Guide to FHWA Funded Wrap-Up Projects
V. Cost Calculations
To understand how wrap-up costs are developed, consider the following brief review of the components of the insurance premium. All insurance premiums (the dollars necessary to insure a particular risk) must include a cost provision for program costs (70 percent) and carrier expenses (30 percent). For any construction project, wrap-up or conventional, the insurance coverages required generally will include workers' compensation and employer's liability, general liability, builder's risk, property insurance and boiler & machinery coverage.
- Program Costs
- Expected Losses
- Loss Handling Costs (adjusting)
- Services (loss prevention, claims management)
- Risk Transfer (insurance)
- Carrier Expenses
- Insurance Carrier Overhead
- Policy Administration (policy issuance, audits)
- Premium Taxes and Assessments
- Insurance Carrier Profit
- Workers' Compensation Rates
Each state and the District of Columbia develop rates (per $100 of Payroll) for over 600 different job classifications. The rates are based on the jurisdiction's loss experience reported by each employer and include a reflection of the insurance company(s) requirements for the expenses identified above. The premium generated by these rates cover, on a prospective basis, expenses, expected losses and loss handling costs. With minor variation, all carriers use the same rates.
- How Rates Are Applied
The published rates are applied to the contractor's payroll to develop the Workers' Compensation Premium. Applying an Experience Modification Factor, which is unique to each contractor and reflects that contractor's prior loss history, modifies these premiums. The resultant premium, which varies only as a result of payroll fluctuation, is referred to as a guaranteed cost premium. The contractor then determines the charge to include in the bid by applying the rates to the estimated project payroll and adding mark-up for fees or other burdens and contingencies. Actual loss experience does not influence the premium - if actual losses are only 50 percent of the total premium - the insurance carrier (or contractor) retains the "excess".
- How Savings Are Realized
The wrap-up develops its cost savings by using a structure that isolates the expense and loss components of the premium with the following results:
- Overall costs are reduced by using the economies of scale and market leverage.
- Actual losses are less than market experience.
- Administrative costs are reduced through centralization of activities.
- Although the services provided are enhanced, the elimination of duplication results in cost savings.
- The contractor mark-up loaded into the bid is eliminated.
It is not unusual to reduce the 30 percent expense provision by 40 percent to 50 percent through the use of a wrap-up. Savings that result from the implementation of the program, which tends to reduce loss experience by a significant percentage, can be collectively referred to as the "up front savings".
- General Liability
The General Liability premium (cost for the actual risk transfer or insurance and specified expenses) is discounted to reflect administrative savings (only one policy is issued for all parties), more efficiently deployed loss control, claims and auditing services, and the reduction in exposure from cross contractor suits and subrogation claims from workers' compensation carriers.
The most significant savings opportunities are developed as a result of the actual project loss experience. Wrap-ups historically have generated better loss experience (safety records) than both the Insurance Bureau rate allocations of 70 percent and general construction industry statistics. The project specific claims service and the single project safety program typically produce loss ratios ranging from 30 percent to 45 percent.
- Loss Sensitive Programs
To create this savings opportunity, wrap-ups are usually written on a "loss sensitive" program. This means the insurance "premium" is determined by adding the expenses to the actual losses and loss handling costs. Rather than fixing the cost on a prospective basis, the cost is determined retrospectively. To protect the owner from the financial impact of unforeseen catastrophic losses the impact of any one event is capped. In addition, further protection is provided by capping the total amount of project losses that can be used to calculate the final wrap-up cost. This structure is used for the Workers Compensation and General Liability Coverages of the wrap-up.
Over the past five years, there have been a limited number of wrap-up programs written on a guaranteed cost basis. The premium is adjusted based on payroll audits and in some cases changes in the state workers' compensation rates. The premium is unaffected by the loss experience of the project. Savings are developed by the economies of scale and reduction in administrative costs. They offer no opportunity to benefit from good loss experience but cannot be adversely affected by poor experience. An informal poll of the leading wrap-up carriers indicates that carriers will be reluctant to offer programs on this basis.
- Pollution Liability, Professional Liability and Excess Liability (Catastrophic Protection) achieve their cost savings and coverage enhancements by effectively leveraging the economies of scale presented by a single consolidated purchase and the reduction in exposures previously identified.
- Property Insurance
- Fire and all Perils
The program insures its buildings and their contents against the perils of fire, extended coverage, vandalism and special extended coverage. The coverages include direct damage caused by such perils as fire, lightning, windstorm, hail, smoke explosion, riot, vehicle damage and collapse to name a few.
- Loss Limit (any one occurrence)
- Blanket value
- Self-insured retention (deductible)
- Aggregate retention
- Catastrophe limit
- Scheduled Property
The program has elected to insure certain property on scheduled basis. Coverage is on an "all risk" basis and included the following property:
- Electronic Data Processing equipment
- EDP data and media
- Boiler & Machinery
Insurance is carried for direct damage to boilers and related equipment. The coverage applies to damage to boilers, water tanks, air tanks and other vessels arising from explosion or other kinds of accidental breakdown. In addition to insurance protection, the policy provides ongoing inspection service.
- Builder's Risk
Insurance covering the project during the course of construction. Coverage is generally written on an "all risk" basis subject to certain exclusions such as consequential delay (see Business Interruption), inherent vice, nuclear risks, contamination, mechanical breakdown, war and new policies may include terrorism exclusions. Each carrier has its own form and the scope of coverage may differ. Many of the exclusions can be deleted for additional premium or are more properly insured under related but separate coverage part or policy.
- Property Covered: All materials to become a part of the permanent road and/or structure and materials consumed in the construction process are covered. Forms, scaffolds, contractors' equipment and automobiles are not covered.
- Where Covered: Coverage may be provided at the project site, specified off-site storage areas, and while in transit. Most policies also contain a limited amount of coverage for temporary unnamed off-site storage locations.
- Duration: The coverage is written for an estimated term to end at substantial completion, occupancy, or when the project goes into revenue production (eg. tolls). Coverage can be amended to address partial occupancy.
- Limit: The policy limit should be equal to the estimated completed value of the project.
- Deductibles: Depending on project size and location, deductibles have historically ranged from $5,000 to $50,000 with higher deductibles and sublimits applicable to the perils of flood, earthquake and coastal wind. Current market conditions suggest that underwriters may demand minimum deductibles of $10,000, $25,000 or higher. In addition, terrorism buy-back coverage (where the underwriter will charge an additional premium to delete the exclusion) will likely contain more substantial deductibles.
Office of Program Administration