FEATURE STORIES | MARCH 2008

Three Things You Must Know About OCIPs

By Gary W. Griffin, ARM

Insurance brokers, insurance company personnel, and risk managers can be quick to boast the potential benefits of an OCIP: Significant cost savings, more consistent and broader liability insurance coverage, dedicated limits of protection, and potential to encourage increased participation of small and disadvantaged contractors.

Although many project owners realize some or all of these OCIP benefits, many others do not because they fail to understand the risks and administrative responsibilities they will assume with an OCIP, the three most common of which are

1. underestimation of or failure to identify internal administrations costs,
2. failure to fully comprehend and anticipate possible construction delay and insurance market risks, and
3. failure to recognize limitations in proving OCIP savings

Underestimation of or Failure to Identify Internal Administrations Costs

Most feasibility studies and insurance broker proposals include the estimated cost of routine administration functions such as insurance broker commissions or fees for contractor enrollment, safety, claims administration, and other external costs. They often fail to identify, however, the internal costs to the project owner, including

• Internal legal costs associated with claims handling. Government ordinances, for example, can require legal counsel's ongoing approval, oversight, and involvement of uninsured claim settlements, which can continue to grow even years after project completion.
  
  
• OCIP management and oversight. While some OCIPs require only minimal internal administration or are nearly fully administered by third-party providers, other public entities retain overall management and oversight. Even a modest-sized construction project can require a risk manager, an OCIP manager, and other support staff, and these staffing costs (including salaries, expenses, and overhead costs such as office space and health and retirement benefits) can be as high as or more than 200 percent against base salary. These costs must be accounted for during the full OCIP period plus whatever period beyond OCIP expiration required to handle claims run-off issues, which could be as long as 10 years.

Failure to Fully Comprehend Construction Delay and Insurance Market Risks

Most OCIPs are written for a defined period of time for a specified construction project or projects. But even the most carefully designed and aggressively marketed OCIP can fail to accurately estimate delays caused by weather, earthquake, strikes, disruption in funding, environmental and legal challenges, delays or inability to obtain materials, terrorism, etc.

When construction is delayed and the OCIP must be renewed or extended, the insurance company may offer very different terms for renewal or extension. If the OCIP performance is already poor or market conditions have changed, the project owner may find itself negotiating from a position of weakness and, in the extreme case, may have to unwind the program and revert to conventional insurance or absorb increased program costs.

OCIPs may contain a prohibitive minimum-earned-premium clause as high as 90 percent of the originally estimated premium. Significant delays may mean that the actual earned premium, which is directly related to the amount of construction during the policy period, is far less than the minimum earned premium. The result may be that the project owner must pay premium in excess of what was actually earned.

Although most OCIPs today are written on a non-cancelable basis, it is possible for even large, highly rated insurance companies to become insolvent or have their ratings lowered, requiring project owners to replace entire OCIPs with little notice. Having to replace a large and complicated OCIP can require much effort and may result in substantially increased cost, thereby reducing or eliminating any potential cost advantage.

Failure to Recognize Limitations in Proving OCIP Savings

Determining OCIP savings (the total cost differential between the OCIP and traditional insurance) presumes that the construction project owner can verify or accurately estimate contractors’ insurance costs and that all or most of those costs are removed from the contractors’ bids. (The conventional thinking here is that through market forces of the bidding process, a contractor will remove all or most of these costs.)

But contractors may not remove some or all of their insurance costs when they believe those insurance costs are not significant to the competitive position of their sealed bid. This could occur when (1) the contractor already has significant financial advantage over its competitors, such as when a contractor may already be mobilized on or near the construction site; (2) the contractor's insurance costs are highly loss-sensitive, such as in programs where very large deductibles are assumed; (3) the contractor’s insurance program is subject in part to a flat premium that is not adjustable; (4) there is collusion among or bid-rigging by contractors; or (5) there are change-order provisions that can allow contractors to include certain insurance costs.

Contractors also may be concerned that the OCIP will not sufficiently cover their risk, so they choose to continue with their own insurance, causing no or only limited reduction in the contractor’s cost of liability insurance.

Unless the construction project owner has the right and ability to fully audit a contractor’s bid, it may be difficult or impossible for the project owner to know the contractor’s true cost of insurance or whether some or all of such costs have actually been excluded from the contractor’s bid.

Verifying OCIP savings is tricky and may never be known with certainty. Many OCIP managers report what appear to be significant savings early on in an OCIP, only to have an internal audit dispel or question whether such savings really exist.

Conclusion

Although OCIPs promise project owners potential benefits over traditional insurance programs, the benefits are not without risk. Project owners must know the risks and understand their potential consequences so they can make informed decisions to minimize unrealistic expectations and ultimate disappointment in their OCIP’s performance.

ABOUT THE AUTHOR

Gary W. Griffin, ARM, is Executive Vice President of Warren, McVeigh & Griffin, Inc., an independent risk management consulting firm in Newport Beach, California. Gary has 25 years of experience in insurance broker operations, risk management consulting, and publishing of risk and insurance references. His expertise includes construction risks and insurance, employment practices insurance issues, directors/officers liability, professional liability, pollution liability, and umbrella liability insurance. Gary can be reached at 949-752-1058, ext. 228, and by e-mail at gary@griffincom.com.

riskVue | The webzine for risk management professionals
March 2008