Department of Public Works: Improvements Are Needed to Better

DEPARTMENT OF PUBLIC WORKS:

Improvements Are Needed to Better Monitor Subcontractors’ City Services Auditor Insurance and Licenses and Strengthen Contract Terms for the San Francisco General Hospital Rebuild Project

Office Controllerthe of – May 23, 2013 CityandCounty of San Francisco

OFFICE OF THE CONTROLLER CITY SERVICES AUDITOR

The City Services Auditor (CSA) was created in the Office of the Controller through an amendment to the Charter of the City and County of San Francisco (City) that was approved by voters in November 2003. Charter Appendix F grants CSA broad authority to:

• Report on the level and effectiveness of San Francisco’s public services and benchmark the City to other public agencies and jurisdictions. • Conduct financial and performance audits of city departments, contractors, and functions to assess efficiency and effectiveness of processes and services. • Operate a whistleblower hotline and website and investigate reports of waste, fraud, and abuse of city resources. • Ensure the financial integrity and improve the overall performance and efficiency of city government.

CSA may conduct financial audits, attestation engagements, and performance audits. Financial audits address the financial integrity of both city departments and contractors and provide reasonable assurance about whether financial statements are presented fairly in all material aspects in conformity with generally accepted accounting principles. Attestation engagements examine, review, or perform procedures on a broad range of subjects such as internal controls; compliance with requirements of specified laws, regulations, rules, contracts, or grants; and the reliability of performance measures. Performance audits focus primarily on assessment of city services and processes, providing recommendations to improve department operations.

CSA conducts audits in accordance with the Government Auditing Standards published by the U.S. Government Accountability Office (GAO). These standards require:

• Independence of audit staff and the audit organization. • Objectivity of the auditors performing the work. • Competent staff, including continuing professional education. • Quality control procedures to provide reasonable assurance of compliance with the auditing standards.

For questions regarding the report, please contact Director of City Audits Tonia Lediju at [email protected] or 415-554-5393, or CSA at 415-554-7469.

Audit Team: Mark P. de la Rosa, Audit Manager Nicole Doran, Auditor-in-Charge Edvida Moore, Associate Auditor

City and County of San Francisco Office of the Controller – City Services Auditor

Department of Public Works: May 23, 2013 Improvements Are Needed to Better Monitor Subcontractors’ Insurance and Licenses and Strengthen Contract Terms for the San Francisco General Hospital Rebuild Project

Purpose of the Audit

The audit evaluated whether the Department of Public Works (Public Works) and Webcor Construction, LP, doing business as Webcor Builders (Webcor), have adequate operational controls to ensure that subcontractors comply with all relevant contractual insurance and license requirements and whether Webcor’s bills for certain types of insurance and bonding are based on actual costs that Webcor incurred. The audit also determined whether contractors apply vendor markups in accordance with the contract and whether lump sum billings for Webcor’s general conditions are applied in accordance with the contract.

Highlights Recommendations

Webcor correctly applied markups to contactor costs and The report includes 11 recommendations permanent materials and billed its overhead costs in accordance for Public Works to strengthen contract with contract terms. However, Webcor does not actively monitor terms and improve its monitoring of compliance with certain contract terms for all subcontractor tiers. subcontractors’ compliance with license Also, certain elements of the contract for the rebuilding of the Main and insurance requirements. Specifically, Hospital (the Rebuild) at San Francisco General Hospital and Public Works should ensure that: Trauma Center and the related General Conditions Agreement inadequately define some key requirements. Specifically, the audit • All supplier and subcontractor bids found that: specify whether or not sales tax is • Subcontractors inconsistently applied sales tax, resulting in included. $24,903 in related taxes and $5,161 in profit markups that • Webcor verifies that written contracts may have been incorrectly approved for payment. between subcontractors and their • The City and County of San Francisco (City) is not always lower-tier subcontractors are named as an additional insured party on subcontractors’ established, as required by the insurance certificates. Of 42 tested automobile liability contract, or consider amending the certificates, 3 (7 percent) did not insure the City as required. contract to remove such requirements. • Webcor lacks certain policies and procedures to monitor • Webcor verifies that its direct compliance with the contract’s insurance and license subcontractors include a clause in all requirements by subcontractors of all tiers. agreements with their lower-tier subcontractors requiring that the City • The City may pay more than it would otherwise because, be named as an additional insured although the General Conditions Agreement allows a total party on the subcontractors’ insurance contractor profit and overhead markup of no more than 25 policies for the Rebuild project. percent on a change order, it does not specify the basis upon which the maximum is calculated. The City also may pay • Webcor verifies initially, and thereafter more in markups that it would otherwise because suppliers’ annually, that insurance companies direct costs, which include markups, are considered the direct used by all tiers of subcontractors on materials cost of the supplier’s subcontractor and are the Rebuild project maintain the excluded when determining whether the 25 percent maximum minimum A.M. Best rating of “A-, VIII.” on markups has been reached. • The General Conditions Agreement be • Contracts were not established between a subcontractor and amended or interpreted in writing to two lower-tier subcontractors, causing $1,417 of direct costs explicitly define the method to be used to be approved for work done without a contract. to apply the 25 percent maximum markup to change orders.

Copies of the full report may be obtained at: Office of the Controller ● City Hall, Room 316 ● 1 Dr. Carlton B. Goodlett Place ● San Francisco, CA 94102 ● 415.554.7500 or on the Internet at http://www.sfgov.org/controller

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TABLE OF CONTENTS

Glossary i

Introduction 1

Chapter 1 – Webcor Does Not Actively Monitor Compliance With Certain Contract Terms for All Subcontractor Tiers 9

Finding 1.1. The City faces undue risk because 7 percent of insurance certificates tested do not name the City as an additional insured party 9

Finding 1.2. Webcor lacks certain written policies and procedures to monitor compliance with the contract’s insurance and license requirements by subcontractors of all tiers 11

Chapter 2 – The Rebuild Contract and General Conditions Agreement Inadequately Define Some Key Requirements 15

Finding 2.1. The City may pay more than it would otherwise because the General Conditions Agreement inadequately defines how to calculate the total contractor markup allowed 15

Finding 2.2. The City may pay more in markups than it would otherwise because suppliers’ direct costs are considered the direct materials cost of subcontractors 20

Finding 2.3. Formal contracts were not established for two lower-tier subcontractors and their direct subcontractor for work performed 22

Finding 2.4. Subcontractors inconsistently applied sales tax on work release letters, resulting in $24,903 in related taxes and $5,161 in profit markups that may have been incorrectly approved for payment 23

Chapter 3 –Webcor Correctly Applied Other Markups to Trade Contractor Costs and Billed Its Overhead Costs In Accordance With Contract Terms 25

Finding 3.1. Webcor correctly applies markups to trade contractor costs and permanent materials 25

Finding 3.2. Webcor properly bills its overhead costs in accordance with contract terms 27

Appendix A – Department Response A-1

Appendix B – Contractor Response B-1

Appendix C – Recommendations and Responses C-1

GLOSSARY OF TERMS

Board Board of Supervisors CCIP Contractor Controlled Insurance Program City City and County of San Francisco CM/GC Construction Manager/General Contractor CO Change Order CSA Office of the Controller’s City Services Auditor Division CSLB Contractors State License Board IPD Integrated Project Delivery Jacobs Jacobs Project Management Co. P&P Payment and Performance Bond Public Health Department of Public Health Public Works Department of Public Works The Rebuild Rebuilding of the Main Hospital building at San Francisco General Hospital and Trauma Center SFGH San Francisco General Hospital and Trauma Center Seismic Safety Act Alfred E. Alquist Hospital Seismic Safety Act (a California law) Webcor Webcor Construction LP doing business as Webcor Builders WRL Work Release Letter

iii Office of the Controller, City Services Auditor Improvements Are Needed to Better Monitor Subcontractors’ Insurance and Licenses and Strengthen Contract Terms for the San Francisco General Hospital Rebuild Project San Francisco General Hospital Rebuild Project

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Audit Authority This audit was conducted under the authority of the Charter of the City and County of San Francisco (City), Section 3.105 and Appendix F, which requires that the Office of the Controller’s City Services Auditor (CSA) conduct periodic, comprehensive financial and performance audits of city departments, services, and activities.

