"It's A Wrap!" Insuring Construction Projects Through OCIPs and CCIPs, Part II, Insurance Policyholder Advocate
Part 2: The Pros and Cons of Insuring a Project under a Wrap Up Program
Part 1 explained the nature of a unified wrap up insurance program for a construction project, and contrasted it with the traditional mechanism of having all of the construction participants – including the general contractor and all of the subcontractors – procure their own individual insurance policies to cover project claims. The next question is whether it is advisable to have the controlling entity – whether the owner/developer on an OCIP or the general contractor on a CCIP – insure the project under a wrap up program. The decision whether to use a wrap up program for a particular project should be made as part of a feasibility study, since a wrap up program offers several benefits when compared to the traditional approach, but also presents several obstacles. These factors should be weighed in light of the nature and risks of the project. Below is a general discussion of some of the key factors relevant to deciding whether to insure a project under a wrap up program.
1. The cost of insurance
A wrap up program is intended to reduce the overall cost of insurance for the project by providing what amounts to volume pricing for the whole project. Further, if the wrap up program is written on a loss-sensitive basis (e.g., where policy premium is adjusted based on claims history), reducing paid claims under the wrap up program will reduce the cost of insurance. This might be accomplished through a comprehensive project safety program and better claim management. On the other hand, a higher than anticipated claims history could increase the cost of insurance to the wrap up sponsor.
2. Control over coverage limits
A wrap up program provides higher per-occurrence or per-claim liability limits than would be provided by a typical subcontractor's individual liability policy, which frequently carries liability limits of $1-2 million regardless of the size of the project, and often with no excess layer. By contrast, wrap up policies allow the controlling entity to procure for all participants much higher liability limits appropriate for the size and risk of the project.
3. Control over the scope of coverage
Under the traditional approach, by which each participant furnishes its own insurance, the owner and general contractor generally have little control over the coverage provided by downstream participants. Sometimes subcontractors are contractually bound in their subcontracts to procure certain coverages and limits, but even then, there is no guaranty that the subcontractors will actually obtain that coverage. Even if the subcontractors procure the contractually required coverage, the owner or general contractor has little control over whether (a) the individual policies remain in force, (b) the subcontractors pay any required deductibles or retentions in the event of a covered claim, (c) the individual policies' limits are eroded due to the payment of claims on other projects, and (d) the owner and contractor have been properly added to the individual policies as additional insureds.
Individual liability policies may also contain exclusions or limitations not present in a wrap up policy. For example, individual general liability and professional liability policies may contain exclusions for residential work (such as condominiums) due to historically costly construction defect claims arising out of this work. In addition, construction participants may not be able to obtain sufficient "completed operations" coverage to protect against claims (such as for latent defects) throughout the applicable statute of limitations or repose. It may also be difficult for upstream participants to ensure that downstream participants maintain this coverage for a sufficient duration.
Under a wrap up program, by contrast, the controlling entity should have greater control over the types, scopes, and limits of coverage, and can better tailor the coverage to the particular project. In this same manner, wrap up policies may present a viable solution to the insurability hurdles that might otherwise confront builders and design professionals, including challenges in obtaining coverage for residential exposures, as well as coverage for "completed operations" that is commensurate with the applicable statute of limitations or repose. The controlling entity can also ensure that the policy does not lapse by taking responsibility for the payment of premiums, and can readily monitor the erosion of the wrap up policy's indemnity limits as claims are paid.
4. Wrap up's impact on a construction participant's individual liability policy
With a wrap up program, the insurance limits under the participants' individual (corporate) liability policies are not at risk, or are at risk only after exhaustion of the underlying wrap up coverage (i.e., where the individual policy has been endorsed to provide excess/difference-in-conditions coverage to the wrap up coverage). This benefits the owner and other participants by ensuring a certain amount of coverage for the wrapped project regardless of the extent to which certain participants' individual coverage limits have been eroded by the payment of claims on other jobs. This also benefits subcontractors by allowing them to preserve their individual policy limits for other jobs without fear of erosion through the payment of claims under the wrap up policy.
