Chapter 6 | Contracting or Servicing Risks
Upon completion of this section, you should be able to:
- Identify the proper classification for subcontractors.
- Identify the special classification exclusions.
- Determine the proper amount to include subcontractors in the premium computation.
- Define adequately insured subcontractor and identify the best method to determine the subcontractor is adequately insured.
Under the CGL program, the auditing of contracting or servicing risks presents a formidable challenge to even the most experienced auditors. Although the premium computation procedure generally follows the current procedure, there are some concepts within this business group that require particular attention by the auditors. At the same time, this business group, more than the others, requires the auditors to educate the policyholders so that the policyholders meet the terms of their policy by "furnishing the proper records necessary for a premium audit". As we will see later, manual terminology, such as adequate insurance, may necessitate the policyholder to provide certificates of insurance for their subcontracted labor. We will cover this concept along with other procedural changes during the following discussion.
Contracting or servicing risks are classified according to the specific procedures detailed in Rule 28. For construction or servicing risks, each distinct operation may be separately classified and rated, except that any particular part of an operation which by itself may qualify for a classification may not be separately classified if the said operation is an integral part normal and usual to the total operation.
Example 1: Concrete Construction - Code 91560
This classification includes making, setting up and taking down the forms. Therefore, a carpenter involved with the construction of forms would be classified under Code 91560, rather than a carpentry code.
Example 2: Septic Tank Systems - installation, servicing or repair - Code 98806.
This classification contemplates excavation of the ground for the septic tank and drain field lines. While there is a classification for excavation (Code 94007), excavation is a normal and usual part of Code 98806.
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SPECIAL CLASSIFICATIONS EXCLUSIONS
The following special classification exclusions apply in addition to the general exclusions (Rule 26.B.2) and shall be separately rated.
BASIS OF PREMIUM - PREMIUM COMPUTATION
- Blasting operations. All blasting operations performed by the insured should be separately classified under Code 91210, Blasting Operation.
- Restaurant or commissary operation in connection with construction, erection, lumbering or mining operations. (Such operations are a general inclusion on other than contracting or servicing risks.)
The basis of premium for contracting or servicing risks is payroll. As was discussed earlier, payroll is defined as: "Remuneration or money or substitutes for money" (Rule 24.E).
Rule 28.B.3 provides the following additional guidance in the amounts and assignment of payroll or remuneration.
- Divide the payroll for each distinct type of operation as classified at a job or location. Any such operation for which separate payroll records are not maintained shall be assigned to the highest rated classification applicable to the job or location.
- Miscellaneous employees are to be assigned to the governing classification.
At a job site, there may be employees that are common to all or most of the classifications, and these employees are termed miscellaneous employees. Miscellaneous employees include, but are not limited to: job superintendents, timekeepers or watchmen, or operations such as general clean-up or snow removal.
Miscellaneous employees are to be assigned to the classification carrying the largest amount of payroll at a job or location during the policy period (governing classification). It is important to note that this is the classification with the largest payroll, not the highest rate.
- If any draftsmen are exposed to any operative hazard of the business, the entire payroll of such draftsmen shall be assigned to the highest rated classification to which they are exposed.
- If an employee's work involves more than one classification with different exposure bases, assign the entire payroll of such employees to the classification where payroll is the exposure base.
An insured operates a carpet store. Occasionally, the owner will contract to install carpeting that was not sold in the store.
The classifications applicable to this risk are:
|Floor Covering Stores
|Floor Covering Installation
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An employee spends 25% of his time involved in the contracting activities (installing carpets not sold by the store) and works the remainder of the time installing carpets sold by the store.
While the store operation is separately classified, 100% of this employee's payroll should be assigned to Code 94569, because this code uses payroll as the premium basis.
An insured involved in both the retail sales and installation of television sets. The following figures are developed:
The proper classification of this risk would be:
Appliance Stores - household type - Code 10042 (gross sales $300,000).
In determining the primary operation, a review of the relative payrolls would seem to indicate that installation is the principal operation by a slight margin. However, a comparison of the sales clearly shows that the store is the principal operation, as it accounts for 75% of the total sales.
After determining that the store is the principal operation, reference should be made to Rule 29, which governs Mercantile Risks. The installation operations are not to be separately classified according to Rule 29.C.
Using an operation similar to the above example, assume the following figures were developed:
|Store (& shop)
The proper classification of this risk would be:
Television or Radio Receiving Set Installation or Repair - Code 99650 (payroll $45,000),
Appliance Stores - household type - Code 10042 (gross sales $75,000).
In reviewing the relative sales figures, the installation operation is the primary operation.
In this example, the store operation may be separately classified because the classification rules under the principal operation, Contracting and Servicing, allow it. Rule 28.A.2 provides: "If a risk consists of a number of separate operations which do not normally prevail in a business, each operation shall be separately classified."