Background In 2000 the Department of Public Health (Public Health) commissioned a seismic evaluation of the Main Hospital building at San Francisco General Hospital and Trauma Center (SFGH), finding that the building had significant seismic deficiencies that the hospital may not be capable of providing health care services to the public after a major seismic event. The evaluation was conducted in response to a 1996 amendment to a state law, the Alfred E. Alquist Hospital Seismic Safety Act (Seismic Safety Act), requiring acute care hospitals to meet explicit seismic standards, enabling them to remain functional after a major seismic event.

The Rebuild is the result of Hospitals that do not meet the Seismic Safety Act SFGH’s significant seismic standards are required to either retrofit their existing deficiencies. building or construct a new hospital building in conformance with standards, by 2013.1 In 2001 the San Francisco Health Commission adopted a resolution to construct a new general acute care hospital, and in 2008 San Francisco voters passed Proposition A, which allowed for funding of the rebuilding of SFGH’s Main Hospital (the Rebuild) through the issuance of general obligation bonds. A total of $887.4 million in bonds is to be issued to finance the Rebuild, which is scheduled to be completed in 2015. Approximately $680 million in bonds had been issued by August 2012.

The Department of Public Works (Public Works) is responsible for executing and delivering the Rebuild on behalf of Public Health. Through a bidding process, the

1 In 2008 the Department of Public Health petitioned the Office of Statewide Health Planning and Development to extend this date to January 1, 2020, which it did.

1 Office of the Controller, City Services Auditor Improvements Are Needed to Better Monitor Subcontractors’ Insurance and Licenses and Strengthen Contract Terms for the San Francisco General Hospital Rebuild Project San Francisco General Hospital Rebuild Project Board of Supervisors awarded the construction manager/general contractor (CM/GC) contract to Webcor Construction LP doing business as Webcor Builders (Webcor) and the project management contract to Jacobs Project Management Company (Jacobs).

The Rebuild is the City’s The City previously used a design-build project delivery first experience using the method for construction projects. Design-build is a Integrated Project Delivery method in which one entity, the design-build team, works method on a construction under a single contract with the project owner to provide project. design and construction services. According to Public

Works, due to the unusual complexities of the design and construction required for this type of seismic project, the City determined that the construction of the Rebuild would be better executed using an Integrated Project Delivery (IPD) method.

Unlike the design-build project delivery method, which places the contractor in the leading role on a building project, IPD engages the entire building team — including the owner, architect, general contractor, building engineers, fabricators, and subcontractors — to work collaboratively throughout the construction process.

Change orders are used to The total approved contract amount for Webcor’s CM/GC authorize the performance agreement is $690 million, with an initial not-to-exceed of work against the amount set at $1 million. The agreement states that this approved $690 million initial not-to-exceed amount is subject to increase by project budget. further authorization of the City. To facilitate these

increases, the City executed a fifth amendment to the

agreement, which allows the not-to-exceed amount to be adjusted throughout the course of the project through the issuance of work release letters (WRLs). Each WRL reflects the amount by which Webcor’s not-to-exceed sum will be increased for the specific portion of the work that the WRL represents. To be binding, an approved WRL must be effectuated through a change order or contract modification.

The Rebuild involves certain preconstruction and

construction services, which have been divided into the following four phases:

 Phase 1: Site preparation activities involving site

2 Office of the Controller, City Services Auditor Improvements Are Needed to Better Monitor Subcontractors’ Insurance and Licenses and Strengthen Contract Terms for the San Francisco General Hospital Rebuild Project San Francisco General Hospital Rebuild Project utility relocations and replacements, allowing for the continual operations of the nonhospital buildings adjacent to the site.

 Phase 2: Service building modifications and equipment additions.

 Phase 3: Excavations, foundations, structural frame increment.

 Phase 4: New hospital construction (current phase).

The General Conditions Agreement2 of Webcor’s contract (Document 00700), sets forth the responsibilities of the Rebuild’s owner and contractor throughout all stages of construction, including the compensation to which Webcor is entitled. It allows Webcor, its subcontractors,3 and lower-tier subcontractors or suppliers4 to receive a specified profit markup percentage on their direct costs (direct labor, direct materials, and equipment) incurred.

The direct cost of the work performed, along with associated taxes and the profit markups for all subcontractor tiers, is the cost basis on which additional markups related to insurance, contingencies, and taxes are applied. During preconstruction, Phase I, and Phase II of the Rebuild, the following markups were applied to the direct cost basis:

• Payment and Performance Bond (P&P) – a surety bond issued by an insurance company that guarantees satisfactory completion of the project by the CM/GC.

• Subguard Insurance – an insurance policy that indemnifies the CM/GC for direct and indirect costs incurred as a result of a default of performance by

2 Webcor’s overhead costs for the Rebuild, including the cost of supervision, payroll, parking, and other types of necessary administrative costs that are not part of the project’s direct labor. 3 A person or entity having a direct contract with the contractor to perform a portion of the work. 4 A person or entity who has a direct contract with a subcontractor or supplier, or with another lower-tier subcontractor or supplier, to perform a portion of the work at the site or to furnish materials or equipment to be incorporated in the work by the contractor, subcontractor, or lower-tier subcontractor, as applicable.

3 Office of the Controller, City Services Auditor Improvements Are Needed to Better Monitor Subcontractors’ Insurance and Licenses and Strengthen Contract Terms for the San Francisco General Hospital Rebuild Project San Francisco General Hospital Rebuild Project a subcontractor.

• Builders Risk Insurance – an insurance policy that indemnifies against damage to the City's insurable interest in materials, fixtures, and/or equipment being used in the construction of the Rebuild should those items sustain physical loss or damage from a covered cause.

• CM/GC Contingency – an amount reserved by the contractor to pay for unforeseen design and/or construction costs in the project.

• San Francisco Labor Tax – a percentage tax on CM/GC salaried and field labor required by the City.

• CM/GC’s Fee – a percent profit markup received by Webcor on the combined sum of the awarded bid and negotiated trade packages.

• General Liability Insurance – an insurance policy that safeguards the City against liability caused by injury and damages that was required before Phase III.

• Contractor Controlled Insurance Program (CCIP) – a centrally procured and managed insurance and risk program that protects all enrolled contractors and subcontractors in all tiers against injuries and liabilities arising out of work performed at the jobsite during Phases III and IV of construction.

Initially, individual WRLs did During pre-construction, Phase I, and Phase II, WRLs not include all allowable only included the lower-tier subcontractor and/or markups. subcontractor’s profit markups and did not include any of the other markups noted above. Rather, Webcor periodically submitted one WRL including markups for all WRLs approved during a given period. However, during Phase II of construction, Public Works and Webcor agreed to begin including all markups in each WRL, so that the markup calculations could be easily tied to the proposed work and verified.

Public Works issued Change Order No. 3, effective

4 Office of the Controller, City Services Auditor Improvements Are Needed to Better Monitor Subcontractors’ Insurance and Licenses and Strengthen Contract Terms for the San Francisco General Hospital Rebuild Project San Francisco General Hospital Rebuild Project December 2, 2010, which initiated the second, third, and fourth amendments to Webcor’s contract. The second amendment added new section to the Webcor contract, which provided guidelines for schedule of Webcor’s Lump Sum General Conditions Costs for the Rebuild and include the overhead costs incurred by Webcor during the project. The third amendment revised the contract specifications for the environmental management of excavated materials.

The CCIP replaced the The fourth amendment effectively replaced the general requirement for individual liability insurance requirements with a CCIP for Phases general liability insurance. III and IV of the project. The amendment states that, in lieu of worker’s compensation insurance and employer’s liability insurance, excess liability insurance, and general liability coverage, which were previously required, Webcor is required to procure and maintain CCIP for the CM/GC and all subcontractor tiers providing direct labor on Phases III and IV of the Rebuild.

$663 million of the $690 Of the project’s $690 million not-to-exceed budget, Public million budgeted for the Works had approved $663 million (96 percent) as of Webcor contract was January 25, 2013, and paid Webcor $306 million, based approved for construction as on construction that was 47 percent complete. of January 2013.

