Capital Project Solutions – July 2010
Integrated Project Delivery – Risk and Insurance Model David Carter, Consultant Steve Higgs, Senior Vice President John Stanchina, Senior Vice President, Rutherfoord, Inc. Throughout 2010, Capital Project Solutions will run a series of articles dedicated to Integrated Project Delivery (IPD). We will explore all issues related to IPD, from project identification to team selection to contract and incentive development. With three (3) IPD projects currently underway, we will share case studies and lessons learned throughout the series. Last month, we discussed Integrated Project Delivery contracting and how it differs from traditional delivery contracts. This month, we will explore issues related to insuring an IPD project. If you have missed any of the previous articles or to learn more about other strategies to ensure your project’s success, visit KLMK Group at www.klmkgroup.com. In our last issue of Capital Project Solutions, we addressed IPD contracting and the Integrated Form of Agreement (IFOA). In particular, we mentioned the importance of team collaboration in regard to document selection. Specifically, we addressed the need to ensure alignment of all interests between the Owner, Architect and Contractor for both risk and rewards. The sharing of risk and rewards instilled in the IFOA helps break down the trust barriers associated with traditional contracts and allows the team to collaboratively develop the contract document that supports the interest of all parties. As part of the contract development, the team is charged with creating an incentive plan that outlines potential gains for a job well done. The same approach should be taken when developing a Risk Model for the project. Risk sharing can be accomplished through a project specific insurance program that embodies the principle of trust inherent to an IPD agreement. This program should reduce the overall risk for the entire team as opposed to traditional project insurance coverage, which caters to the individual. By 1
Capital Project Solutions – July 2010
establishing a project specific insurance program the owner elects to set the appropriate tone by allocating risk more evenly and placing faith in the team and the IPD process. Therefore, the collaborative development of the project specific insurance program is paramount in aligning the team and creating the trust required for a successful project. Insurance Products Ironically, the commercial insurance products available to all healthcare clients for use on their capital improvement projects are no different under an IPD delivery method than are available under a more traditional project approach. The difference comes in the approach to these options as risk management tools. The typical insurance products used to mitigate risk on a capital project improvement are: • • • • • •
General Liability (GL) Workers’ Compensation (WC) Excess / Umbrella Liability (XS) Pollution Legal Liability (PLL) Builder’s Risk (BR) Professional Liability (PL)
The owner still has the option of securing these products in the traditional sense under an IFOA but the recommendation is to create a project specific insurance program that allows for a more even distribution of the associated risks of any capital improvement project and enhances the trust of the team. Additionally, the owner can realize the added benefits of ensuring adequate coverage is provided for the project, thus, mitigating exposures often realized in traditional project coverage. Workers’ Compensation / General & Excess Liability In today’s world, the purchase of an insurance product to protect personal and business assets is commonplace. It is intuitive that the premium of any insurance policy must be weighed against the benefit. A risk management approach cannot simply be to over 2
Capital Project Solutions – July 2010
purchase insurance as a means of managing the risk. This strategy would not be financially feasible or prudent. Since a major capital project creates unique exposures for the entire project team, an owner must view GL and WC policies with an eye toward risk sharing. The traditional approach to managing GL, WC, and XS has several inherent problems: Each entity is required to carry separate coverage through multiple insurers. Gaps may exist in coverage that expose the owner and team to increased risk. Gaps in coverage may only be identified upon receiving a claim. Profit is applied to coverage at each level of the hierarchy. CM and subs are responsible for monitoring that everyone has obtained adequate and appropriate coverage.
By bundling these insurance products into a project specific policy under an IFOA, it is possible to create an effective option for managing risk, incentivizing safe work habits and sharing risk and rewards. 3
Capital Project Solutions – July 2010
For the reasons listed above, it is recommended that GL, WC, and XS be purchased through a Controlled Insurance Program (CIP) under a project specific IFOA. A CIP can be purchased by either the owner or the contractor. The team must decide ownership early in the process based on the team’s specific needs. A CIP is generally most effective on projects that: are greater than $100 million in construction value, have many subcontractors, are labor intensive, are staffed by a team that is committed to safety and able to provide proper claim and risk management.
