Legal Issues with Obtaining Insurance for Large Transit Projects (2014)

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4 agement approaches for large transit projects; explain the types of available programs, policies, and coverage; discuss controlled insurance pro- gram advantages and disadvantages; identify le- gal issues and constraints; identify procurement and management issues; and conclude with a se- ries of case studies of representative approaches taken by transit agencies. Preparation of this digest commenced with a review of relevant insurance guidebooks, studies, and reports, which are set forth in the footnotes of the digest. Initial interviews were conducted with representatives from the New York Metropolitan Transportation Authority, Los Angeles County Metropolitan Transportation Authority, New York State Department of Transportation, Massachu- setts Bay Transportation Authority, Sound Tran- sit, Washington Metropolitan Transportation Au- thority, American Public Transportation Associa- tion (APTA) Legal Affairs, and FTA. From APTA member listings, surveys were sent to 21 large transportation agencies to explore their ap- proaches to risk management and insurance, pro- ject delivery systems, insurance procurement practices, and legal issues. The authors analyzed the 10 surveys that were returned.4 Survey results indicated that most of the agen- cies had engaged in design–bid–build and DB pro- jects, while 6 of the 10 responders had undertaken construction manager/general manager project delivery. Generally, basic contract requirements obligated contractors to provide specified insur- ance coverages, which included builder’s risk, general liability, and workers’ compensation. Most often, the transit agency was added as an additional insured party to contractor-provided policies. Seven of the 10 responders have used OCIPs for large projects in excess of $100 million and one agency is using CCIPs. Agencies that used OCIPS cited certain benefits of OCIPs, in- cluding safety, loss control, public relations, claims management, increased opportunities for 4 Surveys were returned by Washington Metropoli- tan Area Transit Authority (WMATA), San Diego Asso- ciation of Government (SANDAG), Central Puget Sound Transit Authority (Sound Transit), New York Metro- politan Transportation Authority (NYMTA), Metropoli- tan Atlanta Rapid Transportation Authority (MARTA), Dallas Area Rapid Transit Authority (DART), Massa- chusetts Bay Transit Authority (MBTA), Los Angeles Metropolitan Transportation Authority (LAMTA), San Francisco Metropolitan Transportation Authority (SFMTA), and Tri County Metropolitan Transit District of Oregon (TriMet). A copy of the survey is included as Appendix A. small businesses, guaranteed coverage for the du- ration of the project, and higher limits, cost sav- ings, and broader insurance terms and conditions than contractors typically carry. Contract insurance requirements were gener- ally written by the risk manager and legal coun- sel. Many agencies use outside brokers selected through a competitive procurement process to provide advice on structuring insurance programs and procuring insurance in the marketplace. The survey responses were analyzed and further in- depth discussions were conducted with certain survey responders to elicit more detailed informa- tion that led to the Case Study section of this digest. II. LEGAL ISSUES SURROUNDING PROJECT INSURANCE The following are some of the general types of issues that transit lawyers will encounter regard- ing insurance for large transit projects. This is intended as just a general checklist and introduc- tion to the topics that the transit lawyer will need to address, as each of the topics is covered in more detail later in this digest or in the Case Study section.5 A. Assessing and Allocating Risks All large transit projects are inherently risky undertakings. Depending on the nature of the pro- ject and associated design challenges and con- struction methods, these risks can include envi- ronmental issues, permitting issues, impact on the built (and unbuilt) environment, construction means and methods, political issues, and funding challenges. The focus of this digest is to look at capital project delivery phase risks and risk miti- gation strategies that can be employed, with a focus on insuring against those risks. Risk Allocation Principles. The fundamental challenge for transit lawyers, working in tandem 5 In this section of the digest and in subsequent sec- tions, readers will encounter language and terminology that is specific to the insurance and underwriting com- munity. In general, we recommend that readers avail themselves of glossaries and technical resources avail- able on the Internet. In particular, we think that tran- sit lawyers and other readers will find the IRMI (Inter- national Risk Management Institute, Inc.) Glossary of Insurance and Risk Management Terms (http://www. irmi.com/forms/online/insurance-glossary/terms.aspx) very helpful in defining and understanding the terms used in this digest. Further, the IRMI site provides ac- cess and links to information for a broader understand- ing of certain technical topics.