EXHIBIT 1 Payments Made to Webcor Related to the SFGH Rebuild as of 2012

Note: Excludes payments to Webcor for emergency generators.

Source: Auditor’s analysis based on data from Department of Public Works, Building Design and Construction Division.

5 Office of the Controller, City Services Auditor Improvements Are Needed to Better Monitor Subcontractors’ Insurance and Licenses and Strengthen Contract Terms for the San Francisco General Hospital Rebuild Project San Francisco General Hospital Rebuild Project Objectives The primary objectives of this audit were to determine whether Public Works and Webcor have adequate operational controls surrounding the Rebuild to ensure that:

1. Subcontractors appropriately comply with the contract’s relevant insurance and license requirements and specifications.

2. Billings for the CCIP, payment and performance bond (P&P), builders risk insurance, general liability insurance, and subguard insurance are based on actual costs incurred by Webcor.

3. Contractors properly and accurately apply vendor markups in accordance with contract specifications.

4. Lump sum billings for Webcor’s general conditions are being applied in accordance with the contract.

Scope and The audit covered the period from July 1, 2011, through Methodology September 30, 2012. To conduct the audit, the audit team:

• Reviewed and obtained an understanding of key provisions of the contracts between the City and Webcor, Webcor and its subcontractors, and subcontractors and their lower-tier subcontractors. • Interviewed key personnel from Public Works, Jacobs, and Webcor. • Selected a sample of 42 subcontractors in all tiers and determined if the appropriate insurance coverage and licensures were obtained for work performed during the audit period. • Selected a sample of nine WRLs and determined whether markups on direct costs were accurately calculated in accordance with contract terms. • Verified that Webcor’s monthly lump-sum billings for its general conditions complied with the contract’s scheduled amounts. • Assessed the design and effectiveness of Webcor’s internal controls.

CSA has issued two prior CSA conducted two prior audits related to the Rebuild. audits related to the The first audit report, issued in November 2011, found Rebuild. that Jacobs was complying with its project management

6 Office of the Controller, City Services Auditor Improvements Are Needed to Better Monitor Subcontractors’ Insurance and Licenses and Strengthen Contract Terms for the San Francisco General Hospital Rebuild Project San Francisco General Hospital Rebuild Project contract with the City. The second report, issued in June 2012, found that Webcor generally complied with progress payment requirements, but should improve internal guidelines to ensure accuracy and completeness. As indicated above, this third audit is focused on selected aspects of the management of the Rebuild contract.

Statement of Auditing This performance audit was conducted in accordance Standards with generally accepted government auditing standards. These standards require planning and performing the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for the findings and conclusions based on the audit objectives. CSA believes that the evidence obtained provides a reasonable basis for the findings and conclusions based on the audit objectives.

7 Office of the Controller, City Services Auditor Improvements Are Needed to Better Monitor Subcontractors’ Insurance and Licenses and Strengthen Contract Terms for the San Francisco General Hospital Rebuild Project San Francisco General Hospital Rebuild Project

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8 Office of the Controller, City Services Auditor Improvements Are Needed to Better Monitor Subcontractors’ Insurance and Licenses and Strengthen Contract Terms for the San Francisco General Hospital Rebuild Project San Francisco General Hospital Rebuild Project CHAPTER 1 – Webcor Does Not Actively Monitor Compliance With Certain Contract Terms for All Subcontractor Tiers

Summary Webcor’s policies and procedures for monitoring subcontractors of all tiers for compliance with the Rebuild contract’s insurance and license requirements need improvement.

Finding 1.1 The City faces undue risk because 7 percent of insurance certificates tested do not name the City as an additional insured party.

Some subcontractors’ The City and its officers are not always named as insurance certificates do additional insured parties on the insurance certificates of not name the City as an subcontractors in all tiers. Of the 42 automobile liability additional insured. insurance certificates of subcontractors and lower-tier subcontractors the audit tested, 3 (7 percent) did not name the City as additional insured on the policy, contrary to the requirement in Webcor’s contract with the City. Furthermore, several of the insurance certificates that do name the City as an additional insured party do not include the full text of the contract as to who is insured: “the City, its board members and commissions, and all authorized agents and representatives, members, directors, officers, trustees, agents, and employees of any of them.”

The term additional insured applies to a person or organization that is insured under an insurance policy in addition to the policy’s purchaser. Naming the City as an additional insured on a contractor or subcontractor’s insurance policy provides extra coverage to the City in the event of an insurance claim. Without its name on a subcontractor’s insurance certificate, the City may not be covered or reimbursed by the insurer in the event of a qualifying loss.

The insurance provisions of Webcor’s contract (Document 00805) require that the City be named as additional insured on Webcor’s general liability, professional liability, environmental pollution liability, and automobile liability insurance policies. Paragraph 4.02 of the contract’s

9 Office of the Controller, City Services Auditor Improvements Are Needed to Better Monitor Subcontractors’ Insurance and Licenses and Strengthen Contract Terms for the San Francisco General Hospital Rebuild Project San Francisco General Hospital Rebuild Project General Conditions Agreement, titled Subcontractual Relations, requires Webcor to have an appropriate written agreement specifically binding subcontractors to Webcor by the applicable terms and conditions of the contract documents in the same manner that Webcor is bound to the City. It also requires the subcontractors to have comparable binding agreements with their lower-tier subcontractors.

As previously discussed, the CCIP insurance policy, which names the City as the policy’s owner, provides general liability coverage, excess liability insurance, worker’s compensation and employer’s liability insurance coverage for all Webcor and all subcontractor tiers providing direct labor during Phases III and IV on the Rebuild. However, the CCIP policy does not provide insurance coverage related professional liability, automobile liability and environmental pollution liability.

The audit did not verify the existence of environmental pollution liability and professional liability coverage, as these types of insurance are not required by all subcontractors, but depend on the nature of the work for which the subcontractor was engaged.

The audit tested 42 insurance certificates of subcontractors and lower-tier subcontractors. The insurance certificates indicate whether or not automobile liability coverage was obtained. The audit found that 3 certificates (7 percent) did not name the City as additional insured on the policy. Additionally, the audit verified that Webcor’s contracts (in Section 16.1.2.4) with its direct subcontractors require that the City, its officers, and others be named as additional insureds and found that the three noncompliant insurance certificates covering Webcor’s direct subcontractors do not contain this clause. As of March 19, 2013, subcontractors found to have noncompliant insurance policies had been awarded work valued at more than $16 million.

Recommendations The Department of Public Works should:

1. Obtain assurance from Webcor that the insurance policies of Rebuild subcontractors in all tiers name as additional insured parties the City, its board members and commissions, and all authorized

10 Office of the Controller, City Services Auditor Improvements Are Needed to Better Monitor Subcontractors’ Insurance and Licenses and Strengthen Contract Terms for the San Francisco General Hospital Rebuild Project San Francisco General Hospital Rebuild Project agents and representatives, members, directors, officers, trustees, agents, and employees of any of them.

2. Require Webcor to establish written policies and procedures for ensuring that the City, its board members and commissions, and all authorized agents and representatives, members, directors, officers, trustees, agents, and employees of any of them are listed as additional insured parties on the insurance certificates of all present and future Rebuild subcontractors in all tiers.

Finding 1.2 Webcor lacks certain written policies and procedures to monitor compliance with the contract’s insurance and license requirements by subcontractors of all tiers.

Although Webcor could not initially provide documentation to the audit team to substantiate the following, the audit’s analysis of a sample of 42 subcontractors in all tiers found that:

• Subcontractors who performed work during the audit period had obtained proper insurance coverage and licenses.

• Subcontractors’ insurers were authorized to conduct insurance business in California.

• Subcontractors’ insurers maintain the minimum A.M.

Best credit rating required by the contract.

The contract in part, requires the insurers with which Webcor has Rebuild-related policies to maintain a current A.M. Best rating no less than “A-, VIII.” Because the contract requires Webcor to have a written agreement specifically binding each subcontractor or supplier to Webcor in the same manner in which Webcor is bound to the City, the insurers providing coverage to all tiers of

Rebuild subcontractors and suppliers are also required to

maintain the minimum rating.

