Will Your Insurance Policies Align With Contractual Exposures?

DECEMBER 6, 2022

Every day, companies enter into agreements with third parties such as suppliers, contractors and vendors. In the face of supply chain challenges, increased material costs, project delays, and changing lease agreements, most companies are typically focused on the products or services they’ve promised. Unfortunately, that means contractual insurance requirements may go unnoticed — which can result in coverage gaps and noncompliance with contract terms, leading to uninsured losses and lawsuits.

Practice Better Contractual Risk Transfer

A lot of businesses rely on third parties to keep their doors open and deliver products and services to consumers. It’s common practice for one party to assume the liabilities of another as part of a business agreement, but when such exposures are not covered by insurance policies, businesses often suffer significant uncovered losses.

Contractual risk transfer is a strategy that involves the use of business agreements — i.e., contracts — to shift risk from one party to another. For example, if you’ve ever been asked to name another business as an “additional insured” on a policy, you’re typically agreeing to assume some of that business’s liability and afford them access to the coverage and limits provided by that policy. Hold-harmless agreements, contract clauses limiting liability, and waivers of subrogation are other examples of contractual risk transfer.

It’s critical for businesses that enter into contracts to determine:

1. Where risk can be transferred to a third party
2. Where more favorable contract language can be established for risks to be assumed
3. Contractual exposures and coverage available under current insurance policies, to evaluate whether coverage satisfies contractual obligations

Implementing an effective contractual risk transfer strategy, and then executing on it consistently, presents a challenge for many businesses. Attorneys advising businesses may not possess deep knowledge of insurance coverage and forms, and insurance agents are often uncomfortable engaging in serious consultation on contract language.

It’s imperative to seek expert guidance from insurance professionals who specialize in your industry, understand the various contractual risk transfer methods, can quantify the liabilities being assumed under contract, and can develop customized insurance programs that enable companies to fulfill their obligations in a cost-effective manner.

Case Study: Reducing Uninsured Exposures 

A plumbing company signed a contract with a general contractor (GC) who was renovating a hospital. The construction contract contained two requirements that wouldn’t be covered in the plumber’s general liability policy.

1. The contract required the plumber to provide coverage for damage caused by the presence of mold or fungi resulting from the plumber’s work. However, the policy contained a total pollution exclusion that defined mold and fungi as “pollutants.”
2. The contract required that the plumber include both the GC and the hospital as additional insureds for both ongoing and completed operations.

After USI Insurance Services uncovered these issues during a review of the contract and policy coverages, we recommended that the plumber purchase a pollution liability policy to address the mold and fungi exposure. We also shared that the existing additional insured endorsement on the policy could not extend coverage to an upstream, non-signatory party (the hospital). The plumber named USI as broker of record, and we worked with the underwriter to add the appropriate endorsement to satisfy the coverage requirement for the hospital.

This resulted in the following reductions in uninsured exposures:

• Losses due to the presence of mold and fungi caused by the plumber’s work would be covered under the pollution policy, removing a potential $1 million gap in coverage.
• The plumber was able to include the hospital as an additional insured, eliminating an exposure up to the policy limits of $1 million.

In addition to the exposures discussed in this article, USI can identify other opportunities to reduce uninsured exposures and help companies save on costs. To learn more about the risk management services available through USI, email select.business@usi.com.