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Risk Transfer Requirements: Your Key to Profitability in Construction

Post written by Mike Vettel, CPCU, CIC, Business Sector Analyst

shutterstock_145949204According to First Research, the United States (U.S.) construction industry includes more than 650,000 contractors with combined annual revenue of about $1.4T. Demand for this industry is driven by demographics and the health of the economy. The profitability of individual companies depends on their ability to bid accurately, secure contracts and control costs.

One of the “best practices” in the construction industry that has a significant impact on profitability is contractual risk transfer: the practice of transferring risk from one party to another by use of a contract or written agreement. The goal is to ensure the risk is assumed by the party who is in the best position to prevent loss, which is the party in control of the work site, operations or premises.

An example would be a general contractor receiving a bid to construct an office building. The general contractor will not perform any of the work and will utilize subcontractors to complete the work. The common practice is for the general contractor to enter into a construction agreement with the subcontractors to transfer risk to the parties completing the work. It is important to understand the elements of risk transfer agreements and which of these provide the greatest level of protection.

Solid risk transfer agreements will include all or the majority of the following characteristics:

  • Additional insured status for both on-going and completed operations
  • Certificates of insurance suspense system in place
  • Current insurance carrier has an A.M. Best rating of “A-“ or better
  • Defense requirement included
  • General liability coverage includes per project aggregate or equivalent
  • Hold harmless agreements – contractual agreement whereby one party assumes the liability inherent in a situation thereby relieving the other party of responsibility; or the party assuming the risk agrees not to attempt to recover any portion of damages from the other contracting party.
  • Indemnification agreements – agreement between two parties whereby one (indemnitor) agrees to put the other (indemnitee) back to the financial position they were prior to a loss
  • Legal counsel reviews contracts
  • Primary and noncontributory language included
  • Statement of minimum insurance requirements
  • Waiver of subrogation applies to automobile, general liability, umbrella and workers compensation

The existence of these characteristics will help ensure that risk is assumed by the party who is in the best position to prevent loss. If you have questions about any provisions of a risk transfer agreement, please click here to contact your local Westfield independent insurance agent.

2 Responses to Risk Transfer Requirements: Your Key to Profitability in Construction

  1. Bill Sterling says:

    Mike,

    I like your list of characteristics that make for effective risk transfer agreements. And, at least in theory, I agree that the risk should be transferred to the party in the best position to control the risk. As a claims professional what I usually see in actual practice is that the risk is transfered to the party with the weakest bargaining position. In other words, the party that most needs the overall relationship spelled out in the contract is the party that takes on the risk transfer, regardless of whether that party is in the best position to control the risk. So when claims arise there might seem to be unequitable otucomes for the weak party and its insurance carrier. An example would be an active/on site general contractor who has significant overall control of a work site. A loss ocurrs and a sub-contractor (and its carrier) that has only a peripheral connection with the loss ends up taking on the whole loss due to the risk transfer in the contract brought on by the weak bargaining postion the sub had with the GC. I don’t know if there is any influence or control that underwriters can asset into these relationships, but I hope underwriters have their eyes open to them when they are pricing our products/services.

    Thank you for the article. I enjoyed reading it and found it both instructive and thought provoking.

  2. David Crandall says:

    Does Westfield Insurance Co. give out sample Sub Contract Agreements to share with their clients.

    Such as Cincinnati Ins Co. does ?

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