Owner Controlled Insurance Programs as a Tool of Construction Risk Management

 

Brandon Blankenship and Gouranga C. Banik

School of Architecture, Civil Engineering Technology and Construction

Southern Polytechnic State University

Marietta, GA 30060

In the increasingly competitive construction marketplace Owner Controlled Insurance Programs (OCIP) are becoming more common.  Once used primarily by owners on a single site project, they are now being used to bring multiple sites together under a single insurance package.  Project owners use OCIPs to reduce accidents and costs.  OCIPs can create uniform coverage for all contractors and subcontractors by using a single carrier and a single policy for workers’ compensation and commercial general liability.  This paper presents the risks and liabilities faced by contractors based on exclusions and gaps in the OCIP program.  Several interviews were conducted with industry representatives and relevant insurance data were analyzed to gain valuable information about benefits of OCIPs.  The information presented shows that project owners can save money by properly managing their insurance programs under OCIPs.  However, the odds of success are greatly improved through close partnership with contractors and subcontractors who prioritize jobsite safety and by owners who share financial rewards.

Key Words: Owner Controlled Insurance Program (OCIP), Construction, Insurance, Benefits

Introduction 

Owner Controlled Insurance Programs are becoming an effective Risk Management Strategy to improve the safety of construction operations and to reduce construction costs for a larger project.  According to AGC guidelines, the cost of insurance on a construction project can account for 4% of the total construction budget (AGC, 2002).  In an attempt to minimize this expense, project owners assume the burden of providing workers’ compensation (WC) and commercial general liability (CGL) for all contractors involved with the project.  The basic operational features of an OCIP are: (1) the owner purchases insurance coverage (all or some specific elements) to cover all contractors and subcontractors on a project; (2) there is an integrated owner-contractor managed safety program on the project; and (3) claims are processed centrally. Generally, the use of an OCIP can save money on large projects through lower bulk insurance rates, improved safety management processes, and reduced disputes between contractors over who was responsible for a particular loss (Grenier, 2000, Lew 1998).

There are many variations in how an OCIP can be set up. For example, the project owner can purchase coverage, self-insure, or devise a program that blends the two. By retaining more of the risk (through self-insurance or higher deductibles) the owner can obtain lower premiums for the coverage actually purchased. When the insurance program contains a significant element of self-insurance (either a direct self-insurance program or a program with large deductibles) the owner is usually required to provide assurance they will have the money to make those long-term payments as they come due. The State Insurance Agency (and the insurance company, when it pays claims and then recovers deductibles from the owner) may require the owner to provide a letter of credit or establish a reserve account to guarantee it will have the resources to meet its obligations.

Contractual Risk Transfer Fallacies

One very important issue in making the decision between OCIP and Conventional insurance on a project is the efficacy of the risk transfer process in a conventionally insured project. The conventional approach requires the contractor to provide insurance in accordance with the owner's specifications, to execute an indemnity agreement and to add the owner as additional insured on appropriate coverages. While this is a practice with a long history and while most claims are handled effectively through this mechanism (because it is good business to do so), when the catastrophic loss price tag gets high enough the contractor and the contractor's insurer often undergo a conflicting attitude and approach.

Inherent Defects in the Contractual Risk Transfer Mechanism

Contractual risk transfer is at best a haphazard exercise. A “bulletproof” contract that adequately transfers all risks to another party is unachievable. It would be impossible to keep up with all the potential limitations, exclusions, unknown endorsements and other coverage gaps in another party’s insurance program without almost daily contact with that party and their insurance broker. This is not to say that the risk transfer mechanism does not usually work. It does (often primarily because the contractor wants to maintain good relations with the owner and the insurer is willing to go along) - until a severe loss occurs.

Even if the other party provided very broad insurance coverage, their insurer may work diligently to assure that it will not have to pay a major claim to an additional insured. Insurers introduce legislation, revise policy wording, change standard endorsements and litigate claims with the intent of reducing or avoiding liability to an additional insured. New standard policy forms and new editions of additional insured endorsements usually limit the liability to additional insureds.

In an owner-controlled program, unlike the other options, the owner need not rely on the contractual risk-transfer mechanism (although it is still used). In conventional insurance programs, and even in contractor controlled programs, the risk-transfer mechanism is the indemnity agreement. The financial guarantee for the indemnity agreement is the contractor’s insurance policy.

