INTRO: Contractor-controlled insured programs are increasing in popularity, but these programs are not risk-free. Mike Hastings, Marsh Inc.'s project risk practice leader for U.S. construction, details best practices to create a successful program and solid relationships with both subcontractors and owners.

More general contractors today are implementing contractor-controlled insured programs, or CCIPs, amid pressure to improve profit margins and increased uncertainty in the construction and insurance industries. Several states have passed legislation that limits a general contractor's and subcontractors' ability to indemnify and provide additional insured status for another's contributory negligence on their commercial general liability programs. In addition, contractors remain concerned about the high rate of subcontractor insolvencies and the ability of subcontractors to purchase and maintain adequate insurance coverage.

For a general contractor able to assume and manage the additional risks arising from its subcontracted operations, a CCIP can provide greater coverage certainty, improve relations with owners and subcontractors, and potentially increase the firm's competitiveness and profitability. Such programs, however, do not come without risk.

Contractor-controlled program application

A CCIP may be implemented to cover a single project or on a continuous or “rolling” basis where all eligible projects are enrolled into the program. Under a CCIP, the general contractor purchases general liability, excess liability, and workers compensation insurance covering job site risk for itself and for enrolled subcontractors of every tier. The program is designed to respond to claims arising out of operations during the construction period, as well as those arising out of completed operations through a specified period — ideally, the applicable statute of repose.

Subcontractors enrolled in CCIPs remove from their contracts the cost for insurance. The general contractor in turn applies the “avoided costs” to the purchase of the CCIP.

By implementing a CCIP and controlling claims costs through rigorous loss control and claims management procedures, a general contractor may reduce project insurance costs by up to 50% compared to conventional insurance. The cost savings may be applied to improve competiveness, profitability, or both.

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Risk of implementing a CCIP

Implementing a CCIP presents many potential benefits for a general contractor, but there is a significant assumption of risk involved. Programs are often written with a deductible of $500,000 or even $1 million per claim. Although total deductible losses are typically capped based on a fixed percentage of payrolls, it is not always feasible for a general contractor to charge the full maximum loss cost to its jobs and remain competitive. With an unfunded maximum cost, failure to control losses could potentially result in significant financial loss.

Another potential risk for a rolling CCIP is failure to enroll a sufficient volume of projects in the program. To protect the cost of the capital backing their obligation to pay claims, underwriters often charge a fixed minimum premium equal to between 75% and 90% of the total premium estimated at the CCIP's inception. A general contractor that fails to run the minimum volume through the program will nevertheless be required to pay the minimum premium.

To provide flexibility in the face of uncertainty in the U.S. economic recovery, many insurers have agreed to implement an adjustable rate. In this structure, a contractor that fails to enroll the expected volume of projects faces a higher rate on its enrolled projects, rather than a high fixed-dollar minimum. With additional enrolled projects, the rate may decrease retroactively until reaching an established minimum. While this structure may facilitate fixed minimum premiums as low as 50% of the estimate at binding, the cap on deductible losses typically remains fixed. Regardless of program structure, realistic expectations and a healthy project pipeline are critical elements to implementing a successful CCIP.

Profile of a successful sponsor

Common traits of contractors with successful CCIPs generally include:

• a highly-developed safety culture that permeates throughout the organization, including project managers, superintendents, and tradesmen, and extends to subcontractors of every tier;

• experience in managing claims under a high deductible program;

• a robust subcontractor prequalification process;

• well-established subcontractor relationships in the geographies they operate; and

• a significant percentage of revenue derived from repeat business from established customers to meet the CCIP minimum premium requirements.

Although CCIPs covering smaller projects have been successful, expected projects with values between $30 million to $40 million or more are widely considered necessary.

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Working with subcontractors

Historically, many owner and contractor-controlled insurance program sponsors have measured the financial success of their programs by comparing the cost of the program to the avoided cost of subcontractors' insurance. This approach is widely falling out of favor because it focuses on a measure of contract savings rather than total project costs, including materials, labor, and insurance.

To illustrate this point, consider competing bids from Subcontractor A, whose insurance cost is $50,000 and whose bid price for material and labor is $1 million, and Subcontractor B, whose insurance cost is $30,000, but whose bid price for materials and labor is only $800,000. Subcontractor A's price may represent greater insurance savings ($50,000 vs. $30,000), but Subcontractor B's price represents a lower total cost and greater value to the project.

To shift the focus to project costs, CCIP sponsors are instructing subcontractors to bid net of applicable insurance costs, so that bids are evaluated based on cost of materials and labor alone. To recognize the importance of safety, many implement a robust subcontractor prequalification process including a review of a subcontractor's Occupational Safety and Health Administration total recordable incident rate and workers compensation experience modification rating.

To achieve the full cooperation of subcontractors, best practices include:

• full disclosure of loss control and administrative requirements at time of bid;

• program coverage, limits, and duration providing adequate protection to subcontractors;

• accommodation for subcontractor participation in claims adjustment where the subcontractor's employee or reputation is involved;

• elimination of the “true-up” for insurance costs, whereby subcontractors that underestimate labor on a project are assessed an amount equal to the insurance cost associated with excess payroll.

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Working with owners

Many general contractors with CCIPs establish their contract price net of insurance costs, and charge for the CCIP at a fixed percentage of that cost. This approach provides a simple mechanism to charge the CCIP to a given project. In cases where the owner wishes to understand how the percentage was derived or compare it to the cost of a potential owner controlled insurance program, or OCIP, the supporting detail may be provided.

While there is often no obligation to advertise the CCIP if it satisfies contractual insurance requirements, many general contractors choose to promote their program and its safety culture as an added value to the project and all of its stakeholders.

In cases where the owner is inexperienced in managing construction risks, a CCIP may be seen as a less risky and simpler alternative to an OCIP. In some cases, the general contractor may offer a “CoCIP,” effectively allowing an owner to assume the risks and rewards of an OCIP, but avoid start-up costs and gain economies of scale by using the contractor's established CCIP.

CCIPs are not appropriate for every construction business owner, but a general contractor with a well-developed safety culture, a healthy backlog of business, and an appetite for risk, may benefit greatly by implementing one.

Mike Hastings is Marsh Inc.'s national project risk practice leader within Marsh's U.S. construction practice. Over the past 17 years, he has taken a lead role in developing and implementing Marsh's consultative approach to construction project risk management, including risk identification, financial modeling, loss control and mitigation, insurance program design, and consulting services for company and project-specific insurance programs. He can be reached at 404-995-2680 and Michael.d.hastings@marsh.com