5 with their engineers, construction managers, and technical consultants, is, first, to identify and classify potential risks; second, to develop risk mitigation strategies; and, third, to allocate that risk to the project participants (or others outside the immediate project parties; for example, in the case of insurance). The fundamental principle that should be employed in risk management is to allocate risk to the party or parties that are best able to 1) avoid the risk, 2) mitigate the risk, and 3) absorb the risk. It is when parties have allo- cated to them risks they cannot avoid, mitigate, or absorb that claims are generated, as parties seek to shift that risk to some other party or entity. The more risk is allocated to a party that cannot handle the risk, the more likely it is that the party will seek to shift the risk somewhere else, generating claims, added costs, and potential li- abilities. Risk Assessment Methods. The first step in a project-related risk assessment is assembling a cross-functional team that knows enough about the project to identify, classify, and quantify po- tential risks. The process of identifying risks is fairly straightforward, and can include general categories such as right-of-way, permitting, pro- curement, cost, schedule, and quality, etc. The second and more judgmental step is assessing and classifying those risks by probability and severity. The question for each identified risk is the likeli- hood of it happening and, if it does happen, the severity of the occurrence and resulting impact on the project. The project team must then rank them, with focus given to those of high probability of occurrence and significant impact on the project (typically, transit agencies focus on cost and schedule as the number one priorities).6 Risk Allocation Options. The first step in con- sidering risk allocation is to determine whether there is a risk mitigation strategy that completely avoids the risk—obviously, if a risk does not occur then there is no need to worry about which party is going to mitigate or absorb that risk. So, for 6 The FTA guidance on risk assessment is captured in its Oversight Procedure 40, http://www.fta.dot.gov/ documents/OP40_Risk_and_Contingency_Review_ Rev._2May_2010MB.pdf, and the Project Management Handbook, which directs FTA Project Management Oversight Contractors (PMOCs) through reviews of various risk assessment, evaluation, and mitigation processes. Included among the risks are contractually allocated risks, insured risks, and risks covered by con- tingency. The guidance broadly defines risk well beyond insurable event risk covered by commercially available insurance. example, contract documents can include precon- struction investigations to avoid unknown risks or to establish the baseline against which unantici- pated conditions can be measured for commercial responsibility purposes. This is a simple way to mitigate against the risk happening and, if it does, to be clear on which party has the risk for management or absorption purposes in bidding the project. The key factor here is that defaulting to broad, generic transfers of risk is often not the best option, even though it may appear superfi- cially appealing to do so. So, the options for allocating risk are: 1) com- mercially transfer that risk to the project party best able to manage or absorb the risk, or 2) fi- nance that risk through insurance.7 Although the focus of this digest is on the second option, transit lawyers should give equal time to evaluating the first option. Commercial allocation of risk is done through the contract documents. This involves classifying the risk; determining the party that is best commercially able to avoid, manage, or ab- sorb that risk; and then clearly allocating that risk in the contract. This risk allocation is made through the commercial terms and conditions (for example, indemnity and standard of care provi- sions), and through the detailed specifications, plans, and drawings (for example, Geotechnical Baseline Report or prescriptive or performance specifications). Financial risk transfer involves compensating someone outside of the direct project parties to accept a particular risk. It should be noted that the commercial allocation of risk discussed above to some extent involves risk financing, because it is presumed that the party to which the risk has been commercially allocated will have the finan- cial wherewithal to manage or absorb that risk through its bid price or its company balance sheet. What we are referring to here is a pure transfer of that risk to another party, for a fee. For purposes of this digest, the risk financing mechanism fo- cused on is the transfer of risk to insurance com- panies. As discussed in detail below, the risk trans- ferred to insurance companies is financed by pay- ing a premium to them to accept the financial con- sequences of an insured loss. Impact of Project Delivery Approach on Insur- ance Programs. The traditional delivery method 7 This digest focuses on risk financing through insur- ance; however there are other ways to finance risk, in- cluding project budget contingencies, credit facilities, allowances, and surety bonds.