Webcor eventually obtained and provided to the audit team

11 Office of the Controller, City Services Auditor Improvements Are Needed to Better Monitor Subcontractors’ Insurance and Licenses and Strengthen Contract Terms for the San Francisco General Hospital Rebuild Project San Francisco General Hospital Rebuild Project documentation showing either that the subcontractors met these contract requirements or that the requirements did not apply because the subcontractor was inactive during

the period under review. However, Webcor did not have the

documentation readily available to support that

subcontractors had obtained the proper licenses and

insurance coverage, including verifying that their insurers were authorized to do business in California and maintained the minimum A.M. Best rating. In some instances, Webcor had to request such documentation from direct subcontractors and lower-tier subcontractors or perform extensive research itself.

Webcor’s policies of Webcor states that it is its policy to verify subcontractors’ verifying subcontractors’ compliance with the contract’s license and insurance compliance with the requirements during the bid acceptance process and to contract’s license and ensure that insurance companies providing coverage to insurance requirements are their subcontractors and lower-tier subcontractors maintain not formally documented. an appropriate rating. However, Webcor has not documented such a policy, including the frequency with which the verification should occur. The sampled lower-tier contracts the audit reviewed did not consistently contain the clause related to insurance carriers’ ratings. Furthermore, Webcor could not provide evidence that it had done such reviews. As a result, the audit cannot substantiate that the reviews occurred.

In response to a request made as part of this audit, Webcor documented that all subcontractors selected for testing were licensed for the work they performed during the audit period. However, two of these subcontractors were subsequently listed by the Contractors State License Board (CSLB) as having their contractor’s licenses in threat of suspension for failure to file evidence of workers’ compensation insurance with CSLB. The license of one of these two subcontractors was ultimately suspended.5

Webcor could have identified a subcontractor’s license being in jeopardy of suspension or actually suspended if Webcor had instituted and followed formal policies and procedures requiring staff to periodically verify that

5 This subcontractor had obtained the required insurance as of March 6, 2013, but had not yet provided the documents to CSLB, so its website still reflected the suspension.

12 Office of the Controller, City Services Auditor Improvements Are Needed to Better Monitor Subcontractors’ Insurance and Licenses and Strengthen Contract Terms for the San Francisco General Hospital Rebuild Project San Francisco General Hospital Rebuild Project subcontractors in all tiers comply with license and insurance requirements.

Subcontractors may obtain the various types of insurance coverage required from multiple insurance companies. The 42 subcontractors examined used 76 insurance companies to obtain the required coverage. Although continuously ensuring compliance of such a large number of insurance companies may be time-consuming and require a considerable amount of resources, being in compliance is a contract requirement. In determining how a particular policy or procedure should be established, the likelihood of subcontractors not complying with contract license and insurance requirements and the potential effect that might have on the City should be considered along with the related costs of establishing the new policy.

Given the duration of the Rebuild, it is insufficient only to verify subcontractors’ compliance during the bid acceptance process. Continuous contract monitoring is essential to the success of long-term construction projects such as the Rebuild because it helps to ensure that subcontractors in all tiers comply with contract terms. The use of an unlicensed contractor would place the City at risk of having substandard work done on the Rebuild. The City could also be held liable for any claims resulting from such work.

Recommendations The Department of Public Works should ensure that Webcor:

3. Verifies initially, and thereafter annually, insurance certificates for all required types of insurance coverage and licenses for subcontractors of all tiers.

4. Verifies initially, and thereafter annually, that its direct subcontractors include a clause in all agreements with their lower-tier subcontractors requiring that all insurers on the Rebuild project maintain the minimum A.M. Best rating of “A-, VIII.”

5. Verifies initially, and thereafter annually, that insurers used by all tiers of Rebuild subcontractors maintain the minimum A.M. Best rating of “A-, VIII.”

13 Office of the Controller, City Services Auditor Improvements Are Needed to Better Monitor Subcontractors’ Insurance and Licenses and Strengthen Contract Terms for the San Francisco General Hospital Rebuild Project San Francisco General Hospital Rebuild Project 6. Verifies initially, and thereafter annually, that the subcontractor listed by the California State License Board as having its contractor’s license in threat of suspension and the contractor listed as having its contractor’s license suspended file the necessary documentation with the Board and is reinstated by the Board before commencing work on the Rebuild.

7. Maintains evidence that monitoring procedures are performed and incorporates the monitoring activities into its written policies and procedures.

14 Office of the Controller, City Services Auditor Improvements Are Needed to Better Monitor Subcontractors’ Insurance and Licenses and Strengthen Contract Terms for the San Francisco General Hospital Rebuild Project San Francisco General Hospital Rebuild Project CHAPTER 2 –The Rebuild Contract and General Conditions Agreement Inadequately Define Some Key Requirements

Summary The City may pay more than it would otherwise because the General Conditions Agreement does not clearly define the basis to be used to calculate the sum of the individual profit and overhead markups (profit markups), which cannot exceed 25 percent. As a result, arriving at the 25 percent maximum can be accomplished simply by adding up all the markup percentages applied or by combining the value of all the profit markups applied and expressing the total as a percentage of the original direct costs.

The General Conditions Agreement allows suppliers to receive up to a 15 percent markup on their work performed, but fails to specify whether suppliers' costs should be included in the amount upon which the contractor’s and subcontractors’ profit markups are to be calculated. As a result, supplier’s direct costs, which include profit markups, are considered to be the direct materials cost of the supplier’s direct subcontractor, increasing the markup the City must pay.

Finding 2.1 The City may pay more than it would otherwise because the General Conditions Agreement inadequately defines how to calculate the total contractor markup allowed.

The sum of the individual Webcor’s General Conditions Agreement does not profit markups applied to a clearly define how to arrive at the sum of the individual change order cannot profit markups that may be applied to the original direct exceed 25 percent. costs in a change order. While the agreement’s Section 6.06 places a 25 percent ceiling on the sum of the individual profit markups that can be applied to a change order, the section does not state the starting point upon which the 25 percent maximum is to be applied. As a result, no true maximum for profit markups to change orders is established.

15 Office of the Controller, City Services Auditor Improvements Are Needed to Better Monitor Subcontractors’ Insurance and Licenses and Strengthen Contract Terms for the San Francisco General Hospital Rebuild Project San Francisco General Hospital Rebuild Project According to Section 6.06, Contractor's Markup for Overhead and Profit, the following limitations should be applied to contractors’ profit markups on all change orders:

• For work performed by the contractor, the markup shall be a maximum of 15 percent of its direct costs, as defined in the agreement.

• For work performed by a subcontractor, the markup shall be a maximum of 15 percent of its direct costs. The contractor shall receive a maximum 5 percent markup on the subcontractor's total cost.

• For work performed by a lower-tier subcontractor or supplier, the markup shall be a maximum of 15 percent of its direct costs. Contractor and subcontractor shall each receive a 5 percent markup on the total cost of their respective lower- tier subcontractors.

• In no case shall the sum of the individual profit markups applied to a change order exceed 25 percent, regardless of the number of subcontractor tiers involved in performing the work.

The ambiguity in the contract language is such that arriving at the 25 percent maximum can be accomplished simply by adding all of the markup percentages applied or by summing the dollar value of all profit markups applied and expressing the total as a percentage of the original direct costs. Per Webcor management, it is Webcor’s policy to ensure that the 25 percent threshold is not exceeded. Webcor ensures this by totaling the individual markup percentages.

Although the work release letters apply the markup percentage on a compounded basis starting with the contractor or subcontractor tier that performed the work, Webcor employs a method of summing the individual markup percentages when determining whether the 25 percent maximum is reached. By doing so, Webcor uses one method for calculating the dollar value of profit markups paid to subcontractors of all tiers and uses another method to determine whether thresholds were

16 Office of the Controller, City Services Auditor Improvements Are Needed to Better Monitor Subcontractors’ Insurance and Licenses and Strengthen Contract Terms for the San Francisco General Hospital Rebuild Project San Francisco General Hospital Rebuild Project exceeded. Exhibit 2 shows the effect of using each method to determine whether markups exceed the maximum threshold when the change order only includes one direct subcontractor and one lower-tier subcontractor.

