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

Below is the uncorrected machine-read text of this chapter, intended to provide our own search engines and external engines with highly rich, chapter-representative searchable text of each book. Because it is UNCORRECTED material, please consider the following text as a useful but insufficient proxy for the authoritative book pages.

36 outside the agency. Characteristics of successful OCIP projects include many of the following: • An owner–administrator–contractor partner- ship and commitment. • A program design that supports the needs of both the owner and contractors. • Good communication and information management. • Properly communicated procedures and documentation. • Good, clear contracts, agreements, and incentives. • A realistic and formalized safety program. • Periodic, scheduled performance review and monitoring. Owner Responsibility. While one could argue that many of the insurance-related specialized skills and resources are available from outside sources and that using them wisely is often more efficient, the transit agency remains responsible for the management of the process and the pro- gram. In other words, an owner cannot delegate all the responsibility to the broker/administrator or insurer. To realize the added value of the OCIP, the transit agency must manage the pro- gram effectively. That requires a commitment to the program and the resources necessary to man- age it. In the absence of sufficient internal re- sources, many agencies opt for the CCIP alterna- tive. They still need to verify that coverage and cost are proper, but the enrollment, safety, and claims management oversight are the responsibil- ity of the contractor sponsoring the CCIP, or all contractors in the case of a traditional program. Even if it uses outside professional assistance, the transit agency must manage these critical elements: • Program design and planning. • Service and insurance procurement and contracting, including brokerage/administration. • Contractor (construction) selection and contracting (including bidding). • Contractor enrollment and communications. • Safety program management and communication. • Program administration, maintenance, and close-out. For example, one of the keys to success of an OCIP is a coordinated and effective safety pro- gram for the entire project. The transit agency cannot completely delegate this responsibility to the broker/administrator or insurer(s), but in- stead must maintain an oversight responsibility, since it will have a direct impact on the owner’s cost. The responsibility to maintain a safe work site remains the obligation of the employer (con- tractor), and the construction contract should clearly articulate that obligation. However, en- hanced safety, either in the form of project-wide safety standards or resources (e.g., training or inspection), can be provided by the owner or its administrator or insurer. Further, the transit agency has to be aware of claims activity to mini- mize the ultimate cost. The agency may benefit by retaining control over claims instead of entrusting this to the contracted administrator or insurer. Required Skills and Experience. OCIP admini- stration involves two broad areas of service, in a brokerage capacity and in an administrative or management capacity. Traditionally, both skill sets were contracted for from a single entity, usu- ally a national or large regional insurance broker. However, because the skills are discrete, excel- lence in one area does not guarantee excellence in the other. Increasingly, owners are considering the service requirements separately, evaluating the experience and capabilities of proposing ser- vice providers against two sets of criteria. The first area involves the design, underwrit- ing support, marketing, and placement of the in- surance components of the OCIP. This includes the periodic maintenance of the program through remarketing, continuing negotiations with un- derwriters, handling of billing and premium de- velopment, and certain close-out functions. In the second area of managing the OCIP, a broker/administrator must provide certain admin- istrative services for the OCIP to be successful. These services include, but are not limited to, the following: • Procedures and manuals. • Pre-bid communications. • Pre-bid conferences. • Construction bid cost analysis, evaluation, and support. • Preconstruction conferences. • Contract assistance and verification. • Program maintenance. • Program closeout. VI. MANAGEMENT AND PROCUREMENT ISSUES The following discussion of procurement and management issues focuses on 1) OCIPS, 2) CCIPs, and 3) Project Errors and Omissions

37 Programs. Some of the issues discussed will apply to other insurance elements in a large transit capital project. In the area of program administration, the use of a controlled insurance program approach reduces some of the burden a transit agency would otherwise have in a traditional contractor- provided program, particularly in the area of veri- fying compliance with insurance requirements in a large number of contracts and for multiple lines of coverage. With a controlled insurance program (OCIP or CCIP), the program administrator, usu- ally an insurance broker, typically has a responsi- bility to provide verification of program-provided coverage (especially workers’ compensation and liability coverage) to both the 1) enrolled or in- sured parties, and 2) program sponsor or benefici- ary, i.e., the transit agency. Also, the program administrator’s scope of services usually includes collecting evidence of coverage; verifying it for those required insurance policies that are not part of the OCIP or CCIP, such as automobile liability, some specialized liability, or property coverage; and reporting on the compliance with contract requirements to the owner transit agency. A. Insurance Program Administration One of the central elements of a transit agency’s insurance administration program is verifying insurance