What is risk transfer and why it matters
Sometimes things don’t go as planned. An incident or accident can turn an ordinary workday into anything but business as usual. That’s why it’s so important to have the right protection in place, regardless of whether you’re a multimillion-dollar enterprise or a one-person shop.
For businesses that hire subcontractors to do a portion of their work, it’s essential that their risk management strategy includes risk transfer, which includes using a combination of contract language and insurance coverage to move the contractual and financial responsibility for specified risks from the business managing the contract to the subcontractor.
“Risk transfer helps ensure the business has the right protection in place to protect its interests,” explains Katlyn Glenn, senior underwriting consultant for Nationwide E&S/Specialty Programs.
How contractual risk transfer works
With so much at stake, it’s important to get risk transfer right, which starts with understanding how it works.
“It all begins with the contract,” says Glenn.
When one party hires another party to perform work for them, they sign a contract outlining the scope of work, general terms and conditions, and who is responsible if something goes wrong.
Contracts, which sometimes come in the form of master service agreements (MSA), are common in construction, consulting services, real estate and other fields and industries.
“Within the MSA will be specific language, including indemnification clauses, hold harmless agreements and insurance requirements,” Glenn explains.
When the contracted party decides to hire another party to perform part of the job, the risk the contractor is assuming needs to be shifted to the subcontractor. While the MSA is between the owner and the contractor, the contractor needs to have any subcontractors sign a subcontractor agreement, and they should collect evidence of coverage in the form of certificates of insurance. The subcontractor agreement should have the same terms as the MSA and should include a waiver of subrogation, which prevents the subcontractor’s insurer from suing the contractor in the event of a claim.
“The subcontractor agreement should also ensure that the subcontractor carry the same insurance limits that are required by the general contractor and should have the same additional insured requirements, naming both the owner and the contractor as additional insureds on the policy,” says Glenn.
Getting the right protection in place
An important part of risk transfer is ensuring subcontractors carry the right coverages within their general liability (GL) insurance policy, which should match the requirements outlined in the MSA to ensure there are no gaps in coverage.
“The GL policy should have a primary/noncontributory endorsement, which ensures that the subcontractor’s insurance responds first if there is a covered loss,” adds Glenn. “In turn, subcontractors also need to name contractors as an additional insured on their policy.”
While most of the time insurers use blanket wording to add these endorsements to a GL policy, it’s important to read the fine print to ensure that the proper coverage is there, and it’s critical to verify which Additional Insured (AI) endorsement forms are required under the terms of the contract. Some agreements may stipulate the use of legacy form editions, while the insurer may only offer coverage under the most current versions.
“Older policy language may contain gaps or limitations that could expose contractors to unintended risk. The current policy forms are designed to address these issues and reflect updated industry standards,” notes Glenn.
Underscoring the importance of proper coverage
"Some businesses learn the hard way how important policy language is," Glenn says.
A situation comes to mind where an insured entered into a master service agreement and then hired a subcontractor to complete a portion of the work. The subcontractor agreement did not include a flow-down insurance clause, and when that subcontractor’s work caused an incident injuring several people, the general contractor’s insurance carrier had to defend and indemnify the owner.
In the lawsuit that followed, the general contractor was found liable for the damages, which totaled in the millions.
“Situations like this actually happen all the time,” she says. “And if the business doesn’t have the proper coverage in place the claim could be denied, leaving the insured to defend themselves. The related legal expenses and claims costs can end up putting the company out of business.”
Partner with experts to protect your business
The best way to ensure risk transfer is handled correctly is to work with a team of experts to ensure the MSA, subcontractor agreement and liability insurance policies are strong and complete. This includes seasoned insurance underwriters, legal counsel and risk management professionals who have specific experience in risk transfer.
“It’s critical for businesses to make sure they are protected by their contracts and the right insurance,” says Glenn. “No one wants to pay for a claim for something they didn’t do.”