6 on public capital projects is design–bid–build. The owner contracts with a designer to produce a bid- dable set of construction documents, and the owner then contracts with the contractor to build the project strictly in accordance with those con- struction documents. However, there is a trend toward alternative project delivery approaches, including CM/GC, DB, and P3. This digest does not go into detail on these project delivery ap- proaches, which are described in detail in other sources,8 but the transit lawyer needs to under- stand that each of these delivery approaches in- volves different contractual relationships and cor- responding differences in risk allocation and risk financing. These, in turn, will drive the determi- nation of risks on a particular project and the commercial and risk financing options for financ- ing the allocation of those risks. Stated another way, the transit lawyer cannot apply the tradi- tional design–bid–build risk allocation and financ- ing approach to materially different allocations of risk inherent in these alternative project delivery approaches. B. Lack of Knowledge About, or Understanding of, Insurance Coverages, Limits, or Structuring Options Relationship Between Legal Liability and Transfer of Risk by Insurance. For the transit lawyer to effectively allocate risk and finance risk, he or she must have an understanding of the rela- tionship between legal liability and the transfer of risk. Very simply put, the transfer of legal liabil- ity by contract does not automatically mean that insurance will be available to cover that risk. A good example is professional liability coverage. Many public contracts have broad transfers of risk to design professionals to produce biddable and constructible construction documents. However, professional liability insurance coverage typically covers only damages caused by the negligence of the design professional. Thus, if there are dam- ages caused by design professional errors or omissions, but they do not fall below the applica- ble standard of care, there may not be profes- 8 See DANIEL DUFF, EDWARD J. GILL & G. KENT WOODMAN, LEGAL HANDBOOK FOR THE NEW STARTS PROGRAM 23–25 (Transit Cooperative Research Pro- gram, Legal Research Digest No. 30, 2010) (hereinafter referred to as Legal Research Digest No. 30); STEPHEN D. PALLEY, TIMOTHY E. DELAHUNT, JOHN S. SANDBERG & PATRICK J. WIELINSKI, CONSTRUCTION INSURANCE, A GUIDE FOR ATTORNEYS AND PROFESSIONALS 143 (Ameri- can Bar Association, 2011) (hereinafter referred to as CONSTRUCTION INSURANCE). sional liability insurance coverage for such dam- ages. Under those circumstances, the risk is fi- nanced by the balance sheet of the design profes- sional, not insurance.9 Impacts of Insurance Policy Forms, Coverages, and Structuring. The transit lawyer also must have basic knowledge about the differing forms, coverages, and structuring of insurance policies because that will impact the effectiveness of an insurance-based transfer of risk. Stated another way, the transit lawyer may believe at a general level that certain types of insurance have been mandated, but in the detail of the policy form, the type of coverage, or the structuring of the pro- gram, the actual insurance obtained may be dif- ferent than expectations from the contract provi- sions. The transit lawyer also should be aware of the applicable exclusions and other terms and condi- tions in the policies, which may be industry stan- dard or highly customized. A typical example is where property and liability policies may describe coverage as “all risk.” In practice, however, the coverage grant is defined by the extent to which certain exclusions apply in a loss situation. For example, an “all risk” property insurance policy may contain an absolute exclusion for losses relat- ing to design error or have a limitation on damage caused by a specific peril such as storm surge or flood. The transit lawyer cannot know what he or she is buying without a thorough understanding of the actual insurance policies that are issued, by line of coverage. C. Statutory or Regulatory Limitations that Affect Insurance Options Statutory Liability Obligations and Limita- tions. In allocating risk, both contractually and from a risk financing perspective, the transit law- yer needs to determine whether there are statutes that impose liability or limit liability as to certain parties. These statutory requirements may trump 9 Although not a part of this digest per se, another example is the surety bond. A surety bond is not insur- ance. Rather, it is a guarantee of performance of the contractor, but the surety’s performance under the bond is subject to all of the claims and defenses that the con- tractor would have had under the contract. Surety allo- cation of risk often revolves around commercial claim issues that may impact a contractor’s ability to perform in accordance with the contract requirements. Thus, the transit lawyer should not assume that just because there is a surety bond in place, damages or losses caused by the contractor are automatically going to be covered if the surety bond is triggered by a default.

