Why do Project Owners and Contractors Like OCIPs?
In Part 8: OCIP Insurance Coverage Considerations, we reviewed various insurance coverages that are typically used with OCIPs. Some were base coverages that provide a core foundation of an insurance & risk management program structure. Others, were optional coverages that may be used with an OCIP at the discretion of a project owner for project-specific risks and exposures. In this section, we will review several reasons why both project owners and contractors like OCIPs.
But, before we jump into that discussion, let’s briefly recap what we have learned about OCIPs so far in the previous sections. It should be becoming clearer that the insurance coverage is a key component of any capital construction project. Also, an OCIP allows project owners to maximize the insurance coverages across the construction project’s numerous contractors and subcontractors on the project site, while at the same time providing potential savings for project owners on the insurance premiums.
We also reviewed that OCIPs are an increasingly popular risk financing approach used on various types of projects, but OCIPs have more practicality on large capital projects than they do on small run-of-the-mill projects. This OCIP evaluation criteria is included as part of a comprehensive OCIP feasibility study and assesses a construction project’s “critical mass.” In addition, we reviewed some pros and cons from the project owner’s and contractors’ perspectives. And, we just reviewed insurance coverage considerations, potential OCIP savings, and other risk management issues.
Now that you have a rudimentary understanding of what OCIPs are, why they are used, and some of their key attributes, we will review if an OCIP is the optimal risk financing approach for certain construction projects. We will also review the fundamentals of the OCIP implementation process and what is required to manage a successful OCIP.
Why Project Owners Like OCIPs
Compared to conventional insurance programs, there are several compelling reasons why some project owners consider OCIPs very appealing as a risk financing approach. Some of the main reasons, which we discussed earlier, include:
- Coverage Quality. While project owners can mandate minimum insurance requirements, it can be very difficult to ensure that these requirements are met. Certificates of Insurance (COI), the typical method of verifying insurance coverage, only provide summary information.
Unfortunately, over the past few years, some insurance agents and brokers have manipulated information on contractors COIs to indicate that certain coverages, or liability limits, are in place, but in actuality, the delineated coverage on the COI is insufficient and not in compliance with a project owner’s contract stipulated insurance requirements. (Note: Never be convinced with what you read on a COI because in some cases, it may be erroneous and not worth the paper it is written on. As they say, “the devil is in the details!” It is highly recommended that in addition to obtaining a COI, you should request copies of the insurance policies [if coverage is suspect], or at a minimum, obtain copies of the insurance policy declarations page, as well as copies of all endorsements that were stipulated in the construction contract’s insurance requirements.)
In comparison, an OCIP guarantees that project owner’s requirements will be met. Also, OCIPs allow project owners to secure broader coverage by leveraging premium volume with the insurers.
- Insurance Limits. Many contractors, especially small contractors, carry only minimum limits of $500,000 to $1,000,000 of CGL coverage. These CGL policies respond to liability arising from the work on all the contractor’s projects they work on during the year, i.e. the CGL is an annual insurance policy. However, a contractor’s aggregate limits on their own CGL insurance policy may be eroded by BI or PD claims incurred on other construction projects. Also, the contractor’s insurance coverage may be inadequate, given today’s multi-million dollar claim settlements and jury awards. Under an OCIP, a project owner can provide $100 million or more of dedicated liability limits of coverage on a project, if required.
- Insurer Stability. On a large OCIP, there can be over 100 contractor and subcontractor firms. Theoretically, there could also be as many as 100 different insurers covering these contractors and subcontractors. This poses two concerns; 1.) Not all these insurers may be financially stable, and 2.) the insurers financial stability at the start of a project does not guarantee financial stability throughout!
Under an OCIP, a project owner has direct control over the selection of insurer(s) and can monitor an insurer’s performance and financial solvency. On some OCIP projects, only one insurer is selected for the primary workers’ compensation and CGL lines of coverage. However, that is rare and not typically the case anymore.
(As a safeguard measure it is prudent to always review an insurer’s A.M. Best rating to determine the past and current stability of an insurer. A.M. Best is one of the oldest and most established rating companies in the world. The A.M Best Financial Strength Ratings (FSR) represents A.M. Best’s assessment of an insurer’s ability to meet its obligations to its policyholders. The A.M. Best rating process involves quantitative and qualitative reviews of an insurer’s balance sheet, operating performance, and business profile, including how an insurance company compares to other similar insurance companies, based on industry standards and assessments of an insurer’s operating plans, business philosophy, and management practices. [A higher rating is preferred, e.g. A-, A, or better.])
- Program Innovation. Over the past few years, some project owners have expressed an interest in using integrated risk management and risk financing methods to augment the benefits achieved from design-build project delivery. This type of innovative risk-transfer approach is best utilized on large capital construction projects; e.g. multi-discipline, multi-year OCIPs. It also requires additional knowledge and a strong project management team to administer.