(Note: Any employee involved in both the store and installation would have all of his/her payroll applied to the Contracting and Service classification, Code 99650.)
As can be seen from the three examples above, it is important to review a number of factors in determining the primary operations. Once the primary operation is determined, the classification procedure is guided by the rules addressing the business group of that primary operation. Additional classifications for that entity are permitted only when allowed by the rules for that group.
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The territory in which the job is located determines the rating territory.
CONTRACTORS - SUBCONTRACTED WORK
Subcontractors are commonly hired by a construction business to complete a portion of the operation or service offered. When a subcontractor is hired to perform a construction operation, that operation must be separately classified.
The existence of subcontractors on a construction site creates an additional premises/operation hazard and especially an additional products/completed operations hazard beyond that created by an insured's employees. For this reason, the independent contractors must be separately classified for premises/operations and products/completed operations and the appropriate premium developed on the CGL. Classification Assignment
The classification of independent contractors involved in construction operations depends upon two major factors: (1) type of work performed by the hiring contractor and (2) whether or not the independent contractor is adequately insured.
The type of construction project an adequately insured sub performs work in connection with determines the classification assignment. The following classifications are available:
Contractors - subcontracted work - in connection with:
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- Construction, reconstruction, erection or repair, not buildings - NOC, 91581
- Building construction, reconstruction, repair or erection:
- apartments or office buildings over four stories, 91582 - one or two family dwellings, 91583 - for industrial use, 91584 - NOC, 91585
- Oil or gas field construction, reconstruction or repair, 91586
- Pipeline (other than oil or gas) or communication or power line construction, reconstruction or repair, 91587
- Bridge, tunnel or elevated street or highway construction, reconstruction or repair, 91588
- Street or highway construction reconstruction or repair - not elevated, 91589
- Other than construction-related work, 91591
Each of the classifications above carries the following important footnote:
This classification applies to that portion of the operations performed by adequately insured subcontractors of the insured. Operations performed by subcontractors without adequate insurance shall be classified and rated under the specific classification description for each operation. Adequately Insured Subcontractor
The concept of adequate insurance is not defined in the new CGL manual. Because of this, all companies will prepare their own interpretation. Likewise, no rates or guidance for those rates will be provided by ISO because of the varied company needs.
The General Liability Subcommittee of PAAS constructed the following definition to provide some unity in the industry regarding the intent of this concept: "An adequately insured subcontractor means that the subcontractor carries liability insurance with limits of liability and coverages at least equal to those carried by the insured for the period of time work was performed for the insured." In essence, anything short of the limits carried by the insured will create an additional exposure beyond that which would normally be contemplated by the insured's coverage. The premium auditor will therefore be required to review certificates of insurance to determine if the subcontractor is insured and if the limits of liability are at least equal to those of the insureds.
When there is no insurance or it is not adequate, the subcontractor is to be classified to the specific classification which describes the operation performed. In other words, subcontractors with inadequate insurance are to be classified as though they are employees of the hiring contractor.
An insured building single family homes with $500,000 limit of liability hires the following subcontractors:
(1) ABC Carpentry - $1,000,000 limit
(2) Seth Electric - $300,000 limit
(3) TLC Plumbing - no certificate of insurance available
Assuming equal coverages and concurrent time periods, only subcontractor (1) would be considered to have adequate insurance. Subcontractor (2) has limits of less than $500,000 and subcontractor (3) has no proof of any insurance.
The classification technique would be applied as follows:
Contractors - subcontracted work in connection with building construction, reconstruction, repair or erection - one or two family dwellings - Code 91583
Electric Work - within buildings - Code 92478
Plumbing - residential or domestic - Code 98483 Basis of Premium - Premium Computation
The basis of premium for subcontracted operations will vary, depending upon whether or not the subcontractor is adequately insured. Adequately Insured Subcontractor
The basis of premium for adequately insured subcontractors is Total Cost. The total cost of work is defined as:
The total cost of all work let or sublet in connection with each specific project including:
- The cost of all labor, materials and equipment furnished, used or delivered for use in the execution of the work, however, do not include the cost of finished equipment installed but not furnished by the subcontractor if the subcontractor does no other work on or in connection with such equipment; and
- All fees, bonuses or commissions made, paid or due.
Therefore, the total amount charged for services - labor and materials - should be included for subcontractors when it is determined that they are adequately insured.
Our insured is a general contractor building single family homes with a $500,000 limit of liability on his CGL policy. ABC Carpentry is a subcontractor hired to erect the wood frames. At the time of audit, the following information was developed:
ABC Carpentry has presented our insured with an insurance certificate disclosing the following information:
Insurance Company - Solid Insurance Company
CGL Policy No. - GL359
Limits - $1,000,000
The work performed by ABC Carpentry for our insured was billed as follows:
On the basis of the information presented, the appropriate classification for the subcontracted work and exposure is:
Contractors - subcontracted work - one or two family dwellings - Code 91583 - $500,000.