EXHIBIT 2 Applying the Two Methods Used for Markup Calculations to an Example of $100 in Direct Costs Percentages Value of Percentages of the Value Profit of Profit Description Calculation of Profit Markups Markups Markups Applied Applied Applied COMPOUND COMPOUND TOTALING OF METHOD METHOD PERCENTAGES METHOD Lower-Tier Subcontract Direct Costs $100 NA NA NA Lower-tier Subcontractor’s 15% 15% NA NA 15% Markup Value of Lower-Tier Subcontractor’s $15 $15 NA NA 15% Markup New Direct Cost Basis (Includes Lower-Tier Subcontractor’s $115 NA 15% NA Direct Costs and Markup) Subcontractor’s 5% Markup 5% NA NA 5% Value of Subcontractor’s 5% Markup $5.75 $5.75 NA NA New Direct Cost Basis (Includes Lower-Tier Subcontractor’s $120.75 NA 20.75% NA Markup and Direct Costs and Subcontractor’s Markup)

Webcor’s 5% Markup 5% NA 5% 5%

Value of Webcor ‘s 5% Markup $6.04 $6.04 NA NA

New Direct Cost Basis Subtotal (Includes Lower-Tier Subcontractor’s Markup and Direct Costs and the $126.79 $26.79 26.79% 25% Subcontractor’s and Contractor’s Profit Markups)

Note: NA = not applicable Source: Auditor analysis.

Exhibit 2 shows that the compound method causes the

17 Office of the Controller, City Services Auditor Improvements Are Needed to Better Monitor Subcontractors’ Insurance and Licenses and Strengthen Contract Terms for the San Francisco General Hospital Rebuild Project San Francisco General Hospital Rebuild Project 25 percent maximum to be exceeded, while the totaling of percentages method employed by Webcor does not because the total percentages applied equal 25 percent. The compound method causes the value of all profit markups applied to be $26.79, or 26.8 percent of the original $100 in direct costs. When profit markups are compounded, the larger the amount of the initial cost basis used, the larger the amount of the markup for each higher-tier subcontractor and contractor. Simply adding up the percentages applied could cause the total value of profit markups to exceed 25 percent of direct costs. Therefore, the method used by Webcor allows total profit markups applied to exceed 25 percent of a WRL’s total direct costs.

Using the calculation method applied by Webcor, two (50 percent) of the four WRLs tested that included direct labor costs had profit markups with values exceeding 25 percent of total direct costs, although the sum of the individual markup percentages did not exceed 25 percent. For example, one WRL examined showed that the lower-tier subcontractor received a 15 percent markup on its direct costs and the subcontractor and contractor (Webcor) each received a 5 percent markup on the total cost of their respective lower-tier subcontractors. Although totaling all levels’ markup percentages yielded only 25 percent, the value of the profit markups applied totaled 31 percent.

Webcor was consistent in its application of the markup maximum and individual markup percentages for all nine WRLs examined did not exceed 25 percent. Also, Public Works is aware of the methodology Webcor uses to determine whether the 25 percent markup threshold has been exceeded and considers it appropriate.

Depending on the total value of the WRL, the difference between the two methods can result in a significant variance. Because the total direct cost, including profit markups, becomes the basis to which other additional markups — such as those for a payment and performance bond, contractor controlled insurance program, subguard insurance, builders risk insurance, and contingencies— are applied on a compounding basis, it is critical that the basis is correct. If not, all other

18 Office of the Controller, City Services Auditor Improvements Are Needed to Better Monitor Subcontractors’ Insurance and Licenses and Strengthen Contract Terms for the San Francisco General Hospital Rebuild Project San Francisco General Hospital Rebuild Project subsequent markups applied will also be incorrect. The General Conditions This issue is further complicated by the fact that Section Agreement places the 25 6.06 of the General Conditions Agreement places the 25 percent limit on change percent limit on change orders rather than on WRLs. As orders rather than on WRLs. previously discussed, WRLs include the estimated cost of constructing a specified piece of the project. For a WRL to be binding, it must first be included in an approved change order. Although markups are excluded at the change order level, change orders consist of WRLs, which contain markups. Also, bid packages for core trade contractors are effectuated through change orders and, according to Public Works, are not subject to Section 6.06 of the General Conditions Agreement because they are competitively bid and awarded to the lowest bidder whose bid includes profit markups.

The use of the term “change order” under the Integrated Project Delivery construction method used by the City gives an unorthodox meaning to the term that differs from the meaning commonly used and understood throughout the construction industry. Typically, change orders are used to modify contracts to extend the duration, scope, and/or cost of design and construction contracts to include new or expanded work and services.

Change orders can be used to respond to unforeseen conditions or requests for additional work not anticipated when the original contracts were signed. However, under the Rebuild’s IPD method, change orders are used as a mechanism to reflect the increased cost of work performed on the project as normal and anticipated construction progresses. All the Rebuild work performed must first be approved via a change order. However, not all change orders include markups because, as explained above, WRLs that are described as bid packages for core trade contractors already include profit markups as part of the contractors’ competitive bid.

A contract that specifies the basis upon which the 25 percent maximum is calculated would provide appropriate guidance to all parties as to the application of profit markups.

19 Office of the Controller, City Services Auditor Improvements Are Needed to Better Monitor Subcontractors’ Insurance and Licenses and Strengthen Contract Terms for the San Francisco General Hospital Rebuild Project San Francisco General Hospital Rebuild Project

Recommendation 8. The Department of Public Works should modify the contract to:

a. Explicitly define the basis to which the 25 percent maximum on profit markups can be applied.

b. Clearly detail the method by which the 25 percent markup maximum is to be calculated.

c. Require that the limitation on the contractor’s markup for overhead and profit be applied to all work release letters rather than change orders.

Finding 2.2 The City may pay more than it would otherwise because suppliers’ direct costs are considered the direct materials cost of subcontractors.

Contractors and Section 6.06 of the General Conditions Agreement subcontractors are permitted permits contractors and subcontractors to each receive to receive up to a 5 percent up to a 5 percent markup on the total cost of their markup on the total cost of respective lower-tier subcontractors. However, the their respective lower-tier section does not address the inclusion of suppliers' direct subcontractors. costs when calculating contractor’s and subcontractors’

profit markups. As a result, Webcor considers supplier’s direct costs, which include profit markups, to be the direct materials cost of the supplier’s direct subcontractor. These costs then become a component of the subcontractor’s own direct costs and are the basis upon which their 15 percent markup is applied.

A WRL reviewed by the audit amply demonstrates this finding. One WRL for the Rebuild shows that:

• A supplier claimed total direct costs of $46,161, which included materials and labor of $43,963 and a 5 percent markup of $2,198.

• The subcontractor then applied an 8.5 percent sales tax rate, resulting in $3,924 in sales tax, which was added to the supplier’s direct costs.

• The subcontractor then applied a 15 percent

20 Office of the Controller, City Services Auditor Improvements Are Needed to Better Monitor Subcontractors’ Insurance and Licenses and Strengthen Contract Terms for the San Francisco General Hospital Rebuild Project San Francisco General Hospital Rebuild Project markup on the revised cost basis of $50,085, resulting in a $7,512 profit and overhead markup.

However, the agreement only permits contractors and subcontractors to receive up to a 5 percent markup on the total cost of their respective lower-tier subcontractors, and does not state that a supplier’s costs may be included.

Five of the nine WRLs Five (56 percent) of the nine WRLs tested included the tested included suppliers’ direct costs of the suppliers in the cost basis to which the direct costs in the cost basis subsequent subcontractor profit markups were applied. to which the subsequent Of the five WRLs examined that detailed supplier’s costs, subcontractor profit markups all were also included in the cost basis upon which the were applied. subcontractor and contractor’s profit markups were applied. This practice is consistently applied on Rebuild WRLs. Based on these five WRLs, subcontractors and the contractor (Webcor) received a total of $48,193 and $18,474 in profit markups, respectively, that were applied to suppliers’ direct costs of $293,956.

The same WRL detailed above showed that the lower- tier subcontractor received a 5 percent markup on its direct costs, while the subcontractor and contractor (Webcor) each received a 15 percent and 5 percent markup on the total cost of their respective lower-tier subcontractors. Although totaling all levels’ markup percentages yielded only 25 percent, the value of the profit markups applied totaled 31 percent.