coverages. After the risk allo- cation process has concluded and the resulting risk assignments and decisions have been incor- porated in the project contracts as insurance re- sponsibilities and requirements, it is important to establish that all the requirements have been met and continue to be met during the entirety of the project. As noted in the following sections, some of this administrative burden can be outsourced to insurance brokers administering OCIPs or CCIPs. The documentation of coverage includes the fol- lowing: • Certificates of Insurance. Certificates of insurance (COIs) are often issued by the placing brokers or the insurance company, but may also be issued by the policyholder in certain circum- stances. The actual form of the COI differs from insurance company to insurance company using one of two approaches. Most COIs are issued on industry-standard ACORD95 forms. Others are proprietary to the insurers or the placing broker. The general purpose of COIs is to communicate 95 Published and copyrighted by the ACORD Corpo- ration. the basic coverage information and to verify that coverage was in effect at the date of issuance. There are two important caveats for transit law- yers relying on COIs for coverage verification. First, the issuer has limited responsibility to notify the certificate holder of changes, although some agencies have been successful in getting some acknowledgment of changes within certain time frames from the issuers. Second, the COI does not confer any rights to the certificate holder as only the actual policy language governs the terms and conditions of the coverage. There may be language in the COI suggesting otherwise, but in most cases, that language is nonbinding. • Insurance Policies. Insurance policies are the primary source for coverage verification. Often, the underlying construction and design policies may give the owner the right to request a certified copy of the insurance policies that comply with the contractual requirements. Transit lawyers should note that insurance policies are specialized contracts and that careful reading of the policy, including all the endorsements and project- specific language, is important. While many poli- cies will be based on an industry-standard form, such as an Insurance Services Office (ISO)96 form, coverage can be significantly changed by en- dorsement or specific fill-in language. One value of the ISO forms is the wealth of legal precedent in coverage interpretation. Much of the language has been tested in court. On the other hand, some insurers use proprietary forms of their own or ones suggested by their brokers. These so-called manuscript forms need to be reviewed in detail. Transit lawyers may not find any court interpre- tation of these forms. • Insurance Policy Conditions. As transit law- yers or their advisors review insurance policies, whether purchased by the agency or obtained by the contracting parties, particular attention to policy conditions is critical. One area of review is how a policy applies deductibles or self-insured retentions. It is important that the policy lan- guage describe a methodology of imposing de- ductibles that is consistent with the risk alloca- tion and contractual assignment for the project. Another area of review is whether an insurance policy allows for one party to waive its rights of subrogation against another. Transit lawyers should look at this particular area as a two- pronged test. First, the insurance policy should allow for the policyholder to waive its rights of 96 Published by the Insurance Services Office (ISO).

38 subrogation.97 Secondly, the waiver must be af- firmatively stated in the underlying construction or design contract. Simply having an insurance policy that allows a waiver of subrogation does not execute the waiver. B. Procurement of Insurance 1. Public Sector Challenges Public sector OCIPs and CCIPs present some challenges not found in the private sector. • The emphasis on process and open competi- tion makes the public OCIP more process driven, particularly in the area of procurement as dis- cussed below. • The constraints on funding, cash flow, and budgeting also affect program design and the rat- ing plan. This area is complicated by the under- writing community’s perception of its opportuni- ties to profit. For example, a going concern with operational insurance needs, e.g., a transit agency or authority, can present a long-term opportunity for an underwriter. A one-off project sponsored by a state that does not purchase insurance normally does not. Underwriters factor this into their pric- ing and security requirements. • Legal considerations and regulations regard- ing public construction contracts and contractor selection introduce an additional emphasis on process and often limit options available to the organization. • In Oklahoma, an OCIP was challenged by the independent insurance agents who sought to en- join the Oklahoma Turnpike from proceeding with an OCIP program for the construction of four new turnpikes. The court, in Independent Insurance Agents of Oklahoma v. Oklahoma Turnpike Authority98, determined that OCIPs were not pub- lic construction contracts requiring procurement under Oklahoma’s Public Competitive Bidding Act. The court also noted that a typical OCIP is designed to reduce the cost of insurance premi- ums, and it allows for a coordinated risk man- agement and safety program for workers and visi- tors to the construction site. It further noted that an OCIP provides for insurance premium rebates to the policy owner for good construction safety records. In upholding the Turnpike’s OCIP pro- gram, the court noted that the OCIP was benefi- 97 Most insurance policies, particularly property in- surance policies, allow the policyholder to waive its rights of subrogation 1) in writing, and 2) prior to a loss. 98 1994 OK 69, 876 P.2d 675 (1994). cial, because it provided better coverage and higher limits for less money than could otherwise be obtained, in addition to a safety plan of un- usual merit. • The need to build consensus and understand- ing among a wider range of constituents puts a greater burden on management to “sell” the OCIP idea and to regularly communicate the performance of the OCIP. • The loss-sensitive or retained exposure ele- ment of the typical rating plan presents specific funding and accounting issues, particularly in- volving federal money. • There may be public policy, political, regula- tory, or funding pressures to close an OCIP earlier than a private sector sponsor would normally close an OCIP. This may force some economic choices that are counterproductive. This challenge requires attention to an exit or closure strategy and may affect the program design and implementation. These and other public sector considerations are seen in the typical action plan discussed below. 