Generally, the cost of a CIP on such a project will be less than GL, WC, and XS costs under the traditional tiered approach. Although there is better chance of achieving financial savings on projects over $100M, a CIP should be strongly considered on smaller projects as well. Under a CIP, the sponsor of the program requires subcontractors to identify and remove insurance costs from their bids. This may ultimately reduce overall costs while at the same time enhancing coverage by 4
Capital Project Solutions – July 2010
providing project specific coverage / limits and thus mitigating the risk to the entire team. An additional benefit of the CIP allows for a greater pool of subcontractor bidders as inadequate coverage and associated insurance cost are no longer a burden for the subcontractors. Financially, the CIP is comprised of a fixed and variable premium subject to the loss experience. The fixed premium is generally 40-50% of the maximum cost and the variable premium is 50-60% of the maximum cost. It should be noted that the total cost premium, both fixed and variable, should be carried in the project budget to cover potential work performance claims and to limit potential exposure since there is not a guarantee there will be savings at the end of the job. Any savings from the CIP, which could be .5%-1.5% based on safety performance, can be used to incentivize the IPD team. The split of the savings or overages, if they occur, need to be determined in advance and solidified in the IFOA. Utilizing a CIP as part of an IFOA: simplifies the process with a single policy that covers all the players on team, eliminates gaps in coverage, eliminates the multi-tiered markups, may reduce the overall risk and cost to the entire team.
Professional Liability In addition to the CIP, the IFOA should also include a project specific professional liability policy. Although, every professional design firm is required to carry professional liability insurance, such policies carry inherent limitations and increase associated risks to the project team. Some of the major limitations of such policies include: •
Owners share the design firm's professional policy limit with many other firms. Professional liability policies have a single aggregate policy limit that applies to 5
Capital Project Solutions – July 2010
all liabilities and defense costs arising from current and past work of the insured. If there is a claim, the owner has to hope it is near the front of the line to be sure of adequate protection. •
Protection is here today and gone tomorrow. Many professional liability claims arise well after project completion. An owner has to depend on a design firm to stay in business and continuously renew its insurance in order to have a policy against which to claim in the future.
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The owner cannot be added as an additional insured. Most professional liability underwriters for design firms will not name the owner as an additional insured. If the owner is sued for a professional loss caused by the design firm, the indemnification clause in the owner / design firm contract may provide protection but the professional policy will not defend the owner.
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Limitation of liability. Many design firms will not work without a limitation of liability equal to their fees and a waiver of consequential damages.
Additionally, such professional policies, when utilized in the traditional sense, carry many of the same risks associated with GL, WC, and XS policies such as multiple insurers, inadequate limits, coverage gaps, and the potential for cross litigation. A project specific professional liability policy replaces the practice policy of the design firms and frees the team from the limitations of those policies. Additionally, it provides multiple added benefits for the IPD Team including: • • •
Consistency in coverage for the entire team. Financial security from professional liability throughout the life of the project. Limit of liability that is dedicated to the specific project. Design firms policy serves as excess coverage. 6
Capital Project Solutions – July 2010
•
•
• •
Contractor’s pollution liability (including mold liability) can be included to provide coverage for pollution conditions arising out of construction work and defense costs are covered for third-party claims arising from the design team's errors. The policy is offered on a project-specific basis for up to 10 years (the extended reporting period or ERP is included in that term) and annually for all construction ("blanket" coverage) of the named insured. Limits of liability can be secured up to $25 million with one single insurer. Single source of responsibility for claims.
A project specific professional liability policy is held by the owner or the lead design firm of the IFOA with the premium being paid in full by the owner. The policy is typically negotiated as dedicated limits over a deductible and the term is from the beginning of design, through construction plus 3 to 10 years. A project specific liability policy will likely be the most expensive vehicle for providing professional liability coverage when compared to traditional means. However, in an IFOA the benefits outweigh the costs and could ultimately be the least costly insurance product if a catastrophic event were to occur. In an IPD agreement formulated on the guiding principal of trust, careful selection and implementation of insurance coverage can act as the bond that holds the team together. Both a CIP and project specific Professional Liability Policy provide for a more controlled risk management solution for the entire team. Providing coverage that binds all parties to the same risks further solidifies the collaborative approach required for a successful IPD project and can lead to financial incentives for a job well done.
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