Contractual Risk Transfer

What is Contractual Risk Transfer?

Contractual Risk Transfer is a means to assign liability and financial burden of a loss to the party best able to control or prevent the loss from happening in the first place.  Without a properly worded contract, the supervising party could wrongfully assume the financial responsibility for losses caused by a third party who should have been responsible.  The contract is configured in a way to indemnify and hold harmless the Owner or General Contractor.

Contractual Risk Transfer is extremely effective because it employs two separate Risk Management techniques: Risk Financing and Risk Control.  Risk Financing, assigning a separate party to pay the cost of a claim and Risk Control, developing a means to mitigate the severity of a loss.  When Contractual Risk Transfer mechanisms are in place, tenants and subcontractors have incentive to operate with safe and controlled practices because they know they will be the first party financially liable for a loss.

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Example #1: Contractor and Subcontractor

NS Landscaping, an excavation contractor, was hired by ABC Contracting, a general contractor, to perform utility installation work. NS Landscaping hired a subcontractor, John's Excavating, to perform the trenching work. There was a contract in place, but the contract didn’t require John's Excavating to add NS Landscaping as an additional insured to its policy.

Two employees of John's Excavating were working in a trench that was 12 feet deep and not shored. The trench collapsed, killing one employee and severely injuring the other. The case went to trial and the jury returned a verdict of more than $9 million. NS Landscaping’s insurance carrier paid most of the claim, as well as $448,000 in legal fees to defend the case. If NS Landscaping would have required John's Excavating to list NS Landscaping as an additional insured on its policy, the insurance company representing John's Excavating would have likely been responsible for the entire claim, including legal expenses.

Example #2: Commercial Property Owner and Tenant

Commercial property owners can face a variety of risks and challenges with their tenants. For example, after a business such as a small boutique enters a lease in a commercial property, the boutique owner may also sign a contract with the building owner. The contract should include wording to ensure the boutique owner keeps the storefront and the sidewalk immediately outside the shop clean and free of snow or ice in the winter months . If a customer of the boutique slips and falls outside on ice, the contract will specify that the store owner would be responsible for the injured customer’s medical bills, or the legal costs should that customer sue. The contract would include a “Hold Harmless Agreement” that releases the commercial property owner from the consequences or liabilities due to the actions of the boutique owner.

 

How to Get Started with Contractual Risk Transfer

Contractual risk transfer is achieved in three foundational steps:

• Step 1: Assessing the risks and identifying opportunities for CRT.
• Step 2: Contact your Insurance Agent to get proper coverage for CRT.
• Step 3: Vetting, contracting and maintaining COI recordkeeping processes.

First, it’s important to create a detailed list of the processes in your business, as well as a list of all the service providers, suppliers, vendors and subcontractors hired. Use this list to understand the specific risks your company could face should one of these parties not fulfill an obligation or make an error. This will help you identify where a high dollar claim could arise, and where there’s an opportunity to transfer risk.

Does your business have the right insurance coverage? Schedule your free insurance review by calling us at 914-693-3500.

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