Even the plainest-looking commercial or residential building typically is the product of collaborative efforts by designers and skilled tradespeople — carpenters, masons, electricians, plumbers, drywallers, roofers and more. To function as a modern, structurally sound and safe edifice, the building must include a complex network of pipes and wires and ducts and tanks — most of them hidden behind walls and doors and ceilings and floors.
Both during the building’s construction and after its completion, much can go wrong. And when a job-site accident caused by a contractor or subcontractor results in property damage or bodily harm, an insurance claim is all but inevitable, often with a lawsuit soon to follow. Typically, every contractor involved in the project is named in the suit.
Making sure the right parties are held accountable and keeping claims out of court are the primary objectives of contractual risk transfer.
Good contractors tend to hire good subcontractors. Their reputation and the future of their business depends on it. But because things can go wrong for even the best of contractors, it’s equally important that they also work with a good attorney and a knowledgeable, experienced insurance agent or broker to ensure that risk is assigned to the appropriate parties.
Put another way: Good contractors also have good contracts.
Contractual risk transfer is especially important now, as the insurance trade publication Rough Notes observes, given the construction boom currently taking place across the U.S. amid a perfect storm of supply chain disruptions, “40-year-high inflation and a historically tight labor market” and so-called nuclear verdicts in liability lawsuits.
“Less-than-careful contract language exposes general contractors to the potential of multi-million-dollar jury awards and settlements,” Rough Notes reports. “Top claims we see include transportation-related accidents and forklift mishaps. Unfortunately, these incidents and their resulting jury awards are only getting worse.”
Key Contractual Elements of Risk Transfer
As the International Risk Management Institute (IRMI) notes:
“When astutely negotiated, a construction contract can become a valuable risk management tool. Liabilities can be equitably distributed among the contracting parties — general contractor, subcontractors, suppliers, architects, and the owner. Unfortunately, many construction contracts are drafted (or standard versions modified) by professionals with little knowledge of insurance coverage.
“As a result, it is not unusual for contracts to shift liabilities to the contractor that are extremely difficult or costly to insure, or even uninsurable. Many contractors accept these onerous contractual provisions without complaint (often without even noticing them), particularly when the business climate is very competitive.”
An insurance professional with expertise in construction will, at a minimum, ensure that a client who is a construction project owner or main contractor is protected by:
- Insurance and indemnification agreements — contracts that protect the insured from risks created by other parties, such as architects and subcontractors. Each contract should include:
- An additional insured provision, applying to both ongoing and completed operations, that adds the main contractor to the subcontractor’s General Liability and Umbrella policies for any claim caused in whole or in part by the named insured;
- A primary and non-contributory endorsement to each subcontractor’s liability policies, confirming that the sub’s insurance is first in line to pay claims and defense costs (primary) and ensuring that the main contractor’s insurance won’t contribute to claims or defense until after the subcontractor’s coverage limits are exhausted (non-contributory);
- A waiver of subrogation to prevent the subcontractor’s insurer from trying to recover a loss by making a claim against the owner or main contractor for reimbursement. It’s imperative that this appears in all policies, including Workers’ Compensation, in states where such waivers are permitted.
- Subcontractor agreements — contracts detailing terms and conditions regarding subcontractor duties, deadlines, payment, work area, safety, work hours and more;
- Certificates of insurance (COI) — documentation confirming that all coverages required in the insurance and indemnification agreements are in place.
An astute agent or broker will recommend that contractors use a proactive certificate management system to ensure their subcontractors’ policies are up to date and will remind clients of the importance of making sure certificates comply with the terms stated in the contracts.
While we’ve touched on the basics of contractual risk transfer, there’s a lot more to be said on the subject. In exchange for registering for its free, weekly newsletter IRMI Construction Risk Manager, IRMI offers the comprehensive whitepaper “Effective Contractual Risk Transfer in Construction.” Among its topics:
- Outdated insurance requirements: “Insurance requirements are often given little to no thought by contract drafters, who may copy and paste requirements from prior contracts without consideration of current market conditions and policy language,” IRMI notes. “This practice creates unnecessary friction in the contracting process.”
- Statutory limitations on risk transfer: “Most states limit the amount of risk that can be transferred in certain types of construction contracts. Running afoul of the applicable anti-indemnity statute can nullify the indemnification provision unless appropriate ‘savings’ language is included.”
An important point regarding those statutory limitations: To ensure the fullest possible protection and compliance with statutory limitations, make sure the indemnity clause includes the phrase “to the fullest extent permitted by law.”
As Rough Notes emphasizes in its report on opportunity and risk on the current construction landscape, “This set of frenetic circumstances could cause even the most well-organized business owners to miss routine steps that should be taken regularly to protect their companies. One area of potential exposure for the building, materials, and lumber space, for example, is contract liability.”
Just as working with the right designers and subcontractors is essential to constructing a safe and functional building, working with the right insurance agent or broker and consulting with an expert in construction risk-transfer law is a vital step toward becoming one of the boom’s beneficiaries, rather than one of its victims.
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About the Author
Commercial Insurance Consultant
HMK Insurance, an Alera Group Company
As a Commercial Insurance Consultant specializing in the construction industry, Ryan Rispoli negotiates coverage limits, terms and conditions with underwriters and insurance carriers, reviewing contract insurance specifications and developing risk transfer programs for clients, along with safety and loss control practices. He excels in relationship building and earning the trust of his clients as a consultant and advocate for their business.