Part Three: Identifying and understanding variables in overhead and profit can reduce your chances of overpaying a claim.
A considerable amount of time is spent writing or reviewing an estimate. Do you spend 20% to 25% of your time on the section encompassing general conditions, overhead and profit? You should.
Of the estimate, 20% or more of the total consists of these areas. Considering all the claims an insurance company handles over the course of a year, including substantial losses, claims adjusters really can't afford not to consider this aspect of the claim. Attention also needs to be paid to the construction schedule and how it may affect a business interruption or extra expense claim and total indemnity costs. The following is an introduction to understanding and quantifying the proper cost of managing a construction project.
Understanding General Conditions, Overhead & Profit
Contractor fees are a division within an estimate encompassing job supervision, job site requirements, insurance, permits and all other fixed and variable overhead costs. Although contractor profit of 10% is generally included, it may decrease with large jobs and economic conditions. Job supervision can be the largest single overhead cost of a construction project, and it is where we begin an estimate in the construction industry.
Architectural fees to design a new project and provide construction documents generally are about 7%. On many repair projects, a complete set of drawings is not necessary to obtain proper building permits. The permit requirements of local building officials will establish the level of detail and drawings necessary. It is possible that engineering drawings or other specified drawings will suffice to meet local building requirements. If the contractor is calculating overhead and profit on them, you may be agreeing to an overcharge. Typically, these costs are owner costs and not subject to contractor fees.
In the Claims Advisor article appearing in the Fall 2009 issue (part two of this series), we looked at a budgetary cost estimate which contained a total of 25% allocated, with 10% to general conditions, 5% to overhead and 10% to profit. In a competitive bid project, how a contractor figures overhead and profit is a critical factor in being awarded the job. It is important to keep in mind that the size of the project, contractor annual volume, project complexity, and risk are important determining factors in comparing general conditions and overhead between estimates. Many estimates presented to insurers are compiled by simply adding 10% each for overhead and profit. This is often in addition to a healthy general conditions section of the estimate.
Figure 1 is an example of how project size can affect one method of calculating jobsite supervision, otherwise referred to as project management.
Effective management of a project's overhead differentiates successful, competent contractors from the crowd. The time the construction project requires rests largely on how the trades are scheduled to complete the job. It is unlikely a project would be scheduled so the framers would complete all of their work, to be followed in the same manner by the electricians, plumbers, mechanical contractors and other finishers. Proper scheduling considers the type and degree of work, area of the job, and how to schedule trades to operate concurrently or consecutively as need be.
Just because you are told the job will take five months does not make the contention justified. Project time is based upon the planned schedule and is a topic you need to be prepared to confront with a contractor. A project of sufficient size may require a formal critical path and job schedule to ensure the project costs (overhead and general conditions) don't blow the budget off the proverbial roof.
Variable Overhead Costs
Variable overhead costs are those that are particular to the project and are required to execute the work. They can be included in the 10% general conditions and 5% overhead, or they can be itemized. Either way, they should be close in value. Variable costs may include job supervision, office trailer, portable toilets, storage, utilities and inspections. It is important to anticipate the required aspects that will be peculiar to the project. Some equipment considerations may be more appropriately considered in a trade or other area of the estimate. If you are presented with an estimate that contains a significant difference, look at one of the industry recognized references, such as R.S. Means, National Construction Estimator or your computer estimating platform. Do your research, analyze what you find and ask for explanations until any differences are reconciled.
Fixed Overhead Costs
Fixed overhead costs are applied as a percentage of the work and are based upon a contractor's annual volume. You will see fixed costs shown on estimates either in the overhead percentage calculation, in the general conditions section or as a combination of both. This is determined by the particular style and system of the individual estimator. The annual volume, staff size, office space, insurance costs and other expense items of the contractor constitute the percentage considered as the fixed overhead cost. It is beneficial to understand the contracting firm when evaluating its estimate. Figure 2 is an approximate range of average fixed expenses for a general contractor based upon annual volume.
Consider an estimate totaling $749,253.39. After reviewing the numbers, you find the general condition, overhead and profit totaling nearly 51%. Can you determine how this number was derived and why it is incorrect? Let's count the ways this "estimate" is luring you to overpay.
First, review Table 1 for the items highlighted tan in the general conditions section that are actual trades—the trade items total $94,926.27. Commercial supervision, highlighted light blue, is 9.2% of the actual trade work on the estimate, shown as $495,416.19 on Tables 2 and 3. This is significantly higher than the range shown earlier of 4.5%–7.5%. Viewed another way, the hourly charge for supervision of $57.14 equates to a weekly charge of $2,285. For this particular area, the high average is $1,700 per week. The estimate assumes 800 hours—that's 20 weeks, or five months, to complete the project. Using one of the estimating guides that provide crew size and productivity, an adjuster can determine that this project, properly planned, could reasonably be completed in fewer than three months.
Beware of labor double charges and questionable fees. Regarding double charges, note lines 2 and 19 of Table 1. Included is a double charge for cleanup labor, which is first stated as a $3,809.60 charge on line 2 and isthen followed with anothercharge for cleanup on line 19for $10,076.16. Question fees, too. Look at line 17. Does it make sense to pay$5,587.80 as a "Fuel Surcharge"? The signage line item of $500 is another dubious charge.
Permits and inspections are a valid consideration. A review of either R.S. Means or National Construction Estimator shows a range of 0.5%–2% of total costs. This estimate is figuring 2% or $11,175.60. Considering this project, a charge of $2,800 would have been appropriate. The architectural fees (highlighted medium blue), are not typically subject to overhead and profit. This project was a cosmetic repair with minimal electrical system work. Drawings, if necessary, would amount to little more than a sheet the electrical contractor would probably provide as part of his work with the application for an electrical permit.
How about adding insult to injury? Review Table 2 and see how overhead is calculated at 15%. Everything necessary in the category of general conditions and overhead for this project is sufficiently figured with 15%. Section 1 of Table 2 shows how the estimate was presented for a total of $749,253.39. Section 2 of Table 2 shows how to subtract the amount of the general conditions from Table 1 and add the trade items back in to get an adjusted subtotal of $495,416.19. When 25% for general conditions, overhead and profit is added, an adjusted grand total of $619,270.24 is derived. If you otherwise accept the estimate at face value, this is a reduction in the calculation of general conditions, overhead and profit of $129,983.15.
Review Table 3 for an alternate calculation of the general conditions, overhead and profit. Many of the items from Table 1 were used, but were adjusted for appropriate time or cost, using an assumption for a fixed overhead included with the final calculation for profit. Using the two methods, you will notice the individual corrections reveal an appropriate reduction of nearly $130,000. The two methods are within 2% of each other.
A Reasoned & Appropriate Approach
Guard against inaccuracy in the estimates you prepare or receive. Learn to recognize areas and methods of overcharges in the estimates you review, and exercise your knowledge as authority over the claim.
Make a few calculations and analyze scheduling options as part of an estimate review. General conditions, overhead and profit are about 20% of the estimate total. Above, we legitimately brought into question $130,000 of the amount demanded. Apply this method and eliminate the ways you are being overcharged.
Bradley D. Sharp, BA, AIC, RGA specializes in complex commercial property claims for GuideOne Insurance headquartered in Des Moines, Iowa. He can be reached at (515) 267-5127.