Understanding Contractual Risk Transfer

Contractual risk transfer (CRT) involves shifting financial responsibility for specific risks from one party to another within a contract. This risk management strategy is crucial for construction employers, as it places liability on subcontractors, vendors or service providers. In this way, CRT protects employers’ margins, reduces uninsured losses and helps ensure insurance coverage for losses.

This article outlines key components of CRT, discusses common weaknesses in construction contracts and provides best practices for CRT.

Components of CRT

The following are critical elements of effective CRT:

• Indemnification clauses within contracts require one party, usually the subcontractor, to defend and indemnify the employer for specific claims, such as third-party bodily injury, property damage and defense costs. However, many states have anti-indemnity statutes, so employers must ensure their contracts comply with local regulations.
• Additional insured (AI) requirements stipulate that upstream parties, such as owners, general contractors or construction managers, are named as AIs. Construction employers usually require AIs on commercial general liability (CGL), auto and umbrella policies. Contracts should specify primary and noncontributory wording and require AI coverage for ongoing and completed operations.
• Insurance requirements ensure subcontractors have adequate coverage. Within contracts, employers should mandate minimum limits, designate a preference for occurrence or claims-made policies, and detail required endorsements, such as CG 20 10 for ongoing operations and CG 20 37 for completed operations.
• Waivers of subrogation prevent an insurer from seeking reimbursement from the employer after paying a claim, thereby preserving the intended risk allocation. These waivers are commonly found in conjunction with CGL, workers’ compensation and builders risk policies.

Common Weaknesses in Contracts

Construction contracts may omit critical provisions or language, thereby undermining CRT and exposing the employer to potential risks. Common issues include:

• Lacking indemnification language or using vague language
• Listing AI endorsements that do not match the contract
• Not obtaining or reviewing certificates of insurance (COIs)
• Relying on outdated or expired endorsements
• Not flowing down requirements to subcontractors

CRT Best Practices

Construction employers should implement the following strategies to ensure effective CRT and reduce exposures:

• Conduct a pre-contract review. This ensures all risk-transfer requirements are included in the contract. Confirm that indemnity language aligns with insurance requirements and the law, AI coverage is mandated for operations, and waivers of subrogation and adequate limits are in place.
• Prequalify subcontractors. Review their experience modification rate and total recordable incident rate. Verify that they meet safety, financial and insurance standards.
• Perform audits annually. This maintains ongoing compliance efforts with insurance and contract requirements. Track policy expirations, request updated COIs and endorsements, and ensure subcontractors maintain insurance limits.
• Document everything. Keep contracts, COIs, endorsements, change orders and approved exceptions. Accurate recordkeeping can help with claims handling and reduce disputes.

Contact us for more information on CRT and risk mitigation.

Article Published By: Zywave, Inc.