7 contract terms or insurance policies that do not comply with such requirements. A good example is the so-called “anti-indemnity” statute, which as a matter of public policy provides that a party cannot require another party to indemnify it against its own negligence. Any such indemnity is void as against public policy, and therefore would negate any contractual or insurance risk financ- ing provision to the contrary.10 Statutory Insurance Requirements. The transit lawyer needs to ascertain whether applicable statutes mandate or prohibit certain types of in- surance or insurance programs. Examples include workers’ compensation insurance and OCIPs that may be dictated or limited by statute. In the first case, there are several states that require employ- ers to purchase workers’ compensation coverage from a monopolistic state fund and do not allow commercial alternatives. In the second case, cer- tain states proscribe or limit the use of controlled insurance programs for general liability and workers’ compensation on public projects.11 Statutory and Regulatory Procurement Re- quirements. Transit lawyers need to be aware of any applicable statutory or regulatory procure- ment requirements that can apply to brokerage services or insurance policies. Often these stat- utes and regulations provide for a uniform and transparent process that permits a competitive procurement that maximizes the public’s interest. That said, brokerage services are often procured on a request for qualifications (RFQ) and request for proposals (RFP) basis, where the experience and capabilities of the broker are just as impor- tant as pricing for the services. The procurement of insurance on transit projects is usually done through the broker since the broker is licensed to seek insurance in what is a highly regulated mar- ketplace. However, the transit lawyer needs to be aware of how broker services and insurance are procured, as there is a role for the transit lawyer in defining the need for and parameters of the services, compliance with applicable statutes and regulations on procurement, the terms of the pro- curement documents (including the form of con- tract and form of insurance policies), the selection process, and the entry into legal agreements with the broker and insurance carriers. D. Internal and Organizational Constraints Agency Approaches to Risk Management and Risk Financing. The transit lawyer will need to 10 See infra § III.C. 11 See infra § V.B. familiarize himself or herself with the risk man- agement philosophy and approach of the transit agency. For example, does the agency have a risk manager or risk management department and, if so, what is its scope of responsibility and author- ity? Does the agency have a risk assessment proc- ess for its projects? Does the agency do risk as- sessments for purposes of securing federal funding and, if so, how does that type of risk as- sessment relate to risks that are to be allocated to other parties via contractual terms or risk financ- ing options such as insurance? Agency Policies, Precedents, and Practices. Most transit agencies have a myriad of internal poli- cies, precedents, and practices with which the transit lawyer will need to become familiar. These policies, precedents, and practices can include a risk assessment process, approach to allocation of risk, statutory or regulatory requirements, stan- dard form contracts, procurement requirements, and past experience with risk management- related issues, such as the structuring of insur- ance programs like OCIPs and CCIPs. Many times the specifics of these policies, precedents, and practices are driven by the agency’s approach to risk management in general, the experience that the agency has had historically with certain types of risk allocation and risk financing, and the practices of the agency in procuring brokerage services and insurance policies. Of particular importance is the persistence of old or out-of-date contracts used in design and construction, and related contracts. These vestig- ial contract models for such agreements and con- tracts often refer to nonexistent, antiquated, or unobtainable insurance products, causing imme- diate problems of compliance. Further, these same model contracts may approach risk allocation and risk-related provisions from an older and less effi- cient default perspective, which may conflict with the risk and insurance strategies as agreed among the contracting parties on a specific large project. The transit lawyer must realize that there is no one “right way” to approach insurance programs. For example, as can be seen from the Case Study Section, transit agencies have materially different approaches to the way that they manage risk and implement insurance programs. E. External Limitations or Prescriptions Lender or Bondholder Requirements. Depend- ing on the financing of the transit project, there may be financiers that impose requirements on the parties to insure against certain risks. The best example of this would be a public agency that