5 Contractual Risk Transfer Types to Help Mitigate Risk

Contractual risk transfer is a way to both finance and control risk. Because contracts are a negotiated agreement, there are a number of ways to transfer liability during the drafting process. There are five primary types of contractual risk transfer, each with unique advantages and disadvantages. You should examine each one to determine what’s right for your business.

Consider the following questions:

• How can I establish the best working relationships with others?
• What types of risk transfer are most common in my area and industry?
• What type of risk transfer offers me the most financial protection in this scenario?
• Who will review my contract to ensure it is both legal and in my best interest?

1. Requiring Specific Insurance Coverages

There are many instances where other parties – vendors, cities, partners, investors, etc. – may require specific insurance coverages as part of a contract. These are required to help protect both parties from damages, reduce risk exposure and create a greater sense of trustworthiness between the parties. Coverages may also be required as part of a qualification process.

Common insurance coverages in contracts include:

• General Liability
• Auto Liability
• Workers’ Compensation
• Employer’s Liability
• Directors & Officers Liability (D&O)
• Cyber
• Errors & Omission (E&O)
• Property

2. Additional Insured Provisions

An additional insured provision is a form of risk transfer that allows one party to obtain insurance coverage under another party’s policy. The party that’s added as an additional insured then has direct access to the insurance policy without having to pay any premiums or deductibles. These provisions protect a party that may be exposed to risks that result from the named policyholder’s operations. If an indemnity agreement is found to be unenforceable for any reason, an additional insured may find coverage by making a claim under the named insured’s policy.

Although additional insured provisions usually only function as a secondary form of risk transfer, businesses need to examine a number of key issues:

• Additional insured status may not be available for every type of insurance. For example, professional liability policies usually will not name another party as additional insured, whereas general liability policies usually will.
• Establishing appropriate insurance limits. If the job is small, requiring a $10,000,000 limit may exclude small contractors from performing the task – even when they are the most appropriate choice. Conversely, requiring $1,000,000 for a general contractor hired to construct a multi-story office building is far too low for the exposure to loss.
• Obtain proof of insurance in the form of a Certificate of Insurance to verify coverage and the policy’s limits. It is also wise to request a copy of the additional insured endorsement, as there may be restrictive language included not otherwise made known by the certificate.

Whether you’re asking for additional insured status from a vendor or responding to a bid request, consult with your insurance broker to determine the best approach.

3. Waivers of Subrogation

Essentially, waiver of subrogation voids an insurer’s right to mitigate losses by collecting from responsible parties. This provision:

• Transfers more risk to insurers by limiting the insurance carrier’s ability to reclaim funds
• Can minimize the risk of lawsuits and allow each party’s insurance to cover the losses
• Can protect your insurance limits and future premium rates

4. Indemnity Provisions

Limited or Comparative requires an indemnitor to protect an indemnitee from losses involving the indemnitor’s own negligence. In other words, you are responsible for whatever percentage you contributed to the loss.

Intermediate requires an indemnitor to protect an indemnitee from all related losses, unless it was the sole negligence of the indemnitee. For example, the agreement may call for complete indemnification by the indemnitor if the indemnitor was only 1% negligent.

Broad or Absolute requires an indemnitor to protect an indemnitee from all losses, even if the loss was the result of the indemnitee’s sole negligence. Whether sole negligence can be passed to another party is determined by individual state laws. Some states deem it is against public policy to transfer one’s sole negligence to another party. Do not rely on whether the state prohibits this practice and seek the broadest contractual coverage in your Commercial General Liability (CGL) or other liability policy.

5. Unambiguous Responsibilities

Ensuring contract terms are specific and clear in regard to which party is responsible for what is the best way to protect both parties. Contracts with clear expectations, roles and responsibilities between the parties will be easiest to resolve should there be an issue, perhaps even helping to keep conflicts out of court.

We’re Here to Help

When entering into a contract, you should work with your insurance broker/risk manager and your attorney to develop a strategy to transfer and avoid risk when appropriate. For more information, connect with a member of our team.

This information should not be considered legal advice. Contact legal counsel for advice before you agree to a contract with other parties.