This mechanism is less than perfect. Insurance codes and government codes sections severely restrict the owner’s ability to obtain protection in a construction contract. Some of these statutes, originated by and passed through the efforts of special interest groups recently were made more complex for the owner. Consequently, there may be little relevant case law on these recent code changes further increasing the uncertainty. The owner may have to litigate to enforce its intended protection.

Most of the time, none of this conflict occurs. Contractors' insurers usually pay claims, including those also made against the owner. It is only the big claims that send the attorneys scurrying to find chinks in the indemnity armor. Of course, the big claims are the main reason for which insurance is needed in the first place.

Some of the reasons why “hold harmless” and “indemnity agreements” backed by insurance can not achieve their goals (one cannot get a bond against any of these) are given below.

While some of these problems could occur with an owner’s insurance program (OCIP), all of these outcomes are far less likely to result when the owner is placing a multi-million dollar negotiated insurance program with top-rated insurers through top-level insurance professionals. General contractors of this caliber proposed on some of the CIP projects may have excellent programs with great negotiating strength. However, the contractors don’t have the negotiating leverage of an owner with regard to the specific risk transfer needs of a multi-million dollar project.

Benefits of OCIP Programs 

The Owner Controlled Insurance Program (OCIP) provides the project owner with greater control of the project-related insurance costs.  OCIPs create a single insurance program with consistent coverage for all parties involved in the construction project.  OCIP can combine together insurance coverage, safety coordination and administrative functions into one package, which encompasses all eligible contractors on the project site (ACIG, 2002). In the past, OCIPs typically were limited to large, single-site construction projects.  OCIPs have now been applied on smaller jobs if the project owners make the effort to link multi-site projects together under one single umbrella (ACIG, 2002).  The OCIP generally covers the workers compensation (WC), commercial general liability (CGL), umbrella, and builders’ risk related to each specific job site.  Coverage for the job-site risks of the owner, construction manager, general contractor, contractors, subcontractors and design firms is included in the OCIP.  Projects covered by an OCIP are generally in excess of $50 million in construction costs for single site projects and $100 million for multiple site projects, and they are usually multi-year programs of a fixed duration (Lew, 1998). 

In a traditional project arrangement, the project related insurance costs are fixed by the lump sum bids that include the estimated insurance cost.  With traditional insurance programs, the owner transfers all risk of loss to the contractor and subcontractors.  In return the owner pays a fixed premium for a guaranteed cost.  If the contractor underestimates the insurance costs, and suffers adverse losses, the contractor is not able to pass this additional cost on to the owner.  Contractors typically factor insurance costs into their bid price.  When the owner obtains insurance for the project, contractors can no longer include those costs and bid prices are lower as a result.  When the owner decides to use an OCIP, he is trading financial certainty for the potential of lower cost of risk.  While owners may save money and gain efficiencies through such programs, some experts warn that OCIPs can be risky for both owners and contractors. 

Owner Benefits 

Many large projects have multiple contractors due to logistics, size and project phases.  This situation can lead to different coverages, different terms and conditions policies for each contractor.  OCIPs are designed to provide project owners with the specialized coverage and the program management control they need.  Project owners expect an OCIP to reduce insurance costs through volume discounts and better management of claims.  Through volume purchasing of insurance coverage, owners may realize a cost savings of up to 10-15% and owners typically obtain a net savings of 1-2% of the total construction costs (David Grenier, 2001).  Cost savings are a key benefit and are usually the reason owners select an OCIP, but improved coverage is the main goal (Hastings, 2000).   

Owners obtain improved coverage by ensuring that minimum insurance requirements are met without having to verify each contractor and subcontractor’s coverage limits, as well as monitor the financial stability of the insurer. 

Table 1: Costs for WC Claims

(Name of owner, insurance company and sites are removed for Proprietary Purposes) 

Claims management is a primary method through which the costs savings of a project are obtained. OCIPs efficiently process claims by eliminating litigation to determine responsibility for any accidents, as only one broker is involved.  OCIP claims costs are evaluated in terms of total straight payroll, hours worked, number of workers compensation claims, number of lost time incidents and the number of Occupational Safety & Health Administration (OSHA) recordable incidents for four sites for the same owner based on unpublished insurance cost data (Table 1).  Information in Table 1 reflects the final cost of the OCIP per project work hour and per $100 of payroll which is a good indicator of success of OCIP.   

