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Analysis of the 2006-07 Budget BillLegislative Analyst's Office
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The Department of Transportation (Caltrans) is responsible for planning, coordinating, and implementing the development and operation of the state’s transportation system. These responsibilities are carried out in five programs. Three programs-Highway Transportation, Mass Transportation, and Aeronautics-concentrate on specific transportation modes. Transportation Planning seeks to improve the planning for all travel modes and Administration encompasses management of the department.
The budget proposes total expenditures of $12 billion by Caltrans in 2006-07. This is $899 million, or 7 percent, less than estimated current-year expenditures. This decrease is explained in large part by unusually high estimated capital outlay expenditures in the current year, which assume that the Bay Bridge self-anchored suspension contract will be awarded before July 2006. The department’s proposed staffing level of 21,863 personnel in 2006-07 is similar to the current year. About $3.7 billion (32 percent) of Caltrans’ total support will come from the State Highway Account, $3.5 billion (31 percent) from federal funds, and $2.3 billion (20 percent) from the Proposition 42 transfer and early repayment of a previous suspension. The remaining support will be funded from reimbursements, as well as from the Traffic Congestion Relief Fund and various smaller transportation accounts.
Caltrans requests $1.4 million to contract with an insurance broker to procure coverage for contractors on 82 construction projects over three years. The department anticipates that this would result in substantial savings in construction costs. The requested amount only reflects the cost of program administration and does not include other related costs, such as insurance premiums, which we estimate would be at least $100 million over the pilot’s three-year period.
Due to the state’s very limited experience with the proposed type of insurance arrangement, we think that the pilot should be scaled down to involve fewer projects. Accordingly, we recommend the adoption of budget bill language to limit the scope of the pilot project.
Construction Contractors Must Provide Insurance Coverage. Currently, contractors and subcontractors bidding on construction contracts of transportation projects must have insurance for exposures such as liability and workers’ compensation. The cost of insurance is included in the cost of a contractor’s bid, and eventually becomes part of the cost of the contract that Caltrans pays. The department estimates that currently about 4 percent of the cost of construction for a project is attributable to insurance costs.
Department Proposes Pilot to Reduce Construction Costs. The department requests $1.4 million in the budget year to begin implementing an Owner Controlled Insurance Program (OCIP) pilot over three years. This pilot would purchase a single insurance policy to cover all contractors that work on 82 capital outlay projects anticipated to begin construction over the next three years. The requested amount would cover the budget-year cost of retaining a consultant (most likely an insurance broker) to acquire the insurance policy. The proposal, however, does not account for other costs, including the insurance premium, which we estimate would be at least $100 million to insure all 82 projects. According to Caltrans, the insurance premium would be paid from each project’s construction budget.
The department used two criteria to select the 82 projects to be included in the pilot: (1) the project is planned to begin construction over the next three years and (2) estimated project construction costs are in excess of $25 million each. In total, the projects proposed to be included in the OCIP would have a combined value of $5.5 billion.
Department’s Estimates for Cost Savings Predicated on a Number of Factors. By covering insurance costs through an OCIP, rather than each contractor carrying its own individual insurance policy, Caltrans estimates that it can save between $40 million and $65 million over the three-year period. The department estimates these savings based on several factors. First, Caltrans assumes it could negotiate lower insurance premiums than individual contractors because the department (1) would be buying in bulk, (2) could enforce stricter safety standards, and (3) could assume a high deductible. In addition, Caltrans estimates that it would receive a rebate on the policy if it can achieve a favorable loss record for all the work covered by the policy. Currently, contractors who buy the insurance receive a rebate when they maintain a low loss record, that is, when claims for loss are low.
Savings Estimates Problematic. Our review shows that the cost savings that could be realized through an OCIP are much more uncertain than Caltrans indicates. Specifically, while the department may be able to negotiate a lower insurance premium than individual contractors would pay collectively on these projects, the pilot includes annual administration costs ($1.4 million in 2006-07) that Caltrans previously has not faced. Furthermore, in order to achieve a lower premium, Caltrans must directly, or indirectly through a contracted insurance administrator, enforce safety standards and provide contractors with training on safe work practices. Again, this is a cost that the state has never had to assume.
