The Risks and Rewards of Contractor Wrap-Ups

Like the rest of the nation, Florida's building boom hit the wall in 2008. As we continue to pick our way through the rubble in 2009, an often-misunderstood insurance program is gaining favor with developers and contractors.

OCIPs (Owner-Controlled Insurance Programs) and CCIPs (Contractor-Controlled Insurance Programs) -- commonly referred to as "wrap-ups"-- occur when a construction project sponsor purchases a single set of policies for workers' compensation, umbrella/excess and general liability to cover all the entities involved in the job.

Wrap-ups are becoming more popular with project sponsors partly because the "rolling" wrap-ups that combine multiple construction projects have opened the door for more participation by owners and contractors. The single project size of $100 million no longer is the minimum threshold. George Shank, president of National Insurance Advisors and an administrator for numerous large construction wrap-up projects, said that 50 percent of the largest 100 contractors in the country are currently involved in wrap-ups. Many of these are in public sector projects, power plants, hospitals, roads, schools, shopping centers, and entertainment venues. "They are everywhere and growing," said Shank.

Sponsors Like Wrap-Ups

Lower insurance cost is the number one reason for the growth of wrap-ups. There is a large gap between what the sponsor pays for a wrap-up program and what all the contractors and subcontractors would pay for individual policies, and then factor into their fees.

Let's say that all the companies on the project bought their own insurance policies and the combined premiums are $20 million. With an OCIP, the project's premiums could be as low as $10 million. As long as there are no claims, there is a gap of $10 million between traditional insurance costs and wrap-up.

While economies of scale play a role in reducing wrap-up premiums, so do higher deductibles and aggressive safety and loss-control programs. Because a claim closes the insurance profit gap, most wrap-ups have stringent safety and loss control programs -- often stricter than that which OSHA requires.

Sponsors also like wrap-ups because they can control the policy design and obtain larger liability limits than most contractors could get on their own. The coverage is consistent; all parties have the same coverage, limits and exclusions. Perhaps most importantly, all parties are covered by the same policies, thereby limiting sub-to-sub litigation.

What Agents Can Do

While a wrap-up policy may reduce the revenue an agent would derive from the traditional workers' compensation, general liability and excess/umbrella products, it can open the door to fee-based or contingent revenue during a time of declining rates and premiums. By becoming a wrap-up expert, an agent can offer fee-based consulting services to existing customers and differentiate himself when prospecting for new ones.

There are three stages to a wrap-up: pre-bid, project monitoring, and close out. An agent can come in at any point and deliver sound advice and build a lasting relationship.

A feasibility study, including a walk-through of the extra costs and time involved in the related administration and safety programs, will help the contractor determine if a wrap-up is a wise choice. The agent should review the wrap-up policies, investigate potential gaps in coverage and hidden deductibles, and make sure the insurance deduct amount includes all discounts. An accurate deduct can make or break the bid.

It is important to transfer the RFP documents into a format that delineates the construction companies' responsibilities, potential impact on traditional insurance policies, and potential costs. Contractor margins are tight, so even the tiniest of errors or oversight of details can have devastating consequences.

Throughout the project, agents should help verify certified payroll reports and make sure the contractor's wrap-up deductions match the original percentage. Have there been any claims? Agents should watch for late injury reports and their impact on the client, attend claims meetings, and monitor injured employees and their return-to-work efforts.

At the end of the project, agents should attend wrap-up audits and the audits of non-wrap-up policies to confirm that wrap-up payroll was excluded. Ensuring that deductions are accurate is essential to the client's profitability.

A project my firm reviewed had $265,000 total payroll in a total bid of $900,000. The wrap-up administrator was supposed to apply five percent of the payroll to determine the contractor's final insurance cost deductions. Five percent of $265,000 is $13,250, but the administrator applied that five percent to the total contractor cost of $900,000 and came up with $45,000 in deductions instead of $13,250! We were able to spot and correct the mistake, saving the client $31,750.

Because contractors do not typically think to tell their agents they are getting involved in wrap-ups, agents must proactively watch for signs and offer their services. If a company's workers' compensation premiums are dropping, the agent should ask if the client is working on a wrap-up project and offer to help with wrap-up preparation and management.