The owner paid $3.40M as insurance costs for all the projects under OCIP compared to $5.70M under traditional insurance policy, saving about $2.30M (3.53% based on payroll). 

Based on the evaluations of 30 completed wrap-up projects with an average project size of $419 million and an average duration of 36 months to completion in 1999, it is found that OCIPs saved from -$0.17 to $1.85 per worker hour (Benchmark Report, 2000-unpublished).  The workers’ compensation losses for these projects were 3.3% of payroll, or $0.42 per worker hour, with an average loss of $8,500 per claim.  Out of 30 OCIP projects, 27 projects saved money, on average, $4.2 million per project.  In 2000, 70 OCIP projects with an average project size of $231 million and an average of 40 months to completion were evaluated.  The 2000 data show workers’ compensation losses were reduced to 2.83% of payroll with an average loss of $7,140 per claim due to the better management of programs.  This improvement can be credited to the fact that 86% of the 2000 projects had a full time safety person on site (Benchmark Report, 2000).  

Table 2:  Savings in OCIP Vs. Traditional Insurance Costs in Terms of Payroll Percentages

(Actual insurance industry numbers and descriptions were removed for Proprietary Purposes) 

Table 2 represents a series of five separate OCIPs run by one reputed national Insurance Company (Name was not mentioned for proprietary purpose).  The numbers represent the estimated payroll, the total estimated incurred costs and the estimated cost per $100 payroll and program costs for the projects that were constructed under and OCIP that the costs of insuring the same projects under a traditional insurance program. 

By choosing an OCIP rather than a traditional contractor provided insurance program the owners of these five single site projects experienced an average savings of 2.29%. 

As presented in Table 1, by purchasing an OCIP on this multiple site project the project owner experienced a savings of 3.54% because of volume purchasing.  On the other hand, OCIP project owners saved about 2.29% from five different projects implemented by different contractors and subcontractors and under different conditions. The savings illustrated in both the cases is minimal.  Therefore, in order to achieve cost savings, the project owner will have to have a smoothly operating administrative system as well as an excellent working relationship with the general contractors and the sub-contractors.  Slight variations in the daily operations of the job could result in no net savings.  If the actual claims cost varied significantly from those shown in Table 2, the savings would be quickly lost.

Owner Concerns 

The owner’s administrator collects payroll information for all contractors and subcontractors on a weekly basis.  Significant cost to the owner can be added if this process can not be managed properly.  Market conditions make the success or failure of an OCIP highly volatile.  If an OCIP is begun during a soft insurance market and the market hardens, the costs can increase, coverage may be reduced and the limits possibly will be lowered.  Conversely, if an OCIP is begun in a hard market then soft markets, the cost may be less than projected.  This volatility can make it difficult for the owner to provide the necessary coverages stipulated by the construction project.  Since wrap-up programs usually have a loss sensitive feature, the insurance cost on the project is not fixed.   

Contractor & Subcontractor Benefits 

While operating under an OCIP, contractors can benefit from improved safety and loss control and the elimination of coverage disputes allowing more efficient claims handling.  In many situations OCIPs allow small and minority contractors to participate in major projects since they do not have to be concerned about their own level of loss exposure and are automatically covered under the owner’s insurance.  An OCIP may make it less costly for such a contractor to participate in major projects, since the contractor will not be concerned about its exposure.  OCIPs also allow smaller contractors to have access to cost-control techniques applied to injured employees, which are often not offered by their individual insurance programs.  Contractors benefit from efficient claims management by eliminating litigation to determine responsibility for any accidents by only involving a single broker.   

Contractor & Subcontractor Concerns 

OCIPs often have exclusions and gaps, which place the contractor and subcontractors at a disadvantage compared to the insurance programs on traditional construction jobs.  OCIPs put additional costs and burdens on the contractor and potentially penalize the contractors with good safety and loss control programs.  In A Contractors Guide to Owner Controlled Insurance Programs, The Associated General Contractors of America (AGC, 2001) recommends that contractors consider the following issues when bidding an OCIP project:

OCIP package may not include all the contractors.  Often contractors that perform a large amount of work away from the job site may not be included.  Additionally an OCIP may establish a minimum contract value in order to be included in the insurance package.  It is important for contractors to know which groups are excluded so that their bids and proposals can be correctly submitted.   

