Defense Base Act for U.S. State Department ContractsA Fundamental Change

September 2012 • Lockton Companies

L O C K T O N C O M P A N I E S

MICHAL GNATEKVice President

Aerospace and Defense Sector202.414.2662 (D)202.841.8666 (M)

mgnatek@lockton.com

The method by which the United States Department of State (DOS) procures Defense Base Act (DBA) insurance for contractors and their subcontractors performing public works projects Outside the Continental United States (OCONUS) changed on July 21, 2012, when the sole source method through insurer CNA and Rutherfoord (Marsh) was jettisoned in favor of an open-market approach. Government contractors with OCONUS DOS contracts now have the fl exibility to competitively market their DBA exposures to a select number of insurers.

Until July, all DOS primary contractors and their subcontractors were required by contract to purchase DBA insurance for work performed outside the United States. This coverage was written on an exclusive basis by CNA and brokered through Rutherfoord. Rates for various job classifi cations were set annually and applied to all companies in the program, regardless of exposure or loss history. This sole-source platform benefi ted those small companies who would have faced high minimum premiums in the open market and those larger companies with poor loss experience that would not have been individually underwritten. The uniformity of rate also allowed the DOS to smooth out costs amongst all of its contractors.

Government contractors

with OCONUS DOS contracts

now have the flexibility to

competitively market their

DBA exposures to a select

number of insurers.

September 2012 • Lockton Companies

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In 2009, the U.S. House Committee on Oversight and Government Reform directed the U.S. Department of Defense (DoD)—the largest government agency purchaser of DBA coverage—to reevaluate its acquisition strategy for DBA insurance. The DoD report, published in September 2009, ranked the cost effectiveness and effi cacy of a sole-sourced program similar to those employed by the DOS, U.S. Army Corps of Engineers, and U.S. Agency for International Development. The analysis concluded, “an open market is preferable to any of the alternatives that use predetermined premium rates (whether via single or multiple providers).”1 The DoD eventually concluded the preferred approach would be to have the federal government self-insure the DBA exposure and utilize a private commercial Third-Party Administrator (TPA) experienced in handling DBA claims. It was clear from the analysis, however, that the sole-source approach was not effective for many reasons.

The DOS contract with CNA was to renew in July 2012; however, the insurer decided not to renew the exclusive program at expiration. DOS then conducted an insurer/broker search to fi ll the void. A Request for Proposal (RFP) was issued and bids were solicited for the July renewal. However, only two DBA insurers expressed interest in writing a sole-source program for DOS. Both of those insurers also eventually decided to “no bid” the contract for several reasons, the most signifi cant being the opt out provision for companies that could procure DBA insurance at a more competitive cost. DOS contractors with excellent loss history and good risk control would expect to see potentially material rate relief by competitively marketing their exposures outside the program. Those companies with the poor loss experience or smaller companies with small premium to

1 Acquisition Strategy for Defense Base Act Insurance, September 2009, Department of Defense, Offi ce of the Deputy Under Secretary of Defense, Acquisition, and Technology.

support their losses would create an adverse selection problem for underwriters (i.e., only the poor risks are insured in the program, while the good or larger risks are covered in the open market).

Clients should expect their CNA DBA programs for DOS to run their course through renewal. Companies will receive a notice of nonrenewal from CNA at least 30 days prior to expiration. While DOS contractors and their subs will be forced to fi nd alternatives, this fundamental shift in acquisition strategy provides organizations with an opportunity to effectively market their program to insurers as stand-alone risks. No longer will a company’s annual renewal be judged on the merits of an entire book of business.

At Lockton, we encourage those DOS clients and prospects to take full advantage of this change. While there is no guarantee that the rates or loss ratio as a stand-alone risk will improve signifi cantly, risk managers and other interested stakeholders will know that their rate and premium will be determined by their own exposures, safeguards, and losses.

CNA is not exiting the DBA business altogether. However, the company is being more selective in its underwriting process. Other insurers to consider include those companies comfortable writing DBA coverage for confl ict and post confl ict areas, such as ACE, AIG, AWAC, Starr Companies, and Zurich. Chubb and Liberty Mutual will entertain DBA for nonhazardous countries, such as Japan, South Korea, and Germany.

Please contact your local Lockton representative or Michal Gnatek directly to discuss additional implications of this procurement change at DOS.