Contractual risk transfer

Keeping insurance costs to a minimum
can be a challenge. One way to reduce
long-term cost is by using the proper indemnification and insurance language in
business contracts. By doing so, companies
can limit their liability when working with
outside parties and improve their risk to
loss. Having strong contract administrative
controls and a good loss picture ultimately
leads to lower insurance premiums.

“Whenever there are two parties to a
transaction you want to transfer your risk
of loss (claims for bodily injuries, property
damage, environmental loss, etc.) to the
other party if you can,” says John Kurtz,
vice president of The Graham Company.
“By doing that you’re forcing the other
party to assume liability.”

Smart Business asked Kurtz for more on
how to take advantage of contractual risk
transfer.

How does contractual risk transfer work?

It protects the company when you’re
under contract by transferring responsibility for claims and loss and damages to the
other party. So to the extent that you can
transfer that risk to another party, you’re
not responsible for it.

Can this be used in all forms of contracts?

In construction, it can be a subcontract
or the contract that a construction manager has with an owner. Outside of construction, it could be a contract that you have
with a major vendor, a major customer, a
party in the product distribution chain or a
financial institution. It could even be with a
party sponsoring a special event.

Depending on which side of the transaction you’re on, you look to transfer that risk
through contractual risk transfer anywhere
you can. There are times when you may
not have leverage in a transaction to transfer that risk, but at a minimum in those situations, you don’t want to be indemnifying
the other party for their negligent acts.

Do companies still need insurance?

Regardless of whether you’re able to
transfer the risk or not, you need to have insurance for the risk you assume. You’re
going to have contractual liability insurance. But you still want to transfer the risk
even if you have the insurance because it
protects your loss experience. If your
insurance company had to step up and pay
a claim for a risk that you weren’t able to
transfer to another party, you have that
claim as part of your loss experience. If
you’re able to transfer it, the broker is in a
better position to negotiate lower premiums, and then also generate more interest
among the insurance companies because
you have strong contract administration in
place and a favorable loss picture.

What should be included in a contract for
effective risk transfer?

The business owner is going to want to
have strong indemnification language shifting responsibility for claims and losses to
the other party. So, again, even if you do
not have the leverage in the transaction,
you don’t want to indemnify the other
party for their negligent acts. The most you
want to be responsible for in that situation
is your own negligence. If you have leverage in the transaction, you look to get that party to pick up as much as possible,
including your negligence.

Who’s going to benefit the most in contractual risk transfer?

The party that benefits the most is clearly the party that’s able to transfer the most
risk. It’s not a one-way street. I could sell
you a product, and I might want indemnification and additional insured coverage
from you. And you might say, ‘Why? I’m
buying your product.’ The reason is that
you’re going to buy my product and then
make alterations to it and then re-sell it. So
I want indemnification for that because I
know you are going to make changes to my
product. So there are all kinds of scenarios.
Your broker needs to understand the
nature of the transaction, how much leverage you have and how your policy coverage is structured.

What else should owners do to protect themselves when using contracts?

The other thing that the business owner
wants in addition to the strong indemnification language is to be listed on the other
party’s insurance as an additional insured
on a primary and non-contributory basis.

There are two avenues for transferring
the risk — the one is the indemnification
language, and that transfers the risk to the
other party. If you are sued, you point to
the indemnification language that’s working in your favor. And then you show that
you’re also listed as an additional insured
so your coverage is also on that policy.
Those are the two avenues of recovery
under the other party’s insurance.

What else should a business owner understand before signing a contract?

The smart buyer has his broker look at
anything before he signs it or before developing any subcontract language that he
plans to use on a regular basis. Because in
many cases it’s a couple of sentences or
even a couple of words that can make a
dramatic difference.

JOHN KURTZ is vice president of The Graham Company. Reach him at (215)701-5237 or [email protected].