Contractor Beware

There are hundreds of ways for contractors to lose money in wrap-ups. Providing the wrong information on the Insurance Calculation Worksheet is an easy way. These worksheets are not consistent from job to job. Being unprepared for the additional administrative and accounting burdens, being subjected to gaps in coverage, and being on the wrong end of inaccurate audits are a few other profit-drainers.

Then there are some unintended consequences. Ideally, a contractor would benefit from its good safety record by deducting its discounts, the credit experience modifier, and large deductibles and retrospectively rated pricing to get the net cost of insurance. However, the forms do not always allow for these. In fact, the process can favor contractors with bad safety records. Poor safety translates into higher experience modification factors, claim cost, lost productivity, and higher premiums. Backing out the higher premium means the contractor gets to deduct more money for insurance costs and produce a bid lower than competitors with good safety records and lower premiums.

There is also a cost to safety compliance, which contractors usually do not count until the job is underway. There will likely be requirements for more safety meetings than usual, time they might not have built into the bid.

Plus, once a construction company exceeds a certain number of employees on the site, it may be required to place its own safety manager on site at its own expense. The project sponsor may also have its own safety person, and OSHA could assign another -- so the contractor's employees end up trying to comply with interpretations of three safety programs.

OCIPs and CCIPs frequently have hefty fines for safety violations, and often these are not addressed in the bidding process. Contractors and subcontractors rarely receive copies of wrap-up documents until after they commit to the job. They usually get copies of the contract and may or may receive copies of insurance policies, but the wrap-up documents with the compliance data don't usually arrive until they are already obligated to the job. Then, the documents are usually filed unread until something happens. It is very common for a contractor to be unaware of stiff fines for safety violations until it receives one. Remember, wrap-up safety programs are usually stricter than OSHA's, so even a contractor with outstanding safety protocols may find itself slapped with a $500 fine because a worker climbed over six feet without being tied off.

Another way wrap-up administrators protect their insurance profit is with high deductibles. On the liability side, if a plumber forgets to tighten a pipe and a water-damage claim occurs, the plumber could face a deductible as high as $25,000. Even if contractors read the wrap-up documents -- and that's a big if -- once they are under contract, they're stuck. It is very difficult to negotiate after the fact.

Other Pitfalls

• Additional administrative and accounting costs from maintaining duplicate payroll records to segregate wrap-up costs from other project expenses and for audits of each wrap-up project in addition to audits for the traditional insurance programs
  
• Possible loss of discounts on traditional workers' compensation policies when payroll is moved to a wrap-up -- a reduced payroll could result in a higher premium
  
• Companies' experience modification being adversely affected by late filing or incorrect workers' compensation claims data on the part of the wrap-up administrator
  
• Late-notice fines for not reporting workers' compensation claims within 24 hours. If the wrap-up policy fails to provide coverage, has exhausted liability limits, or is terminated for the owner's benefit, the contractor could be exposed to a catastrophic financial burden.
  
• Coverage gaps when the liability policy on the wrap-up expires, but the contractor's responsibility continues for a number of years after construction is completed

Wrap-ups are not inherently bad, but they are exceedingly complicated and require a lot of attention to detail and knowledge of the insurance industry. Agents must remember that the wrap-up administrator's goal is different from the contractor's. The administrator's goal is to protect the dollars in the insurance gap; the contractor's goal is to make profit on the job. The agent's role is protecting the client's profit.

Dealing with wrap-ups is a lot of work, and your agency should be compensated with a consulting fee for providing it. With workers' compensation rates plummeting, premiums and commissions declining and more contractors getting involved in wrap-ups, it is knowledge worth gaining and applying.

Duke Mills is the founder and president of WorkComp Solutions, Inc., an insurance agency focused exclusively on workers' compensation for mid- to large-size employers, and its Wrap-Up Experts division. Mills is the author of "Contractor's Survival Guide for Wrap-Ups." More information is available at www.wrapupexperts.com or 863-646-4642 or duke@wrapupexperts.com.