Many owners are turning to owner-controlled insurance programs (OCIPs) as a cost-effective solution for ensuring risk exposures are covered adequately.
An OCIP is obtained and managed by the project owner and can be implemented for single or multiple construction projects. Rather than each contractor providing its own insurance and passing this cost on to the owner, the owner purchases certain lines of insurance (such as general liability, excess liability and workers’ compensation) to cover participating contractors of all tiers, except those specifically excluded. A contractor enrolled in an OCIP provides the owner with a bid credit (or estimated insurance cost), which in essence helps the owner recoup premiums for the OCIP’s coverage.
Projects deemed feasible for an OCIP typically cost around $100 million and subsequently have a greater exposure to losses based on size and scope. Owners may consider OCIPs unappealing on the surface due to the collateral insurers require to cover payment of losses and large program deductibles.
However, OCIPs can provide insurance cost savings, broader coverage with higher limits, and better claims control and coordination.
Types of Programs
Depending on the program design, insurers require collateral for two types of financial loss mechanisms: paid loss and incurred loss programs. An insurer providing a paid loss program will require the owner to provide the anticipated deductible expenses upfront, but will wait until the losses are developed and paid out before seeking reimbursement for a claim payment from the owner. To ensure the owner can pay future losses, a letter of credit is used as a form of collateral.
An incurred loss program requires the owner to provide cash collateral in the amount the insurer deems to be the project’s potential maximum loss. In the event of such a loss, the cash collateral account will pay the owner’s deductible expenses and developed losses on a depleting or non-depleting basis.
Managing the Overall Risk
Many see collateral as a cut-and-dry issue and are not advised of the options available to effectively manage it. Collateral is directly affected by the owner’s risk management techniques and procedures. Here is a brief step-by-step overview of how to manage this risk successfully.
- Negotiate the amount of collateral required by the insurer. In some cases, insurers may consider a collateral amount that is less than the projected maximum loss. A sound review of the owner’s financials and project history are key to achieving an initial reduction in the collateral requirement.
- Engage a general contractor that shares the owner’s vision on safety. This is critical because the contractor ultimately will apply the owner’s safety approach. Employing full-time safety managers, mandatory safety programs and orientations are a few common techniques. The overall loss control strategy inevitably will impact collateral, whether positively or negatively.
- Schedule collateral reviews. The timing of reviews of collateral obligations should be outlined in the program agreement and should occur at least yearly. Having an appealing loss development factor while illustrating a strong project safety culture, as well as high-quality materials and workmanship, are critical negotiation tactics. When possible, loss development factors should be negotiated upfront, agreed upon with the insurer and outlined in the program agreement.
- Inform the insurer of any changes in project size and scope. A substantial fluctuation in exposure can directly impact collateral requirements. Understanding the statute of repose imposed on the project will provide transparency on the number of years (post-completion) the project will be exposed to products or completed operations claims brought by third parties. For example, the statute of repose for a project in Iowa is 16 years, and the likelihood of construction defect claims is far more probable than in Kentucky, where no statute applies. Essentially, an Iowa project can expect to have a portion of collateral tied up for a substantial period of time.
- Identify the most prevalent construction defect claims in the project’s geographic region and adopt a strategy to mitigate the potential for loss. For example, water intrusion is the most common cause of construction defect claims in the Northeast. Therefore, the implementation of a microbial remediation program, along with evidence of sound flashing and window systems, would provide a strong case when proposing a minimal likelihood of normal construction defects for that region.
- Engage contractors with strong reputations for safety and quality workmanship. Reviewing references and project résumés are essential tools; however, reviewing a contractor’s loss history provides the most transparency. For example, a contractor with a workers’ compensation experience modification rating above 1.0 should automatically raise a red flag. A trend of liability losses stemming from completed operations hazards would lead an insurer to assume the quality of workmanship or materials was not adequate.
- Ask the insurer to participate in comprehensive claims review meetings on a quarterly basis. Understanding current claims helps keep losses under control.
When considering an OCIP, it is important to secure support and advocacy from a broker or risk management advisor to ensure the successful management of collateral and overall risk.