5. Ease of administration
This factor cuts both ways. On one hand, a wrap up program relieves the controlling entity of the daunting burden of ensuring that all lower-tiered participants (e.g., subcontractors and material suppliers) have obtained appropriate coverage for themselves, as well as "additional insured" coverage for the upstream participants (e.g., owner and general contractor). Indeed, the need for "additional insured" coverage is significantly reduced under a wrap up program because all of the participants are "named" insureds. The controlling entity also can more easily track compliance with policy terms and conditions, including satisfaction of any claim reporting requirements and payment of any deductible or retention.
On the other hand, the controlling entity will face certain administrative hurdles not present under the traditional approach. For example, the controlling entity may be responsible for educating participants about the wrap up program, enrolling participants into the program, allocating the cost of the program through deductive change orders, overseeing project safety, and managing claims, although controlling entities frequently pass this responsibility down to their insurance broker who acts as the wrap up "administrator." Enrolled participants are not free from administrative burden, since they may have to review the sufficiency of the wrap up coverages, enroll in the program, analyze the cost of insurance in bidding for the job, and periodically submit documentation bearing on the cost of insurance (e.g., payroll information) to the administrator. These administrative burdens may render small construction projects unattractive for wrap up programs, although for multi-residence projects, a wrap up program may be the only game in town.
6. Improved safety and risk management
An owner/developer or general contractor, working in conjunction with the wrap up insurer and administrator, may be better positioned to create and maintain a unified safety and security program, and to set consistent risk management standards for the project. This centralized risk management may help achieve a higher level of project safety, which could reduce the frequency and severity of bodily injury and property damage claims, thereby reducing the cost of insurance for the project.
7. Reduction in disputes among construction participants
Since all construction participants are insured under the same wrap up policy, a wrap up program hopefully has the beneficial effect of reducing finger-pointing and litigation among the participants in the event of a third-party claim, such as a claim against them by an injured passer-by, subcontractor employee, or neighboring property owner. Indeed, wrap up programs present an opportunity for participants to work cooperatively in resolving such claims. Further, because all enrolled participants are insured under the same policy, the wrap up insurer typically cannot pursue a subrogation claim against the insured participant that caused the loss.
8. Risk of the wrap up insurer's insolvency
Unfortunately, wrap up insurers, like other insurers, are not immune from the risk of insolvency. In the unlikely event that the wrap up insurer becomes insolvent, there may be a gap in coverage and claims administration. This gap may be partially filled if the wrap up program includes excess or umbrella policies that "drop down" in the case of insolvency, or when a state insurance guaranty fund takes over for an insolvent insurer. Nonetheless, a primary purpose of insurance is to spread risk, and that purpose might not be advanced under a wrap up program, where one insurer (at least at the primary layer) takes the place of what would otherwise be multiple insurers for the individual participants.
9. Lack of legal precedent
There are few judicial decisions interpreting wrap up policies. This is likely a function of the fact that wrap up insurers frequently use custom (manuscripted) provisions in their policies to address a particular project, and even when standard insurance language (e.g., ISO forms) is used, that language may be modified. On the other hand, where a wrap up insurer uses standard forms (e.g., ISO's CG 00 01), judicial decisions in the non-wrap up context may be relevant to interpreting the same language in a wrap up policy. Nonetheless, parties tend to favor certainty in their business affairs, and the use of untested language in a wrap up policy, and the lack of precedential authority, may increase the risk of differing interpretations and, therefore, the risk of coverage disputes and litigation.
10. Limited market for wrap up insurers
Few insurers are underwriting wrap up programs. If residential exposures are involved, the market shrinks even further. Depending on the size and nature of the project, the limited market for wrap up underwriting may impact the controlling entity's ability to bargain for coverage terms and price.
Having addressed the nature of a wrap up program in Part 1, and the pros and cons of using a wrap up program in this Part 2, Part 3 will address several key issues that can arise under a wrap up program and that should be considered by all of the construction participants.
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