Insurance - Professional Liability

We've been working our way through various types of insurances to see what FAR (Federal Acquisition Regulations) has to say about the allowability of their costs and also to highlight, where we can, the audit procedures that contract auditors might employ to assess the reasonableness and propriety of such costs.

We began early this year with War Hazard Insurance, a type of insurance coverage that most Government contractors don't need (see War Hazard Premium Payments). We wrote a couple of posts on "self-insurance" because this is an area with potential 'cost' issues (see FAR Provisions Covering Self-Insurance and  Self-Insurance Plans - What Contract Auditors Will Look For). Next, we asked the question of whether it is necessary to insure Government property in contractors' possession (see Should You Insure Government Property in Your Possession). And last week we discussed the need for product liability insurance (see Insurance - Product Liability Insurance). Today we will look at Professional Liability insurance.

The cost or professional liability insurance is allowable, subject, of course, to tests of reasonableness and allocability. The allocability test is where some contractors run afoul of Government oversight.

If a professional liability insurance policy provides coverage for its general practice, allocation of premiums to all contracts through overhead or G&A (general and administrative) expense is usually acceptable. However, if the policy is written to provide unique liability coverage for a particular business segment or product, costs should be directly allocated to the benefiting cost objective.

Consider Boeing. Boeing builds airplanes for commercial customers and for the Government. It is safe to assume that the company's its potential liabilities for commercial customers is much greater than that for its Government customers. One only needs to consider the on-going 737-Max saga to realize that is true.

Where a plain reading of the policy does not clearly establish the general nature of the coverage or the contract auditor has reason to believe that unique liability coverage is involved, the Government will examine the types of services being rendered to both the Government and commercial customers. If the services are essentially similar, a broad-based allocation is acceptable. On the other hand, where the services are dissimilar, examination should be made of the claims and loss experience.

In determining premiums for a contractor, the insurance carrier usually considers such factors as location of the business, size of the firm, professional discipline being practices, and loss experience. The proper allocation of premium costs should be determined primarily by the terms of the coverage. If the coverage between commercial and Government is similar, a broad based allocation method is probably appropriate.

Should You Insure Government Property in Your Possession?

Continuing on with our discussion of insurance costs and the allowability of such, we move now form our discussion of self-insurance to a few other types of insurance that have conditions upon whether associated costs are allowable.

Many Government contractors have Government property in their possessions for various reasons - usually temporary. The question often arises over whether the risks of loss of Government property should be insured and then if insured, whether the costs are allowable. FAR 31.205-19(e)(2)(iv) answers that question. FAR states that the cost of insurance for the risk of loss, damage, destruction, or theft to Government property are allowable only when three conditions are met:

1. the contractor is liable for such loss, damage, destruction or theft
2. the contracting officer has not revoked the Government's assumption of risk (in accordance with FAR 45.104(b). The contracting officer can revoke the Government's assumption of risk when the property administrator determines that the contractor's property management practices are noncompliant with contract requirements, and
3. such insurance does not cover loss, damage or destruction which results form willful misconduct or lack of good faith on the part of any of the contractor's management personnel. Contractor's managerial personnel are defined in FAR 52.245-1(a) as directors, officers, managers, superintendents, or equivalent representatives who have supervision or direction of the company's business, plant, or separate location.

DFARS (Defense FAR Supplement) adds one other consideration to the allowability question. DFARS 231.205-19(e)(7) states that in addition to the FAR limitations listed above, the allowability of insurance costs are also subject to other limitations. These limitations are listed in DFARS 252.217-7012 and essentially related to contractor negligence.

The key to ensuring the allowability of insurance costs related to Government property is to maintain close coordination with your contracting officer as to what is insurable and to make sure your internal controls over Government property in your possession are adequate.

Board of Contract Appeals Denies Contractor Claim for Insurance Costs

The Department of Energy (DOE) and Mission Support Alliance LLC (MSA) entered into a contract to provide support services to DOE's environmental cleanup mission. Although the contract did not require MSA to do so, MSA submitted an application to the Department of Homeland Security (DHS) to become a seller of Qualified Anti-Terrorism Technology (QAAT). As a condition for receiving QAAT status, DHS required MSA to have liability insurance coverage of up to $30 million for acts of terrorism.

MSA charged the insurance premiums to its DOE contract. MSA did not seek contracting officer approval for the premiums, as per contractual requirements and by the time DOE became aware of that the premiums had been billed to its cost-reimbursable contract, they had grown to $1.36 million.