According to Public Works, the Rebuild is the City’s first experience using the IPD method on a construction project and developing an IPD contract. As a result, many of the provisions stipulated in the design-build contracts previously used by the City were incorporated into the Rebuild IPD contract. Due to the nature of design-build projects, their associated contracts can inherently accommodate virtually all project types, sectors, and sizes. However, the broad terms commonly employed by a design-build contract cannot readily be applied to an IPD contract, where the projects tend to be limited in scope due to the detail required and the sustained owner involvement throughout the design and construction process.

21 Office of the Controller, City Services Auditor Improvements Are Needed to Better Monitor Subcontractors’ Insurance and Licenses and Strengthen Contract Terms for the San Francisco General Hospital Rebuild Project San Francisco General Hospital Rebuild Project A change order is meant to be a written instrument used Public Works and Webor to modify specific terms of the General Conditions Agreement. However, the General Conditions Agreement fails to define certain key details that can have a significant financial impact. This is in part because Public Works used a generic construction agreement for an IPD project.

Recommendation 9. The Department of Public Works should modify the Rebuild contract to explicitly state whether or not the contractor and each subcontractor are allowed to receive a markup on the total cost of their respective lower-tier subcontractors as well as their suppliers.

Finding 2.3 Formal contracts were not established for two lower- tier subcontractors and their direct subcontractor for work performed.

The contract requires lower- Formal, written subcontractor agreements were not tier subcontractors be bound established between one subcontractor and two lower- to their subcontractors in the tier subcontractors on two of nine WRLs examined by same manner in which the audit. Section 4.02 of the General Conditions Webcor is bound to the City. Agreement requires Webcor to have an appropriate

agreement specifically binding each subcontractor or supplier to Webcor by the applicable terms and conditions of the contract in the same manner that Webcor is bound to the City. The section also requires that all subcontractors and suppliers have similar agreements with their lower-tier subcontractors and lower-tier suppliers. The General Conditions Agreement permits each lower-tier subcontractor to receive a markup of up to 15 percent of its direct costs for work performed.

$1,417 of direct costs was The WRLs related to the two “contractless” lower-tier approved for two WRLs for subcontractors detailed direct costs of $1,417 that they which no contract was would incur. Although the subcontractor applied a 5 established between the percent markup on the related costs, no written subcontractor and its lower- subcontract agreements had been enacted that bound tier subcontractor. the parties. Per the subcontractor’s management, the firm did not consider the lower-tier subcontractors detailed on the WRLs to be subcontractors and, as a result, did not establish formal agreements between the

22 Office of the Controller, City Services Auditor Improvements Are Needed to Better Monitor Subcontractors’ Insurance and Licenses and Strengthen Contract Terms for the San Francisco General Hospital Rebuild Project San Francisco General Hospital Rebuild Project parties.

Requiring subcontractors of all tiers to be contractually bound helps to prevent the use of unauthorized laborers. Also, requiring lower-tier subcontractors to have a written agreement binding them to a subcontractor in the same manner in which the contractor is bound to the City helps to preserve all of the City’s rights regarding the work performed. To maintain order and cohesion throughout the construction of the Rebuild, which often requires numerous subcontractors in all tiers, it is imperative that a legal instrument defines the relationship between the parties and that the terms and conditions of the lower-tier subcontractor are expressly delineated in the document.

Recommendation 10. The Department of Public Works should require that Webcor verify that written contracts exist between subcontractors and their lower-tier subcontractors.

Finding 2.4 Subcontractors inconsistently applied sales tax on work release letters, resulting in $24,903 in related taxes and $5,161 in profit markups that may have been incorrectly approved for payment.

The cost of direct materials Subcontractors added sales tax to the direct costs of includes sales tax. lower-tier subcontractors or suppliers on three of the nine (33 percent) WRLs tested, resulting in $24,903 in related taxes and $5,161 in profit markups that were incorrectly approved. Section 6.06.A.2 of the General Conditions Agreement states:

“The City will pay Contractor on Change Orders only for those materials furnished by Contractor and directly required for performing the Change Order. The cost of such material shall be the direct cost, including sales tax, to the purchaser….”

The audit examined five WRLs that explicitly included sales tax and found the following inconsistencies in their application:

• Three WRLs included an 8.5 percent sales tax rate applied by the subcontractor that was not explicitly included in the suppliers’ bid amount.

23 Office of the Controller, City Services Auditor Improvements Are Needed to Better Monitor Subcontractors’ Insurance and Licenses and Strengthen Contract Terms for the San Francisco General Hospital Rebuild Project San Francisco General Hospital Rebuild Project

• Two WRLs included sales tax applied by five suppliers, which were included in the subcontractors’ direct costs. (Three of the five suppliers applied the correct city sales tax rate, but two applied a rate that was higher than the city sales tax rate that was in effect on the bid date.)

These five WRLs included costs related to 13 suppliers’ invoices submitted to three subcontractors and then to Webcor. Of the 13 invoices examined, 5 (38 percent) included sales tax, totaling $131. Of the remaining 8 instances where sales tax was not charged by suppliers, 6 had sales tax subsequently applied to them by two of the three subcontractors, resulting in $24,903 in related taxes and $5,161 in profit markups that may have been overpaid.

Although the contract states that sales tax is considered to be part of direct materials costs, the contract does not state whether sales tax should be applied by the supplier or subcontractor and does not require the application of sales tax to be explicitly identified in the WRL. Because sales tax is not always identified on the suppliers’ bids, even when it may be included, it is sometimes not evident whether or not the bid amount includes tax.

Recommendation 11. The Department of Public Works should require that all supplier and subcontractor bids supporting a work release letter specify whether or not sales tax is included.

24 Office of the Controller, City Services Auditor Improvements Are Needed to Better Monitor Subcontractors’ Insurance and Licenses and Strengthen Contract Terms for the San Francisco General Hospital Rebuild Project San Francisco General Hospital Rebuild Project CHAPTER 3 – Webcor Correctly Applied Other Markups to Trade Contractor Costs and Billed Its Overhead Costs in Accordance With Contract Terms

Summary Webcor correctly applied and calculated the markups related to insurance, contingencies, taxes, and Webcor’s fee on all five WRLs examined by the audit. Also, the amounts Webcor billed from September 2011 to November 2012 related to its overhead costs agreed to the General Conditions Agreement’s schedule of lump sum billings for the same period.

Finding 3.1 Webcor correctly applies other markups to trade contractor costs and permanent materials.

Webcor correctly applied and calculated the markups related to insurance, contingencies, taxes, and Webcor’s fee, which are applied to trade contractor costs and permanent materials on all five WRLs the audit tested. The trade contractor costs are the direct costs of the work performed as specified on the WRL and include any associated taxes and the profit markups for all subcontractor tiers. Below are the types of additional markups and their related percentages as detailed in the contract:

• Payment and Performance Bond – allows a 1.5 percent markup of the cost of the work performed before preconstruction to enable the CM/GC to recoup the costs for obtaining a surety bond issued by an insurer that guarantees satisfactory completion of the project by the CM/GC.

• Subguard Insurance – allows for a 1.389 percent markup on the costs of all subcontracts and permanent materials to enable the CM/GC to recoup the actual cost for obtaining insurance that indemnifies the CM/GC for direct and indirect costs incurred as a result of a default of performance by a subcontractor.

25 Office of the Controller, City Services Auditor Improvements Are Needed to Better Monitor Subcontractors’ Insurance and Licenses and Strengthen Contract Terms for the San Francisco General Hospital Rebuild Project San Francisco General Hospital Rebuild Project

• General Liability Insurance – allows for a 0.936 percent markup of the cost of the work, including preconstruction costs, to enable the CM/GC to recoup the actual cost for obtaining insurance that safeguards the City against liability caused by injury and damages. This markup only applies to WRLs issued before the City obtained CCIP coverage.

• Contractor Controlled Insurance Program – allows for a 0.451 percent markup of the cost of the work to enable the CM/GC to recoup the actual cost for obtaining insurance that protects all enrolled contractors and subcontractors in all tiers against injuries and liabilities arising out of work performed at the job site.

