Potential Savings from Owner-Controlled Insurance Programs

February, 2001

This article is part of a series discussing Owner-Controlled Insurance Programs (OCIPs).

Potential Savings to the Owner

It’s extremely difficult to determine the total savings an owner can realize from an OCIP because the potential savings can vary significantly based on a number of factors.

Savings are derived when contractors and subcontractors remove insurance costs from their bids because these bid reductions lower the contract price. The owner’s cost for providing workers’comp, CGL, and excess liability coverage on behalf of contractors and subcontractors will likely be substantially less than the deduction received from the contractors and subcontractors. The potential savings is the difference between the bid reductions and the owner’s cost of contractor and subcontractor-provided insurance coverages.

Contractor and subcontractor bid deductions can vary between 2-5% of construction costs. However, the amount contractors and subcontractors spend on OCIP-provided coverages will vary by geographic area, contractor size, and type of project.

Some Numbers to Crunch

A study conducted by the Risk and Insurance Management Society provided statistical data from 30 contractors on the cost of risk (COR) based on annual revenue. This is a small sample from a much larger total population of contractors, but it will serve our purposes here.

The largest contractors in this study indicated a COR of approximately $25 per $1,000 of revenue. If you subtract the cost of the insurance coverages an OCIP would not normally include and then subtract a contractor’s average risk-management administration costs, the OCIP-provided insurance cost would be less than $20 per $1,000 or 2% of revenue. Assuming a total bid reduction of 2%, total owner savings would be 2% of construction costs less what the owner expends to purchase the OCIP-provided insurance coverages or an estimated savings in the range of 0.5-1% of construction costs.

Cost Comparisons

Most construction estimators use one of several techniques when preparing their bids. When bidding fixed-price work, they may use either a unit rate (cost per square foot for an office building or cost per floor, room, etc., for a hotel) or they may use labor and material estimates provided by the owner or owner’s design professional. When bidding cost-plus work, estimators may use the prevailing wage rates for the geographical area and then gross-up this rate to include G&A expenses. Regardless of what method is used, each contractor’s bid will contain insurance costs.

The costs on fixed-price bids are usually embedded in the wage rate, which can be directly factored into the estimate or indirectly included in the unit rate. The contractor’s bid includes wage rates that are comprised of its employees’ base wages and overheads, and are usually expressed as a percentage of Contractor and subcontractor bid deductions can vary between 2-5% of construction costs.

CFMA Building Profits • September/October 2000 the base wage. Some of the overheads that are factored into the gross billing rate include profit, G&A, benefits, taxes, and insurance.

Contractors typically include state workers’ comp rates (adjusted by their own experience modification rates) and company-specific general liability rates in their insurance overhead calculations. The insurance overhead assumes firstdollar (i.e., no retrospective rating plan or deductible fixedcost) coverage. This is usually in the range of 8-14% of payroll, depending on the specific geographic location under consideration.

Many large contractors will include a standard premium figure in their billing rates because their actual insurance cost is undetermined at the time they are bidding on a proposed project. If these contractors were willing to gamble on the unknown, they could ultimately pay less by purchasing firstdollar, guaranteed-cost coverage.

OCIP Costs/Benefits

On an OCIP, the bid packages issued to contractors and subcontractors will contain an “Instructions to Bidders” section specifically stating that bids are to be submitted with and without insurance. However, the cost of insurance is to be included with their bids, as either an alternate/add or an alternate/deduct.

By combining the cost for all of the contractors’ and subcontractors’ owner-furnished insurance coverages into an OCIP, an owner creates substantial leverage in the insurance market. That’s why owners are able to purchase insurance at a lower rate than individual contractors. An owner can realize cost savings of as much as 10-15% due to the volume purchasing of the OCIP coverages.

Owners can also significantly reduce project insurance costs through risk retention. This is achieved by assuming a higher deductible (e.g., $100K-$250K) per loss. Additional savings can be realized if project loss experience is better than the actuarial loss experience factors contained in the insurer’s guaranteed-cost rates. It should be noted that loss experience on a significant number of OCIPs has historically averaged less than 40% of standard insurance rates.

A Hypothetical Example

Let’s look at a hypothetical example of how an OCIP works in practice. An owner is considering building a $500 million luxury hotel and entertainment complex. The estimated payroll for this proposed project is equal to 25% of the hard construction cost, and the average contractor and subcontractor insurance rate is $10.75 per $100 of payroll (a composite rate, which includes workers’ comp and general liability). Using a traditional insurance approach, the insurance cost on this project would be approximately $13.5 million.

[($500M x .25)/100] x $10.75 = $13,437,500

Based on empirical data collected over the past several years on various types of projects, we can expect to reduce this insurance cost by approximately 5% through the use of an OCIP – spending $12.8 million over a 24-month period, instead of the $13.5 million in the above example. The cost of owner-provided insurance contains two components: fixed expenses and retained losses. Fixed expenses include overhead expenses, claim reporting, commissions (if fixed), and premium taxes and assessments. Retained losses are the contractor’s and subcontractors’ losses that are paid by the owner under the owner’s established deductible threshold. If the loss experience on this project is average, the total OCIP insurance cost would be approximately $8.75 million, and the owner’s savings would be $4.05 million.

Next: Insurance Coverage Considerations

About the Author: David L. Grenieris President of C-Risk, Inc., a national risk management consulting firm providing risk management strategies and solutions to construction-industry clients. He specializes in construction, contract management, and wrap-up insurance programs.

Copyright © 2001-2006 David Grenier . All rights reserved. No portion of this article may be reproduced without the express written permission of the copyright holder, except as follows: You may link this article to your website, either directly or through an ExpertLaw Library index page, provided your link does not depict this article, its author, or expertlaw.com in a negative manner.