2. Typical Action Plan: Selected Implementation Issues (OCIP Specific) While the theory behind a successful OCIP is simple, the execution required for success can be complex. Public sector processes and considera- tions can complicate implementation further. The following discussion of a typical action plan high- lights some of those public sector considerations. It also assumes a luxury not often found in the “real life” public arena—the absence of time con- straints and the ability to implement the program in an ideal order. Often, this is not the case. The actions take place in four time periods. These are 1) a pre-bid planning and design phase, 2) a predeployment–preconstruction phase, 3) the active construction phase, and 4) the close-out phase. During the pre-bid planning and design phase, the transit agency may conduct a feasibility study. The purpose of the study is nominally to explore the options for construction risk financing and to decide if an OCIP makes sense financially. How- ever, the most important function such a study may fill is educational. It informs the project owner’s governing board, management, and con- stituents about the elements, expected benefits and costs, and other considerations regarding an OCIP. It can be used to promote discussion and decision and to define the expectations of each of

39 the concerned groups. Another activity during this phase is the development of an action and staff- ing/resource plan, as well as a procurement plan. Having adopted the OCIP concept and the ac- tion plans, the project owner then begins the pro- curement process. Decisions are made about which entities will provide what services and the manner of conducting the various procurements. • The first decision concerns whether a single broker/insurer team will provide all the services on a “bundled” basis or whether brokerage, ad- ministration, and other services may be “unbundled.” • The second decision relates to the manner of procuring the insurance components and possibly the services. The choices are sometimes referred to as “the single broker” or “conceptual” and “the multiple broker” or “competitive” approaches. Single Broker/Conceptual. In the first model, a single broker is selected, based on qualifications (RFQ) and possibly a fee proposal, and that broker approaches a number of insurance companies for proposals. In this model, the insurer is then selected based on an evaluation of cost, program design, and coverages. Multiple Broker/Competitive. The second in- volves qualifying two or more brokers through some process, assigning insurance companies to each of the participating brokers, and selecting the broker/insurer team based on cost and cover- age considerations. Both approaches have their advocates, and both approaches work. Often, local considerations and preferences make one approach superior to the other. Generally speaking, the first approach assures that the transit agency selects the best- qualified broker/administrator and avoids the pos- sibility that a low insurance cost may be delivered by an inferior service provider. The second ap- proach assures that there is verifiable competition underlying the selection. It takes some of the ap- pearance of subjectivity out of the process. Which- ever procurement approach is chosen, it must be based on identified selection criteria heavily weighted to the experience of the staff assigned to the team. It is advisable to hold pre-proposal meetings with the various insurance underwriters to assure that they understand the project, the project owner, and management’s commitment. Once the OCIP team is selected, the public owner needs to execute an appropriate contract with the various parties, particularly the broker/administrator. This will spell out the re- sponsibilities of the various parties and serve as the basis of future performance evaluation. It also sets the groundwork for the communication and coordination required in a successful OCIP. Next, in the pre-bid phase, the broker/admini- strator and other OCIP team members formulate a communication plan and begin the contracting process. This may involve pre-bid conferences for the participating contractors, preparation of bid documents and contracts, development of OCIP manuals, decisions regarding who will be eligible to enroll in the OCIP, and what coverages will be required outside the OCIP. It is at this time that the owner affirms the safety responsibility of the various contractors through the language of the contract and the OCIP manuals. The question of which contractors will be cov- ered or enrolled is a practical one. In most cases, some contractors will be excluded, particularly those who are not on site, involved in hauling or fabrication off site, or involved in small subcon- tracts in particularly hazardous trades. This deci- sion will have an effect on the way the insurance requirements are stipulated in the construction contract. Another decision made during the pre-bid or pre-contracting phase is how insurance costs are to be reflected in the construction bids (if bid) or estimates (if negotiated). This is one area where local ordinances or state law may constrain the agency. In