181 W. Old Country Rd. Hicksville, NY 11801
A contractor and two subs need to understand risk transfer

The Basics of Risk Transfer for Contractors

Contractors are often in the position of using subcontractors to fill certain roles. Whether you’re a general contractor or a subcontractor who subs out some portion of a job, it’s important to transfer risk in order to protect your assets in the event of a loss. This is possible when you execute well-crafted written contracts and insist that everyone on the project is appropriately insured.

What Is Risk Transfer?

Risk transfer is simply transferring liability for a loss between the parties in a contract. For example, when an owner hires a general contractor, he will create a contract that transfers risk to the general contractor, making it liable for any losses for injury or property damage that occur. Similarly, the general contractor will transfer risk to a subcontractor, and a subcontractor will transfer its risk to any subcontractor it hires.

In the verbiage of risk transfer, parties in the contract are referred to as “higher tier” or “lower tier,” with risk generally being transferred from above. However, these designations are fluid. For example, in a contract between an owner and a general contractor, the general contractor is the “lower tier.” But in a contract between a general contractor and a subcontractor, the general contractor is the higher tier.

The basic principle of risk transfer is that the higher tier transfers as much risk as possible to the lower tier, thereby minimizing its exposure in the event of a loss.

How is Risk Transfer Accomplished?

Parties in a construction contract transfer risk in a number of ways. First and foremost, they enter into written contracts, which are preferable to oral agreements. Although oral contracts are legal and enforceable in most states, they are often hard to prove as well as incomplete.

A well-written contract transfers risk in a number of ways. These include:

Indemnification Agreements

Also called an indemnification provision or an indemnity agreement, this part of the contract specifies that the lower tier party will indemnify, or compensate, the higher tier for any losses that occur. Many but not all of these losses will be covered by the lower tier’s insurance. If they are not, the lower tier who has assumed the risk will have to reimburse the higher tier for any losses from its own funds. If those funds aren’t available, the higher tier will not be reimbursed.

There are several different types of indemnification agreements.

  • A broad form agreement transfers all risk to the lower tier, regardless of who is at fault.
  • An intermediate form agreement transfers all risk to the lower tier unless the higher tier is 100 percent at fault
  • A limited form agreement transfers risk based on the degree of fault. For example, if a third party claim for which the higher tier is 50 percent responsible results in a $30,000 settlement, the lower tier would be responsible for 50 percent of the settlement, or $15,000.

 

Be aware, however, that most states have enacted anti-indemnity laws that limit the enforceability of indemnity agreements in construction contracts. And if the court declares your agreement invalid, you will be liable for any loss that occurs.

Hold Harmless Agreements

Hold harmless agreements are similar to indemnification agreements, but they are two different legal terms. A hold-harmless agreement specifies that the lower tier who assumes a risk will not try to recover payment for damages from the higher tier.

Additional Insured Endorsements

An additional insured endorsement adds the higher-tier business to the lowered tier’s insurance policy as an additional insured. As such, it helps protect the higher tier contractor from financial loss if an indemnity agreement is ruled invalid by the courts. The endorsement will protect you from covered losses that arise from work the lower tier does for you. In the event of a claim, the lower tier’s insurance policy will defend all parties insured under the policy and pay the amount of any settlement that occurs.  

An additional insured endorsement may be written on a primary or an excess basis. If the policy is written on a primary basis, the lower tier’s insurance pays out on any loss first. The higher tier’s policy will only kick in if the amount of the settlement exceeds the limits of the lower tier’s policy. Conversely, if the endorsement is written on an excess basis, the lower tier’s policy will pay only if the amount of the settlement (and defense costs) are in excess of the limits of the higher tier’s policy.

To transfer risk to the greatest degree possible, an additional insured endorsement should cover both work in progress (ongoing operations) and completed work (completed operations.) What’s more, since claims can be made long after work is completed, it’s a good idea to require that the additional insured endorsement remains in effect through the statute of limitations defined by state law.

Learn More

At The Carmoon Group, we have been helping contractors manage risk for over 15 years. We understand the risk profile of all construction professionals, from home remodelers to metal erection and elevator contractors. And we offer many affordable options to help you manage your risk. Give us a call today to set up an appointment for an insurance review. Or if you prefer, reach out online and we’ll get back to you right away.  

Please follow and like us:

Floyd Arthur

View All Posts

Leave a reply

Your email address will not be published. Required fields are marked *

Enjoy this blog? Please spread the word :)

The Carmoon Group, Ltd. is rated 4.8 stars by 5 customers