Summary: When entering a contract with a contractor or subcontractor, businesses should understand how to transfer risk to the party that should be held responsible should an incident occur. Find out what risk transfer is and how it can help protect a company's bottom line.
How Does Risk Transfer Protect a Business's Assets?
Utilizing contractors, subcontractors, service providers and vendors is essential to the success of any business. When negotiating agreements and contracts for services to be rendered, it is important business owners recognize the benefit of transferring potential liability to these providers. This cannot only reduce the risk of being responsible for costly claims, but it can also improve the company’s bottom line.
What is Risk Transfer?
The definition of risk transfer is
an action or strategy that contractually shifts the risk of doing business from one party to another. The purpose of risk transfer is to pass the financial liability of risks, like legal expenses, damages awarded and repair costs, to the party who should be responsible should an accident or injury occur on the business’s property.
Many liability losses occur through the transfer of risk, making it necessary for a Risk Control Consultant to assess the hazards and controls that could arise from various contracts and agreements. This is similar to other risk management and loss control efforts, such as assessing the workplace for potential hazards that could result in injury to an employee.
How Do Businesses Transfer Risk?
Insurance Policies
An insurance policy is the most common way risk transfer is achieved. Contractors like
snow and ice removal companies, for example, should carry general liability insurance,
workers’ compensation coverage and automobile insurance with proper limits of coverage. The insurance company assumes the defined risks for the policyholder in exchange for a fee, or insurance premium, and will cover the costs for worker injuries and property damage.
When a contractor or subcontractor is hired to perform any type of work on a company’s property, such as snow removal, business owners should request certificates of insurance before the work is started. A certificate of insurance (COI) contains all the important details of the insurance policy, including the type of coverage, whom it covers, the effective date of the policy, the policy limits and proof that the contractor or subcontractor is adequately insured.
As the underlying coverage is the backbone of risk transfer, it’s vital that business owners view the COI to confirm the necessary coverage is in place before they begin any work on the premises. Each COI should be reviewed carefully, looking for details such as:
- Expired policy dates
- Adequate coverage is provided for the work required
- Endorsement of the certificate holder as an additional insured. While this may not be shown on the COI, the certificate holder should obtain an actual endorsement from the service provider’s insurance company naming the certificate holder as an additional insured.
It’s important to keep in mind that a COI is merely a representation of a single moment in time and may not properly protect a company’s assets. When hiring a contractor, subcontractor or vendor, it’s recommended to have a contract developed with legal counsel before any work begins.
Contractual Agreements/Hold-Harmless Clauses
A contractual risk transfer is an agreement other than an insurance policy where one party agrees to protect, hold you harmless and indemnify you for claims for damages for specific acts or omissions caused by that party. All contracts should be written by legal counsel and include:
- A Hold Harmless Agreement: There should be a clause in the contract that releases one party from consequences or liabilities due to the actions of the other party. These agreements do work both ways, however, so make sure this agreement is in your favor.
- An Indemnification Agreement: An indemnity agreement ensuring that proper compensation is available for losses or damage.
- A Waiver of Subrogation: An endorsement that prohibits an insurance carrier from recovering the money they paid on a claim from a third party that may be negligent.
- A Primary and Noncontributory Requirement: An inclusive contractual requirement that requires the vendor or subcontractor’s policy to pay before other applicable primary policies and without seeking contribution from other policies that also claim to be primary - noncontributory.
- Additional Insured Status: The vendor or subcontractor is required to endorse the property owner onto its general liability policy as an “Additional Insured.”
In the snow removal services example, the snow removal contractor and the property owner should create a contract with their legal team that clearly defines the duties of the contractor, such as what areas are to be addressed and what time the contractor should arrive to clear the premises during snowy weather. It should include the requirement that if the contractor is liable for a claim due to an injury occurring on the property and/or a lawsuit is filed, the contractor should defend the property owner and possibly even settle the claim, if warranted.
The Advantages of Transferring Risk
No business owner likes to imagine they could be involved in a liability judgment. However, it’s best to be prepared by having a worst-case scenario mentality.
Let’s look at a real-life example of what happened to a business owner when a contractor was negligent and didn’t have proper insurance coverage (names of both individuals and businesses have been changed):
Ms. Walker was walking along a public sidewalk to a restaurant where she often had lunch. She fell to the ground in front of ABC Agency's building. Looking out her office window, Ms. Smith, Executive Director of ABC Agency, saw that a lawnmower operated by their landscaping service had thrown a rock and struck Ms. Walker in the face.
Ms. Smith rushed to Ms. Walker's side, called 911 and later visited her in the hospital. Ms. Smith, working in close cooperation with the claims adjuster for ABC Agency’s insurance carrier, arranged for Ms. Walker's medical bills to be paid. Ms. Walker never hired an attorney or pursued the matter. She still walks past ABC Agency on her way to lunch.
Why was ABC Agency responsible? The reason is that the landscaping service had no liability insurance.
Ms. Smith told the loss control consultant who later visited ABC Agency, "Today, we have a new landscaping service that is a real business and supplies us with certificates of insurance. This will never happen again!" In this scenario, Ms. Smith luckily avoided a lawsuit by working with the agency’s insurance carrier in a timely manner to pay Ms. Walker’s medical costs. Unfortunately, it’s likely that ABC Agency’s rates will increase as a result of the claim. Also, the agency was responsible for paying the deductible out of their own pocket. Had the landscaping company had the proper coverage, ABC Agency could have avoided these expenses.
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Loss Control Department understands that safety starts with knowledge. We offer a variety of
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This material is for informational purposes only and is not legal or business advice. Neither AmTrust Financial Services, Inc. nor any of its subsidiaries or affiliates represents or warrants that the information contained herein is appropriate or suitable for any specific business or legal purpose. Readers seeking resolution of specific questions should consult their business and/or legal advisors. Coverages may vary by location. Contact your local RSM for more information.