• Builders Risk Insurance – allows for a 0.258 percent markup of the trade packages, general conditions, and fees. It cannot be applied to the costs of preconstruction, job equipment, subguard premium insurance, general liability insurance, or payment and performance bonds. The insurance indemnifies against damage to the City's insurable interest in materials, fixtures, and/or equipment being used in the construction of the Rebuild if those items sustain physical loss or damage from a covered cause.

• Construction Manager/General Contractor Contingency - allows for a 6.5 percent markup of the total cost of the work, including the CM/GC’s general liability, builder’s risk, and subguard insurance costs, and the CM/GC’s fee. The CM/GC contingency is an amount reserved by the contractor to pay for any unforeseen design and/or construction costs incurred in the project.

• San Francisco Labor Tax – is a 1.5 percent city- levied tax calculated on CM/GC salaried and field labor expenses (excluding benefits) divided by 2.4.

26 Office of the Controller, City Services Auditor Improvements Are Needed to Better Monitor Subcontractors’ Insurance and Licenses and Strengthen Contract Terms for the San Francisco General Hospital Rebuild Project San Francisco General Hospital Rebuild Project • CM/GC’s Fee – is a 5 percent profit markup received by Webcor on the combined sum of the awarded bid and negotiated trade packages.

As previously noted, the value of the project increases as construction progresses and WRLs reflect the amount of work to be completed, which will ultimately add to the project’s value. These predetermined markups are applied to the direct cost basis of each WRL to ensure that there are sufficient funds to pay for the city labor tax related to the work performed and the additional insurance coverage that will be required based on the project’s increased value.

During preconstruction and Phase I and II, individual WRLs only included the lower-tier subcontractor and/or subcontractor’s profit markups and excluded any of the other markups noted above. A periodic WRL was submitted that included markups for all WRLs approved during a given period. However, during Phase II of construction, Public Works and Webcor agreed to begin including all markups on each WRL so that the markup calculations could be easily tied to the proposed work and verified.

On December 2, 2010, a fourth amendment to the Webcor contract took effect, replacing the general liability insurance requirements with a CCIP for Phases III and IV and reduced the associated markup amount from 0.936 percent to 0.451 percent.

The audit selected five WRLs and recalculated the markups applied to trade contractor costs based on the contract’s specifications. All five WRLs were calculated correctly in accordance with contract provisions.

Finding 3.2 Webcor properly bills its overhead costs in accordance with contract terms.

The amounts Webcor billed from September 2011 to November 2012 related to its overhead costs agreed to the general conditions schedule of lump sum billings for the same period.

27 Office of the Controller, City Services Auditor Improvements Are Needed to Better Monitor Subcontractors’ Insurance and Licenses and Strengthen Contract Terms for the San Francisco General Hospital Rebuild Project San Francisco General Hospital Rebuild Project Webcor has changed the In August 2011 Webcor and Public Works established method used for billing its an agreement that allows Webcor to bill its general general condition expenses. condition costs on a lump-sum basis. The general conditions costs are the overhead costs incurred by Webcor related to the Rebuild. They include such costs as supervision, payroll, parking, and other types of necessary administrative costs that are not part of the project’s direct labor. Before September 2011 Webcor had billed these costs based on actual expenditures incurred, otherwise known as a time and materials basis. However, the time and materials process proved to be time-consuming. As a result, Webcor and the Rebuild’s executive management team (which consists of Public Works and Jacobs) determined that it would be more cost-effective and less time-consuming for the general conditions costs to be billed as a lump sum.

According to Webcor, to facilitate this decision the executive management team analyzed the various general conditions costs that had been incurred to date and estimated that total overhead costs for the Rebuild would be $92.3 million. On August 12, 2011, Public Works approved WRL No. 0069.000, Webcor Lump Sum General Conditions, for $57,848,696.6 This WRL became binding when it was included in Change Order No. 17, which distributes a specific portion of the lump sum amount over the remaining life of the Rebuild, monthly. The amount allocated to each month depends on the anticipated amount of work expected to be completed that month, based upon the anticipated staffing level.

The monthly billing amounts are intended to cover the lump sum general conditions costs over the balance of the project. While the actual monthly billing amount may be adjusted by the City, based on the progress of work completed, the total lump sum cost cannot be adjusted. Exhibit 3 details the scheduled monthly lump sum billings from September 2011 through November 2012.

6 This amount was determined based on the difference between the estimated total general conditions costs and the amounts of such costs approved to date.

28 Office of the Controller, City Services Auditor Improvements Are Needed to Better Monitor Subcontractors’ Insurance and Licenses and Strengthen Contract Terms for the San Francisco General Hospital Rebuild Project San Francisco General Hospital Rebuild Project EXHIBIT 3 Markup Calculations: Webcor’s Scheduled Monthly Lump Sum Billings Year Month Amount Scheduled 2011* September $1,112,248 October 1,132,326 November 1,273,256 December 1,234,231 2012 January 1,296,177 February 1,356,517 March 1,257,446 April 1,252,303 May 1,279,735 June 1,316,617 July 1,406,706 August 1,415,332 September 1,409,040 October 1,505,841 November 1,505,920 Total $19,753,695 * September 2011 was the first month for which Webcor billed Public Works for its general conditions on a lump-sum basis. As of November 2012 $19,753,695 of the total lump sum general conditions costs had been scheduled to be billed. Source: Attachment to Change Order No. 17.

Webcor’s monthly lump sum The audit compared the amounts billed by Webcor from billings were in accordance September 2011 through November 2012 to the general with contract terms. conditions schedule of lump sum billings and found that Webcor properly billed the City, in accordance with the contract.

29 Office of the Controller, City Services Auditor Improvements Are Needed to Better Monitor Subcontractors’ Insurance and Licenses and Strengthen Contract Terms for the San Francisco General Hospital Rebuild Project San Francisco General Hospital Rebuild Project

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30 Office of the Controller, City Services Auditor Improvements Are Needed to Better Monitor Subcontractors’ Insurance and Licenses and Strengthen Contract Terms for the San Francisco General Hospital Rebuild Project

APPENDIX A: DEPARTMENT RESPONSE

A-1 Office of the Controller, City Services Auditor Improvements Are Needed to Better Monitor Subcontractors’ Insurance and Licenses and Strengthen Contract Terms for the San Francisco General Hospital Rebuild Project

APPENDIX B: CONTRACTOR RESPONSE

B-1 Office of the Controller, City Services Auditor Improvements Are Needed to Better Monitor Subcontractors’ Insurance and Licenses and Strengthen Contract Terms for the San Francisco General Hospital Rebuild Project

For each recommendation, the responsible agency should indicate whether it concurs, does not concur, or partially concurs. If it concurs with the recommendation, it should indicate the expected implementation date and implementation plan. If the responsible agency does not concur or partially concurs, it should provide an explanation and an alternate plan of action to address the identified issue.

APPENDIX C: RECOMMENDATIONS AND RESPONSES

Responsible Recommendation Response Agency

The Department of Public Works should:

1. Obtain assurance from Webcor that Public Works Public Works: Concur, DPW and Webcor have reviewed and the insurance policies of Rebuild confirmed Webcor’s commitment to ensure that the insurance policies

subcontractors in all tiers name as from subcontractors in all tiers name the City, its board members and additional insured parties the City, its commissions, and all authorized agents and representatives, board members and commissions, members, directors, officers, trustees, agents, and employees of any and all authorized agents and of them as additional insured parties. representatives, members, directors, officers, trustees, agents, and Webcor: The current Subcontract Exhibit D, which is a part of the employees of any of them. Subcontractor’s contract, requires the additional insured parties as noted. Webcor’s position is that no additional contract language is required. Webcor partially concurs with this recommendation.

2. Require Webcor to establish written Public Works Public Works: DPW will consult with the City Risk Manager’s Office policies and procedures for ensuring and City Attorney’s Office to confirm if DPW has the contract authority

that the City, its board members and to require Webcor to establish written policies and procedures commissions, and all authorized regarding this recommendation.

C-1 Office of the Controller, City Services Auditor Improvements Are Needed to Better Monitor Subcontractors’ Insurance and Licenses and Strengthen Contract Terms for the San Francisco General Hospital Rebuild Project

Responsible Recommendation Response Agency agents and representatives, members, Webcor: The current Subcontract Exhibit D, which is a part of the directors, officers, trustees, agents, Subcontractor’s contract, requires the additional insured parties as and employees of any of them are noted. Webcor’s position is that no additional contract language is listed as additional insured parties on required. Webcor partially concurs with this recommendation. the insurance certificates of all present and future Rebuild subcontractors in all tiers.