Contractors cannot make the assumption that they are getting the same level of insurance that they would normally have under their own policies.  They must remove any wrap-up exclusions from their own CGL policies by adding a difference-in-conditions (DIC) liability endorsement to their own policy.  Frequently, the limits of coverage are shared among all contractors and subcontractors on the job.  The contractor and subcontractors must determine if the limit is adequate in the event of a major loss within their organization.  The project owner may require that he be added as an Additional Insured to the liability policy of the contractors working on the project.  This request protects the owner from (1) off-site exposures and/or (2) limits of the OCIP being deemed insufficient.  With careful examination of the OCIP agreement, the contractor and subcontractors existing insurance should only provide excess coverage.  Filling these gaps requires additional work for the contractor and the broker.  

The contractor’s own general liability and workers’ compensation rates are calculated and based on a moving three-year window in terms of total revenue and experience modification rating (EMR).  EMR represents the past safety performance of contractors and subcontractors.  As they participate in more OCIP projects, their eligible revenue is reduced.  This could cause problems as insurance companies often set minimum revenue requirements to write policies. The contractor’s OCIP revenue is not considered in this requirement.  As a result there is an increase in the cost of insurance on the projects that OCIPs do not cover.  As contractors purchase less of their own insurance, they may have to pay more for the insurance they do purchase and inevitably that additional cost finds its way into the cost that owners must pay to construct traditionally insured projects. 

The contractor plays an important role in making sure the OCIP is administered in a proper manner.  Without proper contract documents it may become difficult for the contractor to enforce compliance by subcontractors on portions of the insurance program. If the contractor is responsible for certain administrative functions, they must negotiate a system for reimbursement for the expenses of providing that service.  Under an OCIP, all contractors must verify that each subcontractor also is enrolled in the OCIP and obtain premium credit worksheets and certified monthly payrolls.  This requires additional time and effort for the contractor, for which it will not be reimbursed.  The administrative cost will be incorporated into the cost of the work performed.  Ultimately, the project owner must accept all responsibility and liability for the OCIP administration. 

The bidding of an OCIP job is an additional time and cost burden placed on the contractor and subcontractor.  Often contractors are required to submit two bid: one containing a bid price with insurance and another without the insurance cost.  The second bid requires much documentation and explanation.  Contractors and subcontractors must carefully consider the hidden costs of wrap-up insurance in an effort to minimize the insurance credits given in their bid prices.  These hidden costs can include the loss of volume discounts for their own insurance purchases, coverage gaps, and administrative cost of dealing with unfamiliar procedures and company representatives. 

An OCIP may encourage the award of contracts to unsafe contractors (AGC, 2001).  This concern arises from the fact that the insurance costs for the contractors and subcontractors have been removed from the bid price.  Insurance brokers and carriers reward the contractors and subcontractors who maintain safe jobsites with lower insurance premiums.  On the other hand, unsafe contractors and subcontractors generally have higher insurance premiums.  On a job with traditional insurance practices, the difference between these two would be reflected in the final bid price, since insurance is typically as much as 4% of the contractor’s bid price.  Contractors with good safety records have a significant advantage of being a low bidder for a project, whereas, contractors with bad safety records are, theoretically, at a significant disadvantage at the bid table.  This significantly increases the odds that the low bidder will be a safe contractor rather than an average or unsafe contractor.  Under an OCIP, safe contractors lose the competitive advantage and have the same chance to become the low bidder as an unsafe contractor.  Because an OCIP transfers the responsibility for the losses to the owner and the insurance company, the general contractor has no incentive to award subcontracts to safe subcontractors.  This potentially admits unsafe subcontractors to the jobsite, a fact that may have a negative effect on the overall safety and well being of all parties on the jobsite. 

