Guide to FHWA Funded Wrap-Up Projects

VII. The Insurance Market

1. Market Influences

   When considering a wrap-up, one of the most important trends to consider is the state of the insurance market. The number of carriers qualified and willing to underwrite wrap-ups has increased dramatically over the past 25 years resulting in a very competitive marketplace. One of the important results has been the virtual elimination of "upside" risk associated with wrap-ups (see how premium is developed).

   Since 2000, the insurance marketplace has been undergoing a transition with costs increasing and availability diminishing. This resulted in cost increases of 20 percent to 50 percent to correct the under-pricing of previous years.

2. Emerging Claim Challenges
   1. Expanded Asbestos
   2. S&A Environmental
   3. Lead Paint
   4. Construction Defects
   5. Synthetic Stucco
   6. Pharmaceuticals
   7. Class Actions
   8. Tobacco
   9. Mold and Mildew
   10. Cell Phones
   11. Nursing Homes
   12. Tires
   13. Fuel Additive (MTBE)
   14. Ohio UM/UIM
   15. Internet-derived Exposures

   The market was affected by the events of September 11, 2001, with the potential for losses in excess of $70 billion. The reinsurance (secondary market) has virtually eliminated any coverage for terrorism. Primary insurers cannot eliminate coverage without state approval and terrorism cannot be excluded from workers' compensation policies. The resultant dramatic market "hardening" characterized by substantial premium increases, coverage restrictions and available limits has been felt across all lines of coverage and all businesses.

3. Transitioning to a Hard Market
   1. Year 2000 Combined Loss Ratio - 110.1%
   2. Year 2001 Projected Results - 119.9%
   3. Year 2001 Commercial Lines Projected - 130.0%
   4. Shareholder pressures to produce underwriting profits
   5. Continued pressure to maximize investment income
   6. Reinsurance consolidation and tightening
   7. Retail insurance carriers out of business or downgraded

   In addition, the financial strength of many insurers and reinsurers is now an issue with many rating agencies downgrading companies and the number of insolvencies increasing. Insurance companies have upgraded the qualification for evaluating reinsurers in what has been called a "flight to quality". This reduces the number of available reinsurers and ultimately translates to higher prices.

   The reduced capacity (availability of limits), coverage restrictions, cost increases and financial strength of insurer are affecting all contractors in varying degrees. This market instability translating in higher construction costs and lack of consistency are even more compelling reasons for an owner to exercise control of the insurance program.

   While it is true that these issues also affect the markets writing wrap-ups, these programs historically have produced more profitable business than "un-wrapped" construction accounts. A survey of the top five wrap-up insurance markets and found that they are continuing to offer wrap-up programs. Overall costs may be affected by each individual carrier's reinsurance costs as well as the carrier's overall profitability and the profitability of their construction and wrap-up accounts.

4. Feasibility Studies

   The feasibility study is used to determine if the project qualifies for wrap-up consideration. A feasibility study is a cost/benefit analysis comparing the cost of contractor provided insurance to the cost of an owner controlled insurance program. The study also considers non-financial considerations such as the workers' compensation jurisdiction, rules governing the use of wrap-ups, the type of project and other factors that could influence the potential for cost savings. The feasibility study may be developed by an independent consultant or by a broker. The consultant will charge a fee, but has no interest in the results. The broker may include the cost of the study in its fee to market and administer any subsequent program.

   The preliminary cost evaluation generally is provided by a consultant, the chosen broker, or as part of the RFP response from all brokers. At this early stage, the cost projections are based on the estimated hard costs, broken down by trade specialty (if available). These costs are used to project the unburdened payroll by trade, which are organized by workers' compensation class codes.

   Feasibility studies are used by owners to determine the viability of a wrap-up for their projects. Insurers will require feasibility study information and additional information (e.g., hard and soft costs, projected payroll by trade, term-of-project, relevant experience of prime contractor, type of construction) to determine coverage specifics, including premiums, minimum deductibles, safety program requirements and maximum payouts for claims (i.e., annual aggregates).

