10 Tips for Transferring Contractual Risk

April 21, 2020

Is your company gambling when it comes to risk? You might be on a winning streak, but sooner or later costly third-party injuries, damages, delays, or defects will happen. Contractual risk transfer provides a loss prevention strategy that places the financial burden for claims and litigation with the parties best able to prevent them – subcontractors and third parties. The practice protects upstream companies from the drain of costly claims and motivates downstream businesses to operate responsibly. When done correctly, the party who creates the problem pays the bill. 

A good risk transfer strategy avoids losses by combining specific agreement clauses with consistent contract management practices. Following are 10 tips for hedging your bets against risk’s financial burdens: 

Tip #1: Include an Indemnity and Hold Harmless Agreement

Under this requirement, the subcontractor agrees to indemnify, or financially restore, the upper tier contractor to its condition prior to the loss and replaces the upstream party as the financial source for legal liability. The hold harmless clause releases the upper tier contractor from responsibility for the acts performed by its subcontractors, tenants, and other third parties. Hold harmless agreement language should clearly state the lower tier’s responsibility for claims, damages, losses, expenses, or other cause of action should a problem arise. 

Tip #2: Add a Waiver of Subrogation

Adding a waiver of subrogation to a contract prevents a subcontractor’s insurer or other lower tier party from seeking reimbursement on a settled claim from an upstream entity. 

Tip #3: Require an Additional Insured Endorsement

Additional insured endorsements provide upper tier parties with insurance coverage under a lower tier’s liability policy. This prevents third parties from seeking financial contribution from the upper tier’s insurance for losses. Additional insureds also can file claims for which they are not solely at fault under the named insured’s policy. 

Tip #4: Don’t Forget Completed Operations

Specify the duration of the coverage when requiring an additional insured endorsement. Most policies default to “ongoing” operations, which only includes the named insured’s active work on a project. Extend coverage by requiring the endorsement include “completed” operations to protect against negligence and faulty work discovered after a subcontractor’s job ends. 

Tip #5: Specify Primary and Non-Contributory

A primary and non-contributory endorsement designates usage order when multiple policies get triggered by the same event. The clause should state that the subcontractor’s policy is primary to the loss without seeking contribution from the additional insured’s policy. This ensures the subcontractor’s policy applies in full before pursuing any financial contribution upstream. 

Tip #6: Beware Blanket Endorsement Language

Blanket endorsements provide coverage under a third party’s insurance policy to any contractually required entity without being specifically named. One of two conditions must exist for blanket endorsement coverage: 1) a direct contract between the named insured and the additional insured exists, or 2) the contract specifies all parties that must be added as additional insureds. 

Tip #7: Detail Types of Coverage

Specify the types of insurance coverages required in the contract. Depending on the project and scope of work, this may include Commercial General Liability, Professional Liability, Auto Liability, Workers’ Compensation, or Commercial Property, among others. Insurance policies are not one-size-fits-all, so fully covering a project or property likely requires multiple policies. 

Tip #8: Set Coverage Limits

Designate required coverage thresholds. Each named insured’s policy should equal or exceed the upper tier’s insurance limits. When a third party has inadequate coverage amounts, the upper tier pays out-of-pocket costs or uses its own insurance policy for the financial overage of the loss. 

Tip #9: Make the Grade Matter

Far too many insurance companies lack the financial solvency for covering major claims and losses. Contractually require that subcontractors’ insurers hold an A- or better rating by AM Best, a top-tier credit rating agency for the insurance industry. 

Tip #10: Review and Retain Certificates of Insurance

Check the certificate of insurance (COI) from every third party before work begins. Verify coverages, limits, and other insurance specifications required by the contract. Maintain copies of the COI and signed contract for reference in the event of a claim. (For help in automating the process of tracking COIs, communicating with insurance agents, and verifying contract compliance, check out myCOI’s cloud-based technology.) 

Agreement language matters. Ensure your company fully leverages risk transfer before its next project. Preventing losses comes from the power of the contract – make sure yours plays to win.

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