3. Ensure that Webcor verifies initially, Public Works Public Works: DPW will remind Webcor that they have an obligation and thereafter annually, insurance under the contract to make sure that they maintain insurance policies

certificates for all required types of that meet the City’s requirements. DPW will also consult with City Risk insurance coverage and licenses for Manager’s Office and City Attorney’s on risk and legal implications of subcontractors of all tiers. implementing CSA recommendation to determine if such action elevates the City risk and liability due to potential business interference. DPW is concerned that implementing this recommendation may create a situation where the City assumes risk by assuming such depth of oversight.

Webcor: The policy is to verify compliance with insurance requirements prior to allowing a subcontractor to work on site. Annual insurance expiration dates are tracked for each Subcontractor. Webcor partially concurs with this recommendation.

C-2 Office of the Controller, City Services Auditor Improvements Are Needed to Better Monitor Subcontractors’ Insurance and Licenses and Strengthen Contract Terms for the San Francisco General Hospital Rebuild Project

Responsible Recommendation Response Agency

4. Ensure that Webcor verifies initially, Public Works Public Works: DPW will remind Webcor that they have an obligation and thereafter annually, that its direct under the contract to make sure that they maintain insurance policies

subcontractors include a clause in all that meet the City’s requirements. DPW will also consult with City Risk agreements with their lower-tier Manager’s Office and City Attorney’s on risk and legal implications of subcontractors requiring that all implementing CSA recommendation to determine if such action insurers on the Rebuild project elevates the City risk and liability due to potential business maintain the minimum A.M. Best rating interference. DPW is concerned that implementing this of “A-, VIII.” recommendation may create a situation where the City assumes risk by assuming such depth of oversight.

Webcor: The Prime Contract already requires that terms and conditions apply to Webcor and lower tiers. Webcor does not review the contractual language between a Subcontractor and their lower level Subcontractors. Webcor does NOT concur with this recommendation.

5. Ensure that Webcor verifies initially, Public Works Public Works: DPW will remind Webcor that they have an obligation and thereafter annually, that insurers under the contract to make sure that they maintain insurance policies

used by all tiers of Rebuild that meet the City’s requirements. DPW will also consult with City Risk subcontractors maintain the minimum Manager’s Office and City Attorney’s on risk and legal implications of A.M. Best rating of “A-, VIII.” implementing CSA recommendation to determine if such action elevates the City risk and liability due to potential business interference. DPW is concerned that implementing this recommendation may create a situation where the City assumes risk by assuming such depth of oversight.

C-3 Office of the Controller, City Services Auditor Improvements Are Needed to Better Monitor Subcontractors’ Insurance and Licenses and Strengthen Contract Terms for the San Francisco General Hospital Rebuild Project

Responsible Recommendation Response Agency

6. Ensure that Webcor verifies initially, Public Works Public Works: DPW will remind Webcor that they have an obligation and thereafter annually, that the under the contract to make sure that they maintain licenses that meet

subcontractor listed by the California the City’s requirements. DPW will also consult with City Risk State License Board as having its Manager’s Office and City Attorney’s on risk and legal implications of contractor’s license in threat of implementing CSA recommendation to determine if such action suspension and the contractor listed elevates the City risk and liability due to potential business as having its contractor’s license interference. DPW is concerned that implementing this suspended file the necessary recommendation may create a situation where the City assumes risk documentation with the Board and is by assuming such depth of oversight. reinstated by the Board before commencing work on the Rebuild. Webcor: Webcor’s approach is to respond immediately upon notification from the State about any license in threat of suspension. Our policy is to not allow any work by a trade contractor that does not have a valid license. Webcor concurs with this recommendation.

C-4 Office of the Controller, City Services Auditor Improvements Are Needed to Better Monitor Subcontractors’ Insurance and Licenses and Strengthen Contract Terms for the San Francisco General Hospital Rebuild Project

Responsible Recommendation Response Agency

7. Ensure that Webcor maintains Public Works Public Works: DPW will remind Webcor that they have an obligation evidence that monitoring procedures under the contract to make sure that they maintain insurance policies

are performed and incorporates the that meet the City’s requirements. DPW will also consult with City Risk monitoring activities into its written Manager’s Office and City Attorney’s on risk and legal implications of policies and procedures. implementing CSA recommendation to determine if such action elevates the City risk and liability due to potential business interference. DPW is concerned that implementing this recommendation may create a situation where the City assumes risk by assuming such depth of oversight.

Webcor: Please explain what is to be monitored in this recommendation.

8. Modify the contract to: Public Works Public Works: DPW does not agree with CSA’s interpretation of the contract language to be an incorrect translation as it relates to a. Explicitly define the basis to which performing the mark up calculations which is leading to a the 25 percent maximum on profit compounding effect contrary to industry practice, as well as markups can be applied. inconsistent with City past and current application of contract b. Clearly detail the method by which requirement. DPW will consult with City Attorney’s office to modify the 25 percent markup maximum is language in an attempt to clarify method of calculation for mark up to be calculated. limitations. Recommendation (8c) for the limitation on the contractor’s c. Require that the limitation on the markup for overhead and profit (to) be applied to all work release contractor’s markup for overhead letters rather than change orders is not achievable to the extent for and profit be applied to all work those work release letters that include competitively bid trade release letters rather than change packages due to associated administrative code constraints.

C-5 Office of the Controller, City Services Auditor Improvements Are Needed to Better Monitor Subcontractors’ Insurance and Licenses and Strengthen Contract Terms for the San Francisco General Hospital Rebuild Project

Responsible Recommendation Response Agency orders. Webcor: Webcor’s position is that the markups have been appropriately applied in accordance with the collective interpretation between Webcor and DPW. The approach is consistent with work on past City and Non-City projects. Webcor does not agree with the CSA’s interpretation of the contract, but does concur that a clarification would enhance the City standard contract.

9. Modify the Rebuild contract to Public Works Public Works: DPW will modify language as needed to more explicitly explicitly state whether or not the state whether or not the contractor and each subcontractor are allowed

contractor and each subcontractor are to receive a markup on the total cost of their respective lower-tier allowed to receive a markup on the subcontractors as well as their suppliers. It is DPW’s position that total cost of their respective lower-tier current procedure is correctly applied as it relates to the contract subcontractors as well as their requirements, while CSA perceives ambiguity in the language. suppliers. Webcor: Webcor’s position is that the markups have been appropriately applied in accordance with the collective interpretation between Webcor and DPW. The approach is consistent with work on past City and Non-City projects. Webcor does not agree with the CSA’s interpretation of the contract, but does concur that a clarification would enhance the City standard contract.

10. Require that Webcor verify that written Public Works Public Works: DPW will remind Webcor that they have an obligation contracts exist between under the contract to make written contracts that meet the City’s

subcontractors and their lower-tier requirements. DPW will also consult with City Risk Manager’s Office subcontractors. and City Attorney’s on risk and legal implications of implementing CSA recommendation to determine if such action elevates the City risk and liability due to potential business interference. DPW is concerned that implementing this recommendation may create a situation where the City assumes risk by assuming such depth of oversight.

C-6 Office of the Controller, City Services Auditor Improvements Are Needed to Better Monitor Subcontractors’ Insurance and Licenses and Strengthen Contract Terms for the San Francisco General Hospital Rebuild Project

Responsible Recommendation Response Agency

Webcor: The means and methods of executing a Subcontractor’s work sit with that Subcontractor. It is not for Webcor to dictate the contract methodology between a Subcontractor and their lower tier Subcontractors. Webcor does NOT concur with this recommendation.

11. Require that all supplier and Public Works Public Works: DPW concurs. However DPW needs to work with subcontractor bids supporting a work Webcor to develop a practical application of suggested requirement for

release letter specify whether or not future work releases. sales tax is included. Webcor: There are challenges in trying to confirm the application of tax in all instances. Webcor is willing to work with DPW on development of a practical approach to address this issue. Webcor partially concurs with this recommendation.

C-7