By Chris Dunlap
As construction contractors know, contractual risk transfer is key to the success of a project. Neglect this protection, and even a single loss incident can destroy a business. And while procuring insurance for the business is a very common and straightforward way to contractually transfer the financial burden of risk, insurance alone is not enough to properly protect a contractor’s interests, especially in the dynamic environment that exists with a construction project.
Contractual risk transfer is a way to share the risk of a construction project so the owner or general contractor is not left paying a claim for a problem caused by one of its subcontractors. It promotes a more equitable shouldering of the risk so that those responsible for it bear it.
Knowing about this sort of indemnification is one thing. Understanding the nuances is another. Contractors should be wary of options that might be offered up under the guise of contractual risk transfer that can present significant exposure to the business. Here are three of the most common so you know to avoid them.
Certificates of Insurance
Too many are fooled into thinking a Certificate of Insurance (COI) is a form of risk transfer. But it really is only a document that serves as a “snapshot in time,” showing insurance coverage. Here are some of the problems with trusting it:
- It’s too easy to create fraudulent COIs with today’s technology.
- The policy that the COI certifies could be cancelled tomorrow.
- If there is no additional insured endorsement, the certificate holder does not have to be notified of policy cancellation.
- Even if the COI is accurate, as many are, the underlying policies could have severely limiting exclusions. As some unethical contractors and insurance brokers have been known to buy such policies to reduce costs, it’s smart to ask for the actual policies to review. And some insurers are known for selling such bare bones policies that exclude the most significant exposures in a contractor’s business.
Additional Insured Endorsements
When a COI is issued, an Additional Insured Endorsement (AI) adds a layer of protection as it affords the certificate holder coverage under the policy, albeit with restrictions. Despite a benefit in that it provides written notification if the policy’s cancelled, the AI has pitfalls to be aware of. The biggest:
- It may not be enforceable if there is no written contract.
- The AI is worthless if claims aren’t covered due to exclusions in the underlying policy.
- Even if the AI functions as intended, a subcontractor’s limits may be inadequate for the full extent of the loss.
A contract can be as simple as a purchase order, and that may be how smaller, less sophisticated contractors do business on a day-to-day basis. A written contract can provide significant protections for the contractor, beyond insurance, but contracts are not without their own limitations. Consider the issues:
- It may not include insurance provisions, or the insurance provisions provided may not be adequate for some types of work.For example, the suggested limits for a plumber may not be adequate for a roofer.
- Many written agreements lack an indemnification clause (also known as a hold harmless agreement). This is important to prevent the other party from taking legal action against you for something that party caused.
- It may be deemed unenforceable in a court of law. The written contract is in a stronger position if accompanied by a COI and an AI.