Every sponsor of a wrap-up program expects the enrolled contractors to remove insurance costs from the cost of the work for the insurance coverages being furnished under the wrap-up. This article details the most common methodologies and the variables that are critical for enrolled contractors to understand when they bid on a project insured with a wrap-up insurance program.
Since the sponsor, whether owner or construction manager/general contractor (CM/GC), is providing specified insurance coverages for work at the project site, they have a keen interest in ensuring that the insurance charges associated with those coverages are removed from the cost of the work. The basic premise of the cost-savings benefit of a wrap-up program is that the sponsor "pools" the insurance costs they avoid by purchasing the wrap-up coverage versus the cost of the wrap-up coverages.
Conversely, enrolled contractors avoid being double charged for the operations insured by the wrap-up as those exposures are excluded 1 from their corporate insurance program.
The methodology for identifying and removing the insurance credit for coverages provided under the wrap-up is specified in the instructions to bidders in the bid documents, the wrap-up insurance article in the contract, and/or the wrap-up insurance manual. It is important for every participant in the wrap-up to thoroughly review these documents to understand not only the instructions to bid the job but also any other potential cost implications.
It should be noted that, while most states don't require disclosure of bid credit methodology requirements, there are two states that impose specific requirements.
- California. Pertaining to certain residential projects insured with a wrap-up program, CA Civil Code Section 2782.9(a) reads: "The total amount or method of calculation of any credit or compensation for premium required from a subcontractor or other participant for that policy shall be clearly delineated in the bid documents."
- Wisconsin. Wis. Adm. Code. § 80.61(3)(b)(7) only allows owner controlled insurance programs (OCIPs) and require that bids be received on an "ex-insurance basis."
Insurance Credit Methodologies
There are three common insurance credit methodologies used today on wrap-up programs.
- Net bid. All bidders are instructed to submit a bid that excludes insurance costs for coverages provided under the wrap-up.
- Net bid with add alternate. All bidders are instructed to submit a base bid that excludes insurance costs for coverages provided under the wrap-up, plus provide documentation as to the amount that was excluded from the base bid.
- Gross bid with deduct alternate. All bidders are instructed to submit a base bid that includes insurance costs for coverages provided under the wrap-up, plus provide documentation for contractors' insurance costs. If enrolled, the deduct alternate will be accepted, and the subcontract value will be lowered accordingly.
Net Bid
Using this approach, the sponsor instructs the contractors bidding on the project to remove their insurance costs for coverages provided from their bid; in other words, the bid is "net" of insurance costs for coverages furnished under the wrap-up. This approach relies on the competitive nature of the bid process to drive the insurance costs out of the bid. Said another way, if a contractor ignores the instructions to remove the insurance costs from their bid, they could be at a competitive disadvantage as they are loading unnecessary additional dollars in their bid that may lead to a competitor winning the work.
This approach is widely used on public projects due to its ease of administration, and it avoids a potential protest if one bidder is the apparent lower bidder on a gross basis and another is the apparent lower bidder on a net basis. This can happen with either the "net bid with add alternate" or "gross bid with deduct alternate" approaches described below.
Often, there is a desire on the part of the sponsor to quantify the amount of savings under the wrap-up. The net bid approach does not offer this quantification. However, if the insurance credits, which are based on the limits, coverages, and exclusions of the bidding contractor's corporate program, include a "residential exclusion," for example, the insurance credit would be meaningfully understated if the insured project involves residential construction. As such, this approach is popular on residential projects as it would be apples versus oranges on comparing the cost of contractor-furnished coverage versus the coverages provided under the wrap-up. It also has the ability to enable a broader spectrum of potential bidders as it opens up the bid process to contractors that may otherwise be precluded from bidding on the project due to residential exclusions.
This approach is also common with contractor controlled insurance programs (CCIP) as the owner is agreeing for the CM/GC to provide the CCIP coverage for a stated cost and the CM/GC retains the incentive to drive out insurance costs to alleviate cost pressure on the fixed price or guaranteed maximum price.
| Advantages | Disadvantages |
|---|---|
| Ease of administration | Questionable if insurance costs are actually removed |
| Increase bid pool of potential bidders | No documentation on insurance costs removed |
| Meet required state requirements (if applicable) | No documentation on insurance costs for excluded parties |
| Reduces the competitive advantage for safer contractors |
Net Bid with Add Alternate
Under this approach, bidders are instructed to bid "net" of insurance for wrap-up coverages and provide an alternate for the cost of wrap-up coverages. Contractors bidding on work are routinely required to provide alternates to their base bid. The owner can pick and choose which alternates they want at the cost specified for that alternate. The add alternate insurance credit operates the same way. The sponsor can elect to provide the wrap-up coverage, or at their discretion, they can elect to accept the alternate and have the contractor provide coverage under their corporate program and increase the base bid accordingly.