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Inadequately Insured Subcontractors
The subcontractors found to be inadequately insured are classified, not to the "Contractors - subcontracted work" classifications, but to the classification that best describes the work they perform. The former classifications use "cost of work" as the premium basis, while the latter use Payroll.
The CLM does not discuss specifically what amount should be included for inadequately insured subcontractors assigned to the payroll based classifications. It could be argued that the "cost of work" should be included the same as for insured subcontractors since there is no apparent attempt to discriminate between the two types of subcontractors. On the other hand, including the cost of work in a payroll based classification would distort premium and rating data.
In lieu of a specific interpretation by a company, the PAAS General Liability Subcommittee suggests that the subcontractor rule issued by NCCI in the Workers' Compensation Manual be used to determine the amount of exposure to be included in a payroll-based classification for an inadequately insured subcontractor:
The contractor shall provide a complete payroll record of the employees of each uninsured subcontractor. Premium on such payroll shall be based on the classifications which would have applied if the employees of the subcontractor had been employees of the contractor.
If the contractor does not supply the payroll records of its subcontractor, the full subcontract price of the work performed during the policy period by the subcontractor shall be established as the payroll of the subcontractor's employees. The additional premium shall be charged on that amount as payroll.
If investigation on a specific job discloses that a definite amount of the subcontract price represents payroll, such amount shall be the payroll for the additional premium computation. In contracts for labor and material, the payroll shall not be less than 50% of the subcontract price. In contracts for labor only, the payroll shall be established as not less than 90% of the subcontract price.
This interpretation is meant to fairly assess the additional exposure created by the existence of the subcontractor at the job site, and then to equate the measured cost to a common exposure base: payroll.
An example at this point should clarify this application:
Assume the same general contractor used in the prior example, erecting single family homes, hired the following two additional subcontractors:
Seth Electric: electrical wiring, $300,000 limits of liability, cost of work - $125,000 (labor only), and
TLC Plumbing: plumbing, no certificate of insurance available, cost of work $200,000 (labor and materials).
The classifications developed and the exposures for each could be as follows:
Contractors - subcontracted work - one or two family dwellings, Code 91583 - $500,000
Electrical Work - within buildings, Code 92478 - $112,500
Plumbing - residential or domestic, Code 98483 - $150,000
You will note that in lieu of the definite amount of payroll, the percentage of total cost applied should reflect the auditor's estimate of the actual payroll exposure of the subcontractor. A flat 90% should not be assumed for labor only contracts (in this example we did use 90% of $125,000 for Seth Electric), nor a flat 50% be used when labor and material are provided (in this example we used 75% of $200,000 for TLC Plumbing). Audit Techniques
At this point it is important to remember that the burden of proof remains with the insured to properly classify subcontractors. This means that all certificates must be kept on file, must show that they are applicable for the time period that they performed their job for our insured, and must show that the limits of liability and coverages equaled or exceeded that of our insured. If these 3 conditions are not met, the subcontracted operations must be classified to the payroll category.
Quite often, however, an insured will obtain these certificates after the audit has been completed and will request that the subcontractors be re-classified. In order for the audit to be properly corrected, the following relevant information should be recorded when auditing subcontractors:
- Name of subcontractor
- Project they were involved with
- Type of work performed by subcontractor
- Insurance coverage: Adequate or inadequate
- Total cost
- Amount included as payroll
- Any necessary documentation or explanation
Without the above information, it may be impossible to change or correct the audit properly, except by doing a re-audit.
OWNERS AND CONTRACTORS
The "Contractors - subcontracted work" classification shown under Premises/ Operations and Products/Completed Operations should not be confused with the Owners and Contractors Protective (OCP) liability policy classifications shown under Rule 46. Rule 46 is designed only for a separate coverage that may be purchased separately and independently from the CGL coverage.
OCP coverage is designed to provide an insured with protection in the event it becomes implicated in a legal action because of a loss caused by a hired independent contractor or from an act or omission of the insured in supervising the activities of an independent contractor. When a loss results from one of these causes, the independent contractor is usually held solely responsible, but all parties involved are commonly named as co-defendants in a legal action. If this should happen, the insured at least has defense coverage. The independent contractor, on the other hand, will rely upon its own CGL policy.
The premium charge for the OCP coverage is developed as it was in the past: the basis of premium is the total cost of work of all subcontracted operations. The classifications to be used for this coverage have remained the same. The rates apply per $1,000 of total cost. It should be noted that there are two rate levels to be applied (1st $1,000,000 and over $1,000,000) for each project.
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