Insurance is confusing, plain and simple. Construction insurance is no exception. In some instances, it has been used as a vehicle to perpetuate fraud. In other scenarios, contractors may use complex insurance programs and policies to hide additional profit from construction project owners and bill for overhead cost or profit that would not otherwise be allowable. Understanding construction insurance and how contractors may use it to enhance profit margins will help you mitigate the risk of overpaying for a contractor’s insurance costs.
Construction project owners should work with their organization’s risk management department and determine the appropriate insurance coverages and coverage limits for the organization’s construction project. Once the required insurance coverages have been set, review the contractor’s insurance billings to verify that the contractor is billing for only those insurance coverages that are required under your contract agreement. For example, contractors will use a singular insurance rate as a way to bill for insurance cost that may not be reimbursable as a direct project cost (property insurance, D&O, professional liability, inland marine, etc.). These insurance coverages may represent contractor overhead, which should be reimbursed from the contractor’s overhead and profit markup and should not be included in the contractor’s insurance billing rate.
Owners need to verify that the contractor is only charging for the limits of insurance that are required for a project. For example, if a contract requires $100 million of excess liability coverage, the contractor should not be allocating $500 million of excess liability insurance to the project. If that is the case, then the construction project owner may be due a credit for cost related to insurance coverage limits that exceed the required insurance limits included in the contract.
While insurance rates may appear small, when applied to the total project value, the resulting credits can be huge. For example, a reduction from a 1.2 percent insurance rate to 1 percent on a $100 million project results in a credit of $200,000 to the owner. Insurance rates should reflect a contractor’s actual cost and should not include any overhead and profit, which would increase the contractor’s profit margins.
Application of Insurance Rates
A common issue related to construction insurance is the misapplication of insurance rates to the appropriate cost basis. With the growing popularity of wrap up insurance programs (OCIP, CCIP, Subguard, etc.), contractors often either intentionally or unintentionally, apply insurance rates to project costs that are not covered under the respective insurance program. Insurance rate misallocations are a high risk and can result in significant credits due the owner.
Project owners should never pay for the same cost twice. If the owner is maintaining builder’s risk coverage on the project, then the contractor should not also bill the owner for builder’s risk insurance coverage. If the owner is requiring the contractor to provide performance and payment bonds, are subcontractor performance and payment bonds also necessary? Duplicate insurance coverage is not an uncommon occurrence and should be avoided, if possible.
Consider Insurance Carefully
Understanding the major insurance risk areas your organization faces on a construction project will help you to manage that risk and identify potential insurance cost overbillings. Insurance rates and costs should be reviewed regularly to ensure they align with the insurance coverage determined in the contract and that the project owner is not being billed for unnecessary or redundant coverage. A professional experienced with construction costs may be able to identify if construction insurance overbilling is affecting you. For more information, please contact us.
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