Wrap-up or Wrap policies are insurance policies that provide coverage to the parties involved in a single construction project - owners/developers, general contractors and subcontractors - under one policy, in lieu of the traditional model where the owner and each contractor have their own general liability policies.  Although the idea of a single policy to streamline the claims process on construction litigation seems attractive, the pitfalls of wrap policies need to be understood.

How do they work?

The primary insured on a policy (usually the project owner or developer) or “sponsor” is often responsible for contractually obligating the subcontractors to fund the premium for the wrap policy (“enrolling” them). The sponsor also determines the allocation of premium costs and deductibles as between the subcontractors.  The sponsor will be obligated to satisfy a significant self-insured retention ("SIR") before the insurer is obligated to participate in the defense or pay indemnity on a claim, so the sponsor is motivated to get subcontractors to pay their deductible amounts on any given claim.  Doing so ensures the sponsor is not solely responsible for satisfying the SIR.

The pros and cons

The benefits of such wrap policies during litigation is that they almost entirely eliminate the need to devote defense resources to enforcing additional insured obligations, and generally eliminate the need for indemnity cross-complaints by and against subcontractors.  These benefits, in turn, allow the defendants to focus on a united front against the plaintiff.  This approach is different from the traditional model, where the general contractor and plaintiffs may both be trying to negotiate settlement amounts out of subcontractors and their insurers.

Pitfalls of wrap policies during settlement negotiations are two-fold.  First, where the traditional general liability policy model may provide multiple sources of indemnity on a project – represented by each subcontractor’s policy – the aggregate limits of a wrap policy only provides one policy to cover the total liability of all parties on a project.  There are situations where one available aggregate may not be sufficient. 

As one example, a wrap policy insurer may be called upon to defend against a third party injury claim arising out of a site accident during construction, then later be called upon to fund a settlement for defects on the project.  Thus, defendants negotiating a settlement of any claim under a wrap policy must keep in mind the remaining aggregate on the policy and the possibility of future claims.  The effect of a policy-limits demand in any one lawsuit can be devastating to all insured parties, as paying such a demand effectively leaves them bare on future claims.

The second pitfall of wrap policies in the settlement process is that the typical wrap policy does not treat costs of defense as a separate obligation under the policy.  Defense costs reduce the aggregate policy limits, even before indemnity payments.  While a unity of interests among the owner and contractors may reduce defense costs by eliminating the need for multiple defense counsel, the cost of a defense is still relatively high in comparison to what is typically paid in indemnity on a construction defect claim.  Estimates are that defense costs under a wrap policy are at least twice the amount paid in indemnity.  Such "burning limits" policies can put the defense at a negotiating disadvantage because of the increased costs a prolonged litigation can entail.

Dealing with wrap policies

To guard against the pitfalls of wrap policies, general contractors need to be mindful of having appropriate levels of coverage.  General contractors and subcontractors need to consider carrying traditional liability insurance in addition to enrolling in a wrap policy.  Subcontractors should also budget to carry a cash reserve to cover the potential cost of any deductible or self insured retention required to trigger its defense of a claim under a wrap policy.

Conclusion

A wrap policy can be an efficient cost effective way of providing coverage for a construction project, but the potential pitfalls of such a policy must be understood in order to minimize the risks inherent in such policies. 

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