bidding situations, the two options are the so-called “bid-deduct” and “add-alternate” approaches. While the consideration of their ad- vantages and disadvantages is beyond our present scope, where law allows the second approach, it consumes less administrative time. Advocates of the first approach argue that it provides a clearer picture of the “savings” achieved by the OCIP. In our experience, the second requires “a leap of faith” by the public agency. In neither case is there complete certainty to the amount of “sav- ings” resulting from the program. During the pre-deployment phase, the OCIP team, primarily through the efforts of the admin- istrator, binds the coverage, enrolls the participat- ing contractors, completes the plan education ac- tivities, and distributes the appropriate manuals. At this time, the safety plan is designed, including imposing safety obligations on all contractors, developing a written owner’s safety plan, explor- ing a possible incentive plan, and establishing a process for verifying and assuring compliance. During the construction phase, the activities include 1) maintaining the insurance program; 2) conducting safety training, support, and auditing;

40 3) verifying outside coverage, payrolls, claims, and other information from enrolled contractors; 4) working with insurers and other service providers on safety, claims, and coverage issues; and 5) re- porting performance and results to the governing board and management. In the final phase, project close-out, insurance cost bases are audited, contractor cost reductions are verified, losses and claims are resolved, per- formance reviews and audits are completed, and final reports are issued. If the early planning and service procurements were done well, and periodic construction phase monitoring and necessary cor- rections were undertaken, then this phase can proceed with little problem. As previously outlined, there are two basic pro- curement models for obtaining an OCIP that fol- low typical approaches used by transit agencies to procure their operational insurance coverages. The complexity and uncertainties of cost elements complicates the procurement, often making the basis of award a matter of judgment (“best value”) rather than lowest demonstrated cost. When done right, the OCIP itself is negotiated before the prime construction and design contracts are awarded, which leads to problems in evaluating the costs of one approach against another or one proposal against another. • The fixed cost components are a function of payroll or contract cost, which may not be known for some period of time, particularly in DB and other alternative delivery models. • The variable components, especially the losses and loss adjustment expenses, will not be known for some time after completion of the pro- ject, subject to maximum and minimum rating plan premiums, which are a function of payroll (itself a variable factor). • There may also be deductibles outside the rating plan that are the responsibility of one party or another and must be treated in the contract documents. In the case of a CCIP, the construction man- ager or prime contractor has the responsibility of obtaining the coverage for the benefit of the pro- ject partners, including the owner. Again, the specification of the CCIP and its programmatic details, such as limits, coverages, deductibles, and parties protected, are spelled out in the proposal documents as performance specifications rather than detailed prescriptive specifications. After award, the CCIP sponsor may approach the in- surance market to obtain a CCIP program with the appropriate coverages and limits, subject to the underwriting and pricing demands of the in- surance companies. 3. Procurement Processes There are various procurement methodologies available to transit agencies in arranging various required insurance and related risk financing ser- vices. These vary by the program approach chosen by the agency. Coverage obtained by the agency can negotiate with an incumbent insurance broker or insurer. This is a typical option for builder’s risk coverage. Conceptually, coverage may also be procured through one of a number of competitive approaches, including: • Appointing a single broker to negotiate pric- ing and coverage of an insurance program for the agency. In our experience, this approach is rarely used in the public sector. None of the survey re- spondents indicated a preference for this model. • Using an RFQ or RFP process to select a sin- gle broker that in turn conducts a competitive bid for specified coverages99 in the commercial mar- ketplace, approaching a variety of commercial in- surers directly or through intermediaries, such as excess and surplus lines brokers. In our experi- ence, we find this approach to be most prevalent in the public sector for large projects where an owner has decided to implement an OCIP. The survey respondents that use OCIP seem to indicate a similar preference for the single broker model. • Using an RFQ or RFP process to select two or more insurance brokers, assigning them specific insurance companies to approach, issuing detailed specifications, and evaluating responses for the best policy or program. We do not find this model used very often for OCIP coverage, due to limita- tions in market capacity and the limited number of lead insurers. For some other coverages, there might be a large enough market to accommodate more than one broker in the marketplace. • Inviting a number of brokers to participate in a general bidding process, assigning markets, is- 99 These include builder’s risk, primary general li- ability, lower layer umbrella liability, and workers’ compensation. Higher levels of excess or umbrella li- ability may be subject to market capacity constraints that prevent securing firm competing quotations for significant limits. For higher limits, where capacity and cost are the primary determinants, the broker’s role includes identifying, negotiating, and placing the limits at the best available terms.

