP excess liability policy includes completed operations coverage. The OCIP excess policy may not mirror the primary policy and might include a completed operations exclusion.

You should be sure there is contract language stating all OCIP policies (primary and excess) are to respond on a primary, noncontributing basis. In addition, ensure the OCIP excess policy applies before your excess policy goes into effect. The OCIP excess insurer or administrator may argue there must be horizontal and vertical exhaustion of underlying policies before the OCIP excess/umbrella policy can be invoked, meaning any applicable insurance you maintain must be tapped before the OCIP excess/umbrella policy applies even if the underlying OCIP policy has been exhausted.

Other disadvantages

OCIPs have other disadvantages. The insurance credit/deduction may exceed your actual insurance costs. If you earned a strong safety record, you may lose that advantage while relatively unsafe subcontractors are not penalized. OCIPs require more paperwork and create increased uncompensated administrative costs. There is no opportunity for markup on insurance costs. OCIP coverage could be severely eroded in the event of a catastrophic claim or otherwise be inadequate through no fault of the subcontractor. To address this, call upon the sponsor to purchase an automatic limits reinstatement in the event of a catastrophic claim when negotiating the insurance credit.

OCIP CGL policies typically reinstate aggregate policy limits annually during construction on commercial projects. However, once construction has been completed, there is a single completed operations/products liability limit that applies to all post-construction claims for the entire period the OCIP remains in effect. OCIP policies should provide products/completed operations coverage on a primary, noncontributory basis for the duration of the statute of repose with limits reflecting the risk and coverage duration.

Your participation in OCIPs during the course of a year may result in you paying more for your insurance than was required. Your annual premium is based on your expected volume of work during the policy year, and your policy may include a minimum required premium. If your estimated yearly volume did not take into account the volume of work performed under OCIPs in lieu of your own policy during the policy year, the premium you paid will be higher than what it should have been.

At the end of the policy year, the insurer will perform an audit. If the audit shows your actual volume exceeded the estimated volume upon which the premium was based, you will be required to pay an additional premium, but the inverse is not true. If you performed more work under wrap-ups during the policy year than anticipated so your volume of work covered under your own CGL insurance was less than the volume of work upon which the premium was based, you are not likely to receive a refund of unearned premium paid during the course of the preceding year and you may still be liable for a minimum required premium.

Your loss experience when participating in a CIP is included when calculating your experience modification rating. You should be sure the CIP administrator reports all your work hours to the applicable ratings agency in your state. CGL claims and losses covered by a CIP do not affect your future CGL premiums.

Know the details

OCIPs and CCIPs will continue to be used on a wide range of construction projects. Without careful planning and expert guidance, you will increase your risk, which the purchase of insurance is intended to reduce. CIPs offer potential advantages to all parties but only if carefully considered, starting with bid preparation.

Before committing yourself to a CIP project, become familiar with the details. And have the CIP reviewed on your behalf by an insurance professional who is well-versed in the coverage provided by CIPs and the potential problems and pitfalls CIPs can pose to subcontractors.

You can have a successful experience working on projects covered by CIPs, but be diligent in the planning and preparation phases to protect yourself from unwelcome surprises.

Stephen M. Phillips is a partner with Atlanta-based law firm Hendrick, Phillips, Salzman & Flatt.