In addition, Caltrans’ assumption that the state would accept a high deductible means that in the event of a claim, the state would have to pay some level of cost before the insurance would pick up the tab. Currently, Caltrans does not have to pay any costs when a contractor files an insurance claim.
Furthermore, the department estimates that 35 percent of the savings ($15 million to $20 million) will be from rebates awarded by the insurance company for projects that maintain a favorable loss record. We think this estimate may be too high. This is because when the state procures the insurance instead of the contractors, incentives for the contractors to maintain a favorable loss record are reduced. If contractors no longer face higher premiums for accidents and do not reap the benefits for a loss-free job, they would have less incentive to maintain the best possible safety record.
Proposed Pilot Too Large. To date, the state has used OCIPs for the construction of five state buildings. While OCIPs have been implemented by other states and local entities for transportation projects, we have reservations about the size of Caltrans’ proposed pilot. With the exception of Boston’s “Big Dig” project, the department’s proposed OCIP pilot would be the largest OCIP ever attempted. We believe that the department could still learn from a pilot program with a smaller number of projects, while at the same time reducing the state’s fiscal exposure.
Recommend Limiting Number of Projects in Pilot. Accordingly, we recommend the following budget bill language limiting funds in support of the OCIP pilot in 2006-07 to administration of no more than 15 projects:
Up to $1.4 million appropriated in this item is available for support of Caltrans’ Owner Controlled Insurance Program to administer insurance coverage for contractors on up to 15 projects.
We think that a limited-scale pilot of Caltrans’ proposed owner controlled insurance program (OCIP) is reasonable. In order to assess the program’s success, we recommend that the Legislature adopt supplemental report language directing the department to report on the net costs or savings realized through the OCIP, the types of projects included in the pilot, and the amount it paid for insurance-related costs.
Recommend Supplemental Report on OCIP Pilot Experience. Before the state makes a long-term commitment to insuring contractors, we believe that further investigation is warranted to better identify the costs and benefits of implementing an OCIP. Accordingly, we recommend that the Legislature adopt the following supplemental report language directing the department to provide specific information that would enable the Legislature to determine whether the program should continue:
By April 1 of 2007, 2008, and 2009, respectively, Caltrans shall report to the Joint Legislative Budget Committee and the policy committees on transportation on the following concerning the Owner Controlled Insurance Program (OCIP):
(1) The type and value of projects included in the pilot.
(2) The amount that Caltrans would have paid contractors for insurance coverage in the absence of an OCIP, as identified in contractors’ bid statements.
(3) The amount the department paid in insurance premiums, deductibles, program administration, and any other OCIP-related costs incurred during the pilot.
(4) The estimated net cost or benefit of implementing the pilot.
(5) An assessment of the projects that were best suited for inclusion in an OCIP and the projects that were least well suited, in terms of cost effectiveness.
For 2006-07, the budget provides $882 million for highway maintenance. This level of funding is almost identical to estimated current-year expenditures and does not address growing maintenance needs. Furthermore, the Governor’s Strategic Growth Plan would further erode funding for highway maintenance in the future.
We recommend the department report at budget hearings on how it plans to maintain the state highway system without further adding to the deferred maintenance backlog.
Funding in 2006-07 Does Not Address Growing Maintenance Needs. In January 2005, Caltrans published a five-year maintenance plan which showed that maintenance expenditures on roadways, drainage, and bridges in the state highway system would have to increase by $105 million each year to stop growth in the maintenance backlog. Furthermore, to address a long list of deferred maintenance projects within five years, annual expenditures for roadway, drainage, and bridge maintenance would have to increase by $250 million annually. In 2006-07, funding for all aspects of highway maintenance will only increase by $8 million over estimated current-year expenditures, to a total of $882 million. This means that the list of deferred maintenance work on roadway, drainage and bridges will grow during the budget year.