Some of these programs can be structured to integrate coverage for professional design, environmental remediation, force majeure perils, and builder’s risk.
- Market Leverage. Capitalizing on the market leverage created under an OCIP approach, a project owner can buy broader coverage at more reasonable rates and premiums. This results from the economies of scale from the volume purchasing of high limit, large deductible, insurance coverages. However, these cost savings can sometimes be offset by any increased administrative costs.
- Coverage Triggers. Combining property & casualty (P&C) policies (typically written on an occurrence basis) with professional and environmental policies (typically written on a claims-made basis) can create some difficulties from a claims standpoint, since these divergent coverage triggers tend to conflict.
An occurrence-based insurance policy protects you from any covered incident, i.e. loss, that “occurs” during the policy period, regardless of when a claim is filed. An occurrence-based policy will respond to claims that come in even after the policy has been canceled, if the incident occurred during the period in which insurance coverage was in force.
A claims-made policy provides coverage for claims only when both the alleged incident, and the resulting claim, occur during the period the policy is in force. Claims made policies provide coverage if the insured continues to pay premiums for the initial policy coverage and for any subsequent renewals with the insurer. Every succeeding year, the claims-made policy is renewed, the “coverage period” is sequentially extended. If premiums are terminated, the coverage is terminated. Claims made to the insurer after the coverage period ends will not be covered, even if the alleged incident occurred while the insurance policy was in force.
A claims-made policy will cover claims after the coverage period only if the insured has purchased “extended reporting” or “tail coverage” to cover this extended reporting period. This tail coverage will provide the insured with continuous coverage up to the pre-established time period that is procured.
Okay, now that you have a general understanding of the two types of coverage triggers, let’s revisit the issues of trying to blend two divergent coverage triggers. Let me try to explain this dynamic by an example: If you were to change insurers from a policy with a claims-made trigger to a policy with an occurrence trigger, it could leave a gap in coverage unless certain steps are taken to provide coverage for the “incurred but not reported” claims, if any. The insured must either; 1.) purchase an extended reporting period “tail” from their previous claims-made insurer or, 2.) try to negotiate with the new insurer, i.e. the occurrence-based coverage insurer, to provide coverage for the claims that have occurred prior to the new insurer’s policy period, but are made within this new insurer’s policy period. Good luck with that!
Why Contractors Should Like OCIPs
When a project owner assumes the risk burden under an OCIP, two important benefits are realized: 1) improved loss control, and 2) improved claims management. Both of these benefits minimize the cost of retained losses. Therefore, some of the reasons why contractors should like OCIPs include:
- Loss Control. By complementing the existing safety programs of participating contractors, an OCIP can help standardize safety procedures on the whole jobsite. Also, the project owner can add additional safety staffing, implement a financial safety-incentive program, expand periodic audits, or some combination of these optional methodologies. At the project owner’s discretion, they could use some of money recouped from contractor and subcontractor bid credits, and insurance deductions, to fund these types of safety and loss control programs.
- Claims Management. Over the years, workers’ compensation reform in several states has greatly improved an employer’s control over injured-employee claims management. Cost control techniques (e.g. directing employees to Preferred Provider Networks, using return-to-work and light or modified-duty programs, and medical bill reviews) can potentially reduce an employer’s workers’ compensation costs by as much as 30%. This is relative, and can vary by state.
Project owners can offer these program features to all contractors and subcontractors on an OCIP. The real advantage is to small contractors, since many small contractors would not normally benefit from these features through their individual insurance programs.
Another claims-related benefit is the streamlining of CGL claims management. Under a conventional approach to project insurance (i.e. contractor-provided insurance), the project owner, contractor, and/or subcontractor involved in a claim are all likely to be represented by different insurers and attorneys.
Using an OCIP helps to mitigate and lower the cost of claims because only one CGL insurer provides the insurance coverage for all parties. (With high limit OCIP programs, it is important that the primary CGL and excess GL coverage that excess GL policies be written on a follow-form basis in order to have seamless coverage through the excess GL tower of coverage.)
Improved safety and loss control programs, as well as enhanced claim management processes, are beneficial to both contractors and to the project owner on an OCIP.
Hope you enjoyed this post. I will look forward to your comments. I will share more Insights in future posts.
In OCIP 2.0 – Part 10, we will review the Necessary Framework for an OCIP.
Thank you for visiting and reading C-Risk Insights.
Until next time…
David Grenier is the Managing Director and Principal Consultant at C-RISK, LLC.
C-Risk is a risk management consulting company that provides strategies and insights on wrap-up insurance programs to help project owners in the public and private sector who are involved with large capital construction projects.
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