Has Your Owner's Wrap-Up Insurance Got You in a Bind?

"With a name like 'wrap-up insurance/ it has to be good!" as the commercial goes. While the name "wrap-up insurance" suggests warm and fuzzy, some prickly issues can come up. For contractors in owner- controlled insurance programs (OCIPs) and subcontractors in either owner- or general contractor- controlled insurance programs (CCIPs), there are some significant plusses, minuses, and really big minuses that accompany participation in these insur- ance programs. CCIPs and OCIPs are both referred to as "wrap-up insurance." According to the testimony of contractors and insurers before the Kansas state legislature, CCIPs and OCIPs are among the most contentious issues in the construction industry today and these programs are the number one problem faced by subcontractors. What are these issues and how can you protect yourself? First, let's start with a brief description of what a wrap-up insurance policy is. Typically purchased by an owner or a general contractor, these insurance policies are intended to insure the owner, general contractor, subcontractors, and sub-subcontractors. The coverage generally includes general liability, workers' compensation, excess liability, and builders' risk. I describe it as "generally" because there are variations in coverage under the policies. Some exclude workers' compensation insurance, others may include other coverage such as pollution liability or professional liability.

Some of the big advantages and disadvantages for CCIPs and OCIPs were discussed in a session at the Construction Financial Management Association's conference by Dennis Tsonis, vice-president of Lovitt & Touche Inc. (dtsonis@lovitt-touche .com). Tsonis was formerly an underwriter and administrator of wrap-up insurance programs. One of the biggest reasons to use a wrap-up policy is that it limits litigation between trades and provides a unified defense in construction defect litigation. These policies reduce fingerpointing among contractors, which leads to less litigation between contractors (and their insurers) and should lead to quicker resolutions of third-party claims.

Other important plusses Tsonis pointed out are potential for insurance premium cost savings (usually inures to the benefit of the sponsor of the program rather than other participants), higher liability limits, (generally coverage is broader than that supplied to individual contractors), and aggressive workers' compensation claims management. As discussed below, this can also be a negative.

Tsonis identified some of the big minuses of these programs that subs or general contractor participants should look at when bidding work that involves wrap-up policies. These issues vary from coverage gaps to additional costs and expenses you need to factor into your bid price to issues that are iust disruptive to your operations.

Risk/coverage issues. Tsonis raises several risk and coverage gap issues that should have your risk manager knocking at your door to discuss them with you. One big issue he raised is that the limits on the policy can be too low. A rule of thumb he suggests is that coverage should be equal to 25 percent to 33 percent of the total project cost.

Tsonis points out that sometimes the "tail" being offered under the wrap-up policy, i.e., three to five years of completed operations coverage, is less than the statute of limitations period. Because your general liability typically excludes completed operations coverage for work performed under a wrap-up policy, a coverage gapfor litigation or claims arises out of your work after the completed operations coverage ends.

Another of these issues is that the contract you sign may include risk transfers that go beyond the coverage provided. An indemnity clause may require something greater than the coverage supplied. Another example is a contract clause including responsibility for uninsured builders risk claims. You run into the same problem described above - your general liability coverage is not going to cover these claims.

Tsonis presented a particularly onerous scenario where coverage ceases before the risk does - such as if the insurance is cancelled for nonpayment, the insurer becomes insolvent, orthe project stalls. These scenarios pose significant financial risks to contractors and subs in the program.

Afew possible exclusions that may create coverage gaps underthe wrap-up policy that you should watch for are professional services such as design work and engineering (these are often exclusions on your general liability policy too), site preparation, off-site fabrication work for the project, and transportation of hazardous materials.

One potential way to resolve some of the coverage gap issues is to negotiate with your insurer to not exclude wrap work after a period of time. Tsonis also recommends purchasing a difference in condition (DIC) policy that will not only be excess to the wrap, but it also may fill in the completed operations coverage gap. Since all DIC policies are different, it would be wise to know ahead of time whether they will resolve the coverage gaps you are worried about. Other ways to mitigate risk is to do what you do on any other project, negotiate for less indemnification language. As for the insurer-becoming-insolvent risk, do your research about its financial strength. AM Best's Web site provides rating information for free and financial reports on insurers for a small fee. Consider negotiating in your contract that you are entitled to a change order if the program sponsor fails to maintain the insurance or the insurer becomes insolvent.

Cost issues. A big expense often overlooked by contractors enrolling in wraps is that they end up losing workers' compensation premium dividends from their safety group or other insurance cost- reduction programs. Some safety groups I have seen provide dividends of up to 30 percent of premium costs. These substantial savings are eroded when the contractor's workers' compensation premiums are paid through the wrap.

A more insidious cost to contractors is that the method for apportioning the selfinsured retention (SIR) (also referred to as the deductible) may be at the whim of the sponsor and can be a disproportionate burden on subcontractors. Tsonis suggests negotiating how the deductible will be apportioned up front. He also suggests negotiating a reduction to no contribution at project completion because at that point, there is no reason to compel you to improve performance or behave in less risky ways once the project is over.

Another cost issue that may arise is that you do not receive a full credit against your bid for your realistic anticipated insurance cost reduction as a result of your program participation. Some wrap programs allow you to be credited based on your calculation of anticipated insurance costs. Others pick an arbitrary percentage of your overall bid price. Tsonis points out that you need to carefully read the bid package to know how the amount will be calculated. If you're given the opportunity to calculate your insurance costs, there are some often overlooked costs you should factor in: the cost of your umbrella policy - if not credited on a dollar-for-dollar basis; the premium cost for DIC coverage - to cover your completed operations coverage gap discussed above; premium cost for autoand equipment insurance, which you still need to provide; administrative costs for participating, including additional safety measures that may be required for participants; and other insurance you are still responsible for outside of the wrap-up, i.e., builders risk.

A hidden cost issue that can have a dramatic impact on your future insurance costs is that in the case of a workers' compensation loss caused by another trade, you may not be able to recover that loss from the culpable contractor because of waivers of subrogation. Keep in mind that at the end of the day, your experience modification will also include your losses from the wrap- up prog ram. One way Tsonis suggests to address this issue is to condition your bid to permit "actions over" for bodily injury claims involving workers that would permit you (or your insurer) to sue the offending contractor.

Operational issues. The use of wrapup insurance will require you to carefully examine your current policy and future policies to insure coverage of the potential risks described above. Also consider that while your risk profile may be unchanged, your insurance pricing will change disproportionately to the risk reduction. You may lose your volume-based discounted pricing on policies acquired while you are enrolled in the wrap-up program. You will also still need to maintain insurance coverage for work performed off-site, equipment supplied, and unowned auto insurance.

Another issue that may crop up sooner or later is that you may lose control of your return-to-work program for your injured workers. The wrap administrators, in their zeal to get employees off the compensation roll, may require workers to go back to work before they can really be productive.

Some other important measures Tsonis suggests you can take to clearly understand the risks and costs associated with wrap-up programs and thus make educated business decisions. Precontract award, review the wrap-up materials and attend the prebid (with your broker or attorney). Post-contract award, he recommends enrolling timely in the program, getting complete copies of the policies, reviewing loss runs regularly, and actively participating in the claims review process. Meanwhile, perhaps some state regulation will address some of the difficult issues presented by wrap-up insurance programs in the future. California has started to discuss these issues. Kansas has enacted legislation regulating wrap-up programs, as we discuss in the box on page 14.