If the OCIP covers Builder's Risk exposures, the general contractor should insure that:

Suggestions for Contractor and Subcontractor on OCIP Projects 

Contractors can discourage owners and their brokers from putting off important decisions by asking the right questions at the right time. Contractors, and their legal and insurance advisors need to start asking questions about any OCIPs they encounter.  Contractors have every right and reason to know exactly how these programs will work, including the details of the safety and other loss control programs that will be one of the keys to its success – or failure. 

Most OCIPs are generally underwritten on some form of loss sensitive program.  The owner’s financial interest is enhanced if there are reduced losses on the project.  The owner benefits financially when a claim is denied or if the contractor must contribute to the claim.  However, since all of the contractors and subcontractors working on the project are also clients of the broker, the broker has a fiduciary duty to protect their interests as well.  This relationship has the potential for conflicts of interest between the owner, broker and insured contractors.  The contractor should seek an additional contract to hold the broker responsible for their performance and represent the contractors’ interests within the OCIP. 

Conclusion 

The financial benefits of OCIP are significant if it is properly written and managed.  But it requires a number of adjustments to practices and policies of all contract participants in order to become successful.  In addition to cost savings by the owner through careful design and efficient administering of OCIPs projects, contractors and subcontractors can also benefit from project savings in terms of insurance as well as the experience gained while on the project and working under an OCIP.  In an effort to maintain a competitive bidding environment, owners should only accept bids from contractors with an EMR above a set level.  The EMR allows them to evaluate the safety performance and experience level of contractors.    

Because contractors are in the best position to manage subcontractors and other firms on a daily basis to ensure a safe job site and maximize project savings, OCIPs must continue to provide them with incentive measures in the form of bonuses based on premium savings.  Likewise negative incentives must be applied if safety goals are not met.  Additionally, owners may want to carefully define the scope of the OCIP brokers’ services and set performance standards.  In the attempt to tie brokers to the performance of the OCIP, owners may begin to tie compensation rates to the programs’ performance. 

Project success comes only when all parties involved carefully monitor their daily operations.  By taking advantage of the safety training and education offered under an OCIP, contractors also have the potential to carry that knowledge to their other projects; resulting in fewer accidents and a generally safer jobsite.  The parties of an OCIP must begin to discuss coverage issues and changes in advance.  Through close communications owners, contractors and subcontractors will become more comfortable working with one another on OCIP projects. 

References 

American Contractors Insurance Group (2002). “Owner Controlled Insurance Program Issues.” ,  www.acig.com. 

Associated General Contractors of America (2001). “OCIPs Look Before You Leap! A Contractor’s Guide to Owner Controlled Insurance Programs.”  

Associated General Contractors of America (2002). “Typical Problems with Studies and Other Pieces On Owner Controlled Insurance Programs.” www.agca.org. 

Bukowski, James (1996). “Best Practices for Owner-Controlled Insurance Programs-Part I.” Volume 17. The Risk Management Letter, Issue 6, www.griffin.com. 

Burnett, Jermal (2003). Account Executive. The St. Paul Insurance Company. Atlanta, GA. Personal Communication. 

Grenier, David L. (2000) “Owner Controlled Insurance Programs, Part I.” Construction Financial Management Association. September/October, www.c-risk.com. 

Grenier, David L. (2001). “Owner Controlled Insurance Programs, Part II.” Construction Financial Management Association. January/February, www.c-risk.com. 

Hastings, Michael (2002). V.P. of Construction Services. Marsh. Atlanta, GA. Personal Communication. 

Johnson, Brian.  (2002). “Contractors look to owner-controlled insurance to cut costs.” Finance and Commerce, www.financecommerce.com. 

Kentner Sellers, LLP (2001).  “OCIPs Becoming More Common.”  "THE ADVISOR" A Construction Industry Newsletter. http://www.kentnersellers.com.

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Pitcock, James D., McIntyre, William S., & O’Neil, Michael J.  (2003). “Multiple Site Wrap-Ups in the Public Sector.” Associated General Contractors of America.  www.agca.org. 

Yoch, Stephen E. (2002). "Stop Gambling — Understanding OCIPs." Sheet Metal and Air Conditioning Contractors National Association (SMACNA). Annual Convention. Felhaber, Larson, Fenlon & Vogt. St. Paul, Minnesota. 

“2000 Wrap-Up Practice Conference. Benchmark Report.” March 6-8, 2000. Marsh.