The contracting officer concluded that the preiums were unallowable under the contract and demanded that MSA refund the amount paid. The contracting officer's position was threefold: (i) the insurance was not required by contract, (ii) MSA knew the costs were unallowable, and (iii) MSA did not seek approval from the contracting officer to treat them as allowable.

MSA appealed the contracting officer's decision to the Civilian Board of Contract Appeals (CBCA). MSA argued that the DOE contract required adequate insurance against liability. MSA reasoned that a terrorist attack at the DOE site could result in liability for damages. MSA further maintained that the purchase of such insurance was reasonable. Third, even if the contract did not require the insurance, MSA was entitled to exercise reasonable judgment to purchase such insurance. Finally, MSA pointed to the benefits that DOE might derive because of the insurance.

DOE countered noting that the contract did not require MSA to receive QATT status, DOE also noted that in its application for QATT designation, MSA certified, under penalty of perjury, that insurance costs were not allowable under its DOE contract. Finally, MSA did not request or receive contracting officer approval for the insurance costs, as required by contract.

CBCA agreed with DOE. CBCA essentially affirmed DOE's arguments. Concerning the benefits that DOE might derive from the insurance, CBCA ruled that although the government may benefit, the contracting officer never had a chance to evaluate the policy to decide whether the insurance would be worthwile.

Contractors need to know that FAR (or a FAR supplement) are not the only consideration for determining cost allowability. A cost may meet all FAR requirements (i.e allowable, allocable, and reasonable) but they must also meet the explicit terms of the contract to be allowable.

You can read the full text of the decision here.

How Good is Your Insurance Coverage?

The U.S. Government filed civil claims against a Department of Transportation (DOT) contractor and its subcontractor for fire damages to the Wichita Mountains Wildlife Refuge (Oklahoma). Those two companies just settled the allegations by agreeing to pay $1.4 million to resolve the claims.

In September 2011, employees of the subcontractor were working on a road improvement project to widen roads, berms, and extending culverts. These employees were using a chop saw to cut rebar. At the time, the fire danger was extremely high and there was a burn ban in effect which included the county where the wildlife refuge was located.

The burn ban prohibited certain activities without necessary precautions being taken. However, necessary precautions were not taken and sparks from the chop saw ignited a fire which quickly spread and burned 28,000 acres on the Refuge.

As a result of the fire, the United States suffered resource damages and incurred significant fire suppression costs. The U.S. alleged that the subcontractor employees were negligent in failing to take precautions when cutting rebar and further, did not have means available to extinguish the fire once it was started. The U.S.also blamed the prime contractor for failing to adequately supervise and monitor the work done by its subcontractor.

In reaching the settlement, the Prime and subcontractor did not admit liability - a critical aspect of the case for pursuing potential insurance recoveries of the $1.4 million. This agreement allows the parties to avoid the delay, expense, inconvenience, and uncertainty involved in ligating the case.

Insurance for Government-Owned Property

DCAA recently clarified its guidance for assessing the cost of insurance for Government-owned property. According to FAR 31.205-19(e)(2)(iv), the costs of insurance for the risk of loss, damage, destruction, or theft to Government property are allowable only to the extent that:

1. the contractor is liable for such loss, damage, destruction or theft;
2. the contracting officer has not revoked the Government's assumption of risk (the contracting officer may revoke the Government's assumption of risk when the property administrator determines that the contractor's property management practices are noncompliant with contract requirements - see FAR 45.104(b)); and
3. such insurance does not cover loss, damage or destruction which results from willful misconduct or lack of good faith on the part of any of the contractor's management personnel.

The clarified guidance now reads: "Where the risk of loss is not the responsibility of the contractor, or the contracting officer has revoked the Government's assumption of risk, or the insurance covers loss, damage or destruction resulting from willful misconduct, etc., the cost of purchased insurance coverage or self-insurance (including the contractor's deductible) should be questioned."

This guidance seems very straight forward, however implicit in the guidance, is the expectation that the auditor will review Government-property records, insurance documents, and other relevant supporting data in order to make such a determination. Contractor's that have insured Government-owned property and have claimed (or plan to claim) the cost of the insurance premiums, should be prepared to demonstrate to the auditor that i) it is responsible for any losses to Government-owned property, and ii) the premiums do not cover loss, damage, or destruction resulting from willful misconduct or lack of good faith. This could be tricky.