The add alternate is typically calculated using an Insurance Cost Worksheet (ICW), which is discussed later in this article. Like the net bid approach, sponsors voice a concern about whether the insurance costs are actually removed from the bid. However, with the add alternate approach, the sponsor always has the option to accept the alternate and have the contractor provide coverage under their corporate insurance program if the cost of the alternate appears to be severely understated. 2
The primary advantage of this approach is an accounting of the insurance costs avoided in exchange for providing the wrap-up coverage.
| Advantages | Disadvantages |
|---|---|
| Documentation on insurance costs removed | Questionable if insurance costs are actually removed |
| Documentation on insurance costs for excluded parties | Additional administration to verify insurance credit calculations |
| Meet required state requirements (if applicable) |
Gross Bid with Deduct Alternate
Contractors are instructed to bid and include the costs of insurance coverages provided under the wrap-up. Additionally, the contractors are required to document the insurance costs included in their bid via the ICW. The sponsor has the option of allowing the contractor to provide coverage under their corporate program, in which case, the cost of the work for that contractor will include the cost of coverages provided under the wrap-up. Conversely, the sponsor can elect to provide wrap-up coverage to that contractor, and the cost of the work will be reduced by the value in the deduct alternate.
This approach provides the purest reconciliation of the insurance costs removed from the cost of the work. However, this can cause the greatest friction between sponsor and contractor as there can be disagreements over the value of the deduct alternate, particularly regarding the credit for large deductibles, flat charge umbrella policies, and overhead and profit loads on insurance.
| Advantages | Disadvantages |
|---|---|
| Documentation on insurance costs removed | Additional administration to verify insurance credit calculations |
| Documentation on insurance costs for excluded parties | Some state requirements prohibit |
| Potential friction with contractors over the insurance credit calculation |
The ICW
The wrap-up insurance manual 3 provides a worksheet that breaks down the exposures and rates associated with work on the project site to quantify the insurance costs for coverages provided under the wrap-up.
The intent of the ICW is to calculate the cost of insurance for wrap-up coverages if the contractor had provided coverage under its corporate insurance program. This ICW is commonly used in both the net bid with add alternate and gross bid with deduct alternate methodologies. 4
The wrap-up administrator will typically require the contractor to submit copies of their declarations page and rate page for each coverage so they can validate that the correct rates were used to compute the insurance credit.
There are four areas that lead to the most discussion in the ICW calculation.
- Exposure. It's difficult for the wrap-up administrator to determine if the exposure used in the calculation is accurate. As a result, sponsors may include a contractual provision that the insurance credit will be adjusted when the work is complete based on the actual exposures reported on the project (the so-called true-up).
- Large deductible/self-insured retention (SIR). When a contractor has a large deductible or SIR, the rate shown in their policy will be for the insurance coverage sitting over the deducible or SIR. The wrap-up administrator will require the contractor to provide 5 years of historical exposure and loss data to calculate a fair insurance credit for the deductible/SIR based on the historical loss rate for the contractor.
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Flat umbrella. The sponsor is seeking insurance credit for both primary and excess/umbrella coverages. If the contractor's excess/umbrella policy is on a nonauditable (flat charge) basis, they do not get a lower premium for participating in the wrap-up. However, since the exposure insured under the wrap-up won't go into the exposure base in subsequent years, there could be a premium reduction.
Additionally, despite the flat charge premium, the sponsor may feel entitled to an insurance credit as the wrap-up program generally provides significantly higher limits than carried by the contractor's corporate program. Often, the sponsor will compute a composite rate based on the flat charge premium divided by sales to calculate an insurance credit.
- Overhead and profit (O&P). Contractors often load an O&P factor to the cost of the work. The O&P line on the ICW is designed to capture the O&P associated with the insurance costs for coverages provided by the wrap-up.
Other Considerations
- Time and material (T&M) contracts. The wrap-up manual may include a separate worksheet for T&M contracts. In contrast to lump-sum or fixed-price contracts, T&M contracts pay a specified rate per hour or unit of work. All three bid methodologies can be used on T&M contracts.
- Change orders. Contractors will be instructed to exclude their cost for wrap-up coverages under both the net bid and net bid with add alternate methodologies. The gross bid with deduct approach requires contractors to include their cost of wrap-up coverages in their change order if the program includes a true-up provision.
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True-ups. As mentioned earlier, with the gross bid with deduct approach, it's common for the sponsor to incorporate their rights to calculate a final insurance credit based on the actual exposures insured under the wrap-up program. In this scenario, the contractor furnishes an ICW when they bid on the work, and an initial or provisional insurance credit is deducted from the bid. Subsequently, when the work is complete, the wrap-up will calculate a final insurance credit based on the actual exposure and adjust the cost of the work accordingly. 5
For projects in New York, note that pursuant to N.Y. Ins. Law § 2505 (McKinney's 2000), a contractor or subcontractor may not change the amount of credit that a contractor or subcontractor used in its bid for a nonpublic construction project. 6
- Lower-tier contractors. It is critical for prime contractors (those having a direct contract with the owner or CM/GC) to understand that the insurance credits for its lower-tier subcontractors will also flow through your contract if there is a true-up provision.
Thus, it will be important for the CM/GC and prime subcontractors to understand if there will be a true-up and, if so, monitor the calculation of the final insurance credits to ensure they reduce the lower-tier subcontractors' cost of the work accordingly. This is particularly important if the prime subcontractor is excluded from the wrap-up (e.g., a steel fabricator) and their lower-tier subcontractor (e.g., a steel erector) is enrolled in the wrap-up program.
Final Thought
Similar to an owner selecting the correct project delivery method on a project, the methodology for identifying and extracting insurance credits should align with statutory restrictions and the objectives of the sponsor. Regardless of which methodology is chosen, clear communication of the insurance credit methodology in the bid process and at the completion of work is vital to facilitating a successful process of removing insurance costs for coverages provided under the wrap-up program. Bidding contractors should carefully review and understand the bid credit parameters so that they understand their financial risk in the program.
Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.
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