   Step - 1 Developing Payroll Estimates and WC Premiums

   Residential High Rise
   Construction Hard Costs 85,000,000
   Work Category	Breakdown	Total Value	Labor %	Derivative Payroll	WC Code	Rates	Est. Standard Premium
   General Conditions	General/Extended Conditions	4,620,000	60.0%	2,772,000	5606	4.76	131,947
   	Material/Personnel Hoists	990,000	20.0%	198,000	5213	33.02	65,380
   	Partnering	990,000	80.0%	792,000	8810	0.59	4,673
   Sitework	Mass Excavation	200,000	25.0%	50,000	6217	14.27	7,135
   	Excavation & Backfill	150,000	25.0%	37,500	6217	14.27	5,351
   	Import Fills/Export Spoils	20,000	25.0%	5,000	6217	14.27	714
   	Dewatering	100,000	20.0%	20,000	6229	12.72	2,544
   	Soil Treatment	10,000	20.0%	2,000	6229	12.72	254
   	Drainage Wells	125,000	20.0%	25,000	6229	12.72	3,180
   	Irrigation System	35,000	20.0%	7,000	6229	12.72	890
   	Seawall Improvements	175,000	20.0%	35,000	5213	33.02	11,557
   	Precast Well Structures	60,000	30.0%	18,000	5213	33.02	5,944
   	Pavement Striping	30,000	20.0%	6,000	5506	16.46	988
   	Curbs, Gutters	75,000	20.0%	15,000	5506	16.46	2,469
   	Precast Interlocking Pavers	175,000	20.0%	35,000	5506	16.46	5,761
   	Cast Keystone	200000	20.0%	40,000	0042	17.30	6,920
   	Landscaping	375000	18.0%	67,500	5213	33.02	22,289
   Concrete/Steel	Formwork	7,140,000	20.0%	1,428,000	5213	33.02	471,526
   	Concrete Materials/Pumping	4,050,000	20.0%	810,000	5221	15.37	124,497
   	Reinforcing Steel/Tensioning	3,725,000	20.0%	745,000	5213	33.02	245,999
   	Hoisting	1,190,000	20.0%	238,000	5213	33.02	78,588
   	Concrete NOC	740,000	20.0%	148,000	5213	33.02	48,870
   Metals	Structural Steel	1250000	22.5%	281,250	5040	51.50	144,844
   	Space Frame (Sheet Metal)	350000	22.5%	78,750	5538	16.89	13,301
   	Non-Structural/Ornamental	588000	25.0%	147,000	5102	15.61	22,947
   Masonry	Exterior/Interior Unit Masonry	1,290,000	25.0%	322,500	5213	33.02	106,490

   Step 2 - Development of Contractor's Insurance Costs and Estimated OCIP Cost Components
   Contractor & OCIP Cost Development

   Workers' Compensation
   	Contractor Cost			OCIP Cost
   WC Standard Premium	3,214,559		WC Standard Premium	3,214,559
   Coverage B	0.033		Coverage B	0.033
   Cov B Premium	106,080		Cov B Premium	106,080
   Total Standard Premium	3,320,639		Total Standard Premium	3,320,639
   Est. Experience Mod	0.90		Est. Experience Mod	0.90
   Modified Premium	2,988,575		Modified Premium	2,988,575
   Premium Discount %	8.50%
   Discounted Premium	2,734,546
   Expense Constants	5,000
   Sub-Total	2,739,546
   Fee + 5%	136,977
   			Deductible Factor	0.85
   WC - Total Premium	2,876,524		Deductible Credit	2,540,289
   			WC - Deductible Premium	448,286
   General Liability
   	Contractor Cost			OCIP Cost
   Estimated Premium	958,841
   Fee + 5%	47,942
   GL - Total Premium	1,006,783		GL - Deductible Premium	352,374
   Total WC/GL Premium	3,883,307		Total Deductible Premium	800,660
   Umbrella Liability
   Limit: $5 to $10 Million	Contractor Cost		Limit: $25 Million	OCIP Cost
   Minimal Estimate	75,000
   Fee+ 5%	3,750
   Umbrella Total	78,750		Premium	350,000
   			Brokerage & Admin	220,000
   TOTAL	3,962,057		TOTAL Expenses	1,370,660
   		See OCIP @ Expected Losses for Total Cost

   The applicable workers' compensation rates are applied and a cost for general liability is added. With the addition of a loading for the contractors' profit, administration and contingency costs this represents the estimated cost of contractor provided insurance. Then, based on current market results (benchmarking) the wrap-up costs are estimated and compared to the contractor's cost.The evaluation of potential savings (and upside risk) is determined by using an estimate of projected losses for the project and a projection of the aggregate amount of losses to be used in determining the wrap-up premium (see how premium is developed).

   Step 3 - Preliminary Projection: Savings vs. Risk

   OCIP "Expected" Cost   Loss Ratio % Losses A. Losses     Workers' Compensation 40% 1,095,818 General Liability 10% 95,884 Total   1,191,703 B. Adjustment Expense 8.00% 95,336 Total   95,336 C. Deductible Premium   800,660 Primary WC/GL Total (A+B+C)   2,087,699 Brokerage   220,000 Umbrella   350,000 TOTAL OCIP "EXPECTED" COST   2,657,699 Contractor Deduct @ 90%   3,565,851 SAVINGS   908,152

   OCIP "Maximum" Cost   Loss Ratio % Losses A. Losses     Workers' Compensation 68% 1,849,194 General Liability 20% 191,768 Total   2,040,962 B. Adjustment Expense 8.00% 163,277 Total   163,277 C. Deductible Premium   800,660 Primary WC/GL Total (A+B+C)   3,004,899 Brokerage   220,000 Umbrella   350,000 TOTAL OCIP "MAXIMUM" COST   3,574,899 Contractor Deduct @ 90%   3,565,851 RISK   (9,048)