3 Strategies for Risk Transfer in Construction Contracts

Risk transfer is a key technique used for managing and controlling risks. It involves shifting pure risk from one party to another through contractual agreements. This may include hold-harmless clauses, providing insurance coverage for another party’s benefit, and reinsurance.

“An effective risk transfer strategy allocates risks equitably, ensuring responsibility for the potential loss on those parties that can control and insure against it,” said Brian Rome, Risk Control Manager at Safety National. “These provisions shift liability for certain risks to the party most directly in control of the risk. Liability should ideally rest on the party that possesses the most control over potential sources of legal responsibility.”

Using layers of protection from risk transfer to safeguard your assets is crucial, and there are various measures you can take.

1. Indemnification

Indemnification agreements transfer risk from one party to another and are used in various contracts. These provisions can shift liability for certain risks (like jobsite accidents, property damage, or defective work) to the party that is most directly in control of the risk. A subcontractor’s agreement may require them to indemnify the general contractor and project owner for claims arising from the subcontractor’s work.

Requiring hold-harmless agreements for lessees, service providers, and subcontractors may protect against liability. However, the extent of risk transfer can vary depending on the wording and interpretation of the agreement. State laws may also influence the effectiveness of risk transfers. Consult with legal counsel to discuss how these agreements apply to specific projects and situations.

2. Certificates of Insurance (COIs)

A certificate of insurance confirms that subcontractors have the minimum required insurance in place before stepping onto a jobsite.  This important document summarizes insured coverage, including policy limits and expiration dates, while specifying the insurer, policy number, coverage period, and the name of the insured. Additionally, a certificate of insurance may provide details on special endorsements added to the policy, such as additional insured endorsements, waiver of subrogation endorsements, or special notice of cancellation endorsements.

It is important to note that a certificate of insurance does not guarantee coverage or transfer risk itself. It is only a snapshot of the coverage that is effective the day it is issued and does not alter the policy’s actual terms and conditions. It does not transfer any risk, but rather provides evidence of the other party’s coverage types and limits. The owners and general contractors should always request copies of actual policy endorsements (e.g., additional insured, waiver of subrogation) to confirm risk transfer provisions are enforceable.

3. Additionally Insured Status

An additional insurance policy has specific rights that a certificate holder does not. This endorsement is beneficial for companies that conduct business with the named insured or policyholder and may protect them from liability resulting from the negligence of another party. This ensures that if a claim arises from a subcontractor’s work (e.g., a worker injury or property damage), the general contractor or owner’s defense and settlement costs are covered by the subcontractor’s policy. Coverage typically applies only to liability arising out of the named insured’s (the subcontractor’s) operations. It usually does not cover unrelated risks.

This endorsement can provide direct coverage under the subcontractor’s policy, beyond what a COI alone can confirm. However, coverage for additional insureds may be more limited than for named insureds, as they are only covered for operations involving the named insured. Exclusions apply equally to named and additional insureds unless specified otherwise.

Layered Risk Transfer in Construction

When combined, these three mechanisms create layers of protection:

1. Indemnification clause – Contractual risk transfer.
2. COI and policy verification – Proof of insurance backing the indemnification.
3. Additional insured status – Direct access to the subcontractor’s insurance program for claims defense and settlement.

This layered approach helps guarantee that risk follows control and the subcontractor manages and insures the risks they are best positioned to prevent. Layered risk transfer can be beneficial for:

• High-risk environments – Jobsite accidents, structural failures, and defective work can lead to multimillion-dollar claims.
• Multiple parties’ involvement – Owners, general contractors, subcontractors, suppliers, and design professionals all interact. Risk transfer can help allocate responsibility fairly.
• Regulatory/legal complexity – State-specific anti-indemnity statutes mean contracts must be carefully reviewed to avoid invalid provisions. Consult legal counsel for review.
• Financial security – Risk transfer protects upstream parties (owners/GCs) from the financial instability of downstream parties (subs/vendors) who may not be able to absorb a loss.

Be sure to obtain new COIs before a subcontractor’s coverage period expires. Using an automated COI tracking system can verify policy coverage for new and expiring COIs. Make sure there is adequate coverage for the scope of work. The size and scope of a project can determine the level of coverage and limits required. Discuss risks and coverage needs with risk management early in the process and review documents with your legal team.