41 suing specifications, and evaluating responses in order to select the best proposal or proposals. While this approach is sometime used in the pub- lic sector for very small projects, it is not suited to larger, specialized projects such as transit construction. For coverages that are required of other par- ties, the transit agency has little or no control over the procurement of the insurance. Instead, it relies on the insurance requirements contained in the construction procurement documents and the various contracts. • This requires that the level of performance requirement be detailed enough to assure that the successful designer, constructor, DB firm, or other third party secures coverage that is appropriate and compliant with the insurance requirements at a reasonable cost to the owner. • Depending on the project delivery model, those costs may or may not be part of the selection decision. • The approach to obtaining the insurance is directed by the third party. • The result is that the transit agency has no ability to effect its disadvantaged business enter- prise (DBE) programs, or to craft insurance poli- cies or products to dovetail with the agency’s own insurance or negotiate improvements to benefit the agency or the public. • The procurement of a CCIP program focuses on the DB entity or the prime constructor or con- struction manager, depending on the delivery approach. The CCIP model does afford a single point of contact for evaluating and verifying cov- erage and presumably provides broader and lower cost coverage than the traditional everyone- brings-their-own-coverage model. 4. Cost Analysis in Procurement Transit lawyers will find that cost analysis for design- and construction-related insurance is a complicated and sometimes very opaque process. There are a number of elements contributing to this complexity and adding to the uncertainty of insurance costs. • Exposure Base Uncertainty. Most insurance policies are priced as a function of some exposure base, most typically 1) payroll for workers’ com- pensation and general liability, 2) replacement cost values at risk for builder’s risk, and 3) construction costs and/or professional fees for pro- fessional liability. Initial premium costs are based on projected exposures, which may vary greatly from the actual exposures. This introduces a pro- jection uncertainty. Another example is found in DB situations where the construction means and methods may be left to the DB organization, and the payroll, number of contractors, and their iden- tities, all of which may drive insurance costs, may be unknown for some time. • Loss Sensitive Rating Plan Uncertainty. In the case of CIPs for workers’ compensation and general liability, the rating plans are loss- sensitive, i.e., the premium consists of certain fixed price components and certain variable (losses) costs. Loss projections are used to deter- mine initial premiums and payment plans, subject to adjustments as losses are reported and resolved. • Placement Timing and Market Conditions Uncertainty. Owners may estimate the cost of OCIPs or builder’s risk programs well before the actual insurance is placed. Constructors, design- ers, and DB organizations may project insurance costs for CIPs, traditional insurance programs, design professional liability, and other insurance as part of their proposals before they actually arrange the insurance. This timing difference introduces uncertainty regarding the market conditions that affect price. Similarly, if the term of the project is long, there is a strong likelihood that insurance programs may need to be renewed mid-project, subject to potential changes in the marketplace affecting both price and breadth of coverage. Policyholders, whether the owner or the contractors and designers, need to rely on their advisors, e.g., insurance brokers, insurance con- sultants, or owner representatives, for guidance on cost estimates. Insurance companies and bro- kers may have proprietary insurance products or programs where they are reluctant to share details of pricing or coverage design until the programs are bound. This, coupled with an under- standably conservative perspective on cost estimation, leads to increased opacity in cost presentations. 5. Contingent Commissions In October 2004, New York Attorney General Elliot Spitzer commenced a civil litigation against Marsh & McLennan, Inc., and Marsh, Inc. (collec- tively “Marsh”), alleging that they cheated major corporate clients by rigging bids and collecting huge contingent commission fees by steering business their way. The allegations involved fraudulent business practices and conspiracy to