Understanding Contractual Risk Transfer in Construction

Contractual risk transfer is a risk management mechanism that many businesses can use. It involves shifting responsibility from one party to another and is commonly used in subcontracting, supplier or sales agreements and lease agreements. 

 This post offers further insights into contractual risk transfer, including when it may be used, commonly used tools and other important considerations.  

When Is Contractual Risk Transfer Used? 

Contractual risk transfer may be suitable for various situations when a party is performing work on behalf of another party. In these situations, businesses should consider using contractual risk transfer as it provides a means to transfer risk to the party who is better positioned to manage it.  

 Consider a general contracting risk as an example. There is an assumption of liability for all parties working on a jobsite. A general contractor can use contractual risk transfer to ensure that a subcontractor it is working with assumes liability for losses that might be caused by the subcontractor’s work.  

Common Contractual Tools to Transfer Risk 

Contractual risk transfer comes in many forms, such as hold-harmless agreements, indemnification agreements, and waivers of subrogation. Additionally, contractors should include a requirement in their contracts to be listed as “additional insureds” on the other party's insurance policy. The following offers a more detailed explanation of the common tools: 

• Hold-harmless agreements are part of a contract that releases one party from responsibility for the actions of another. 
• Indemnification agreements detail how an indemnified party, or indemnitee, will be compensated by the indemnifier, or indemnitor, if a third-party claim is filed. These clauses typically define how the contracting parties will allocate risk and liability, including the specifics of the risk transfer duration. 
• A waiver of subrogation is a clause that prohibits a party’s insurance company from seeking recovery from the other party’s insurer for compensation it provided to a third party. 
• Additional insureds enable one party to obtain insurance coverage under another party’s policy. For example, if a contractor is named as an additional insured on a subcontractor’s policy, the contractor would receive coverage from the subcontractor’s insurance. 

Companies should follow best practices by requiring a certificate of insurance (COI) from parties who may create liabilities (e.g., subcontractors). Additionally, it is advisable to contractually require that these parties name their company as an additional insured on a primary and non-contributory basis. It is also important to request a copy of these endorsements. Together with the COI, these documents help ensure adequate insurance coverage and sufficient limits are in place. 

Contractual Risk Transfer Considerations 

Businesses must also consider other considerations when using contractual risk transfer. For instance, contractual risk transfer laws differ by state, so it is advisable to consult an attorney familiar with these regulations. An attorney can also help ensure the agreements are appropriately scoped and achieve their intended objectives. Additionally, it is crucial for each party involved in a contractual risk transfer to understand their financial responsibilities in the event of a loss. 

An Integral Part of Risk Management 

Contractual risk transfer can help businesses reduce their insurance claims and costs while placing risk with the party better positioned to control it. It can be an integral part of a business’s risk transfer strategy, along with securing insurance. Contact a Hylant risk advisor to learn more.

Related Reading: Wrap-up Insurance Programs for Construction Projects

 The above information does not constitute advice. Always contact your insurance broker or trusted advisor for insurance-related questions.