Governor’s Plan Would Lead to Future Disinvestment in Highway Maintenance. The Governor’s Strategic Growth Plan proposes to divert a quarter of excise tax and weight fee revenues to debt service on revenue bonds to support non-maintenance and non-rehabilitation activities for 30 years beginning in 2015. As these revenues represent the primary funding source for highway maintenance and rehabilitation, the Governor’s plan would result in the state falling further behind in the maintenance and rehabilitation of the highway system. As we indicated in our write-up on Funding for Transportation Programs (in the Crosscutting Issues section), we recommend that the Governor’s revenue bond proposal (for 2012) not be adopted unless a new, dedicated stream of revenue is provided for debt service on these bonds, so that maintenance and rehabilitation expenditures would not be crowded out.
Recommendation. Accordingly, we recommend the department report at budget hearings on how it plans to maintain the state highway system without further adding to the deferred maintenance backlog.
The current-year budget act includes language dedicating a specific amount of the department’s major maintenance contracts to highway pavement preservation. The budget includes $81 million for these projects in 2006-07. In order to ensure that these funds are expended for highway pavement preservation, we recommend the adoption of similar language in the 2006-07 Budget Bill.
Major Highway Maintenance Contracts Are Cost Effective. Currently, Caltrans contracts out many major pavement preservation projects. Both the department and the Federal Highway Administration estimate that this investment is very cost effective, as every one dollar spent on preventative pavement maintenance can save up to six dollars in future rehabilitation costs. Our review shows that in past years, for various reasons, Caltrans has redirected funding for these activities to other programs. To prevent this from occurring in the current year, the Budget Act included language limiting the use of funds provided for highway pavement preservation to that purpose.
Recommend Reinserting Budget Bill Language. For 2006-07, the budget proposes $882 million for highway maintenance, including $81 million for pavement preservation. We think that limiting the use of this amount to pavement preservation would prevent the funding from being redirected. Accordingly, we recommend similar budget bill language be adopted, as follows:
Of the funds appropriated in this item, $81 million is for major maintenance contracts for the preservation of highway pavement and shall not be used to supplant any other funding that would have been used for major pavement maintenance.
Delays in the Bay Bridge project and in the repayment of tribal gaming bonds to the Traffic Congestion Relief Fund will move capital outlay expenditures from the current year to the budget year. Accordingly, we withhold recommendation on $4.8 billion requested for capital outlay projects as these expenditure levels will likely be revised during the May Revision when more accurate information on the Bay Bridge and tribal gaming bonds become available.
Withhold Recommendation on Capital Outlay Expenditures. The budget proposes $4.8 billion to fund capital outlay projects, a 20 percent decrease from estimated current-year expenditures. However, estimated expenditures for 2005-06 include $1.9 billion related to the award of a Bay Bridge contract and various projects to be funded from tribal gaming bond revenue. Neither of these expenditures is certain to occur in the current year. As of January 2006, the bidding period on the Bay Bridge construction contract was extended by almost two months. Given this new timeframe, it is possible that Caltrans will not award a contract until 2006-07. In addition, another lawsuit has been filed delaying the issuance of tribal gaming bonds. For a third year in a row, it is likely that the tribal gaming bond revenues will be pushed back.
Given these potential delays, the 2006-07 capital outlay expenditure level will likely be significantly higher than assumed in the January budget. Accordingly, we withhold recommendation until updated information is available in the spring.
We withhold recommendation on the $1.6 billion requested for capital outlay support staff because staffing needs will be revised during the May Revision when more accurate information on workload for the various state transportation programs becomes available.
Withhold Recommendation on Capital Outlay Support. The budget proposes $1.6 billion to fund capital outlay support, a 7 percent decrease from estimated current-year expenditures. However, the department typically provides new estimates in the spring as a part of the May Revision. By that time, the department will have more accurate estimates regarding the amount of project development work that will be performed during 2006-07. Pending receipt of new workload estimates, we withhold recommendation on the department’s capital outlay support request.