Risk Manage Your Insurance and Contracts Instead

Why would anyone take the time to read an article about insurance?  Well, among other things, who doesn’t want to avoid having an uninsured loss?  How about not breaching a fiduciary duty to a partner? Here are some valuable insights when dealing with development-related construction contracts.

In the post-great financial crisis world, the construction industry is experiencing a significant rebound in development activities, the size and complexity of which have also increased, but with thinning profit margins. Nevertheless, the anticipated returns make it worth taking these risks, at least those taken on purpose. Taking the time to understand and appropriately allocate risk in and among the relevant contracts involving the various parties is important.

The default approach seems to be for the owner, and/or developer, to try to contractually transfer their risk to the contractor. Then at one level the contractor accepts that as the business deal, provides a certificate of insurance as verification of its understanding of the risk it is assuming, etc. The parties move forward on the understanding that the risk has been effectively transferred, with appropriate insurance coverage confirmed via the certificate of insurance (COI). The COI, however, specifically states that it is issued for information only and confers no rights to the certificate holder. 

In the file it goes — we call this “sign it and forget it.” That approach works fine until there’s a claim – then everyone holds up the contracts like garlic to ward off vampires. The harsh reality, far too often, is that the contractor has failed to extend the contractual risk management processes and protocols they routinely use for their subcontractors, to their ultimate partner, the insurance company, with the result that expectations are not met.

Despite your insurer’s advice that your vendors and contractors are your greatest risk, it may be that your greatest risk is the insurance company insuring those vendors and contractors. The contractor is your “work-related” subcontractor, and their insurance company is your “claim-related” subcontractor; however, most firms have no risk-management procedures in place to manage all relevant relationships to a conclusion that satisfies all parties’ expectations.

Quality contractors have numerous procedures that require them to review and approve certain aspects of their subcontractors before they are approved to bid on your work. Here are few we routinely see:

  • Project accounting procedures
  • Project scheduling 
  • Manpower estimates
  • Past project performance
  • Current work back log
  • Audited financials

Twenty years ago, it would have been inconceivable for a contractor to get this level of information on its subcontractors? Now much of this is commonplace. However, neither owners nor contractors consistently request copies of their subcontractors’ insurance policies – that is, until they need their “claim subcontractor” to remedy a claim. That may be too late.

Here are how things break down: In our experience, as much as 70% of the policies reviewed have critical deficiencies between contract requirements and policy coverage. Contractors too often pay inadequate attention to the policies and/or lack the expertise to assess the coverage. The insurers aren’t invited to review the situation and ensure that the parties expectations expressed in their contracts are met. Litigation is an expense and inefficient way to sort all of this out.

In a 2016 survey conducted by AGC and FMI, the respondents ranked contract risk with the skilled labor shortage and subcontractor default as the top risks their firms face. Most contractors of any tier would not hire subcontractors without thoroughly assessing their ability to complete the work. But they routinely enter into multimillion-dollar contracts that require important insurance coverages, without making a thorough evaluation of the policy’s actual coverage of important contract risks. 

Here are some coverage tools and policies that are available to cover and support contractual requirements on large projects:

  • Builders Risk with soft costs, covering interest and loan payments for the owner
  • Builders Risk with some coverage added back for damage associated with defective work
  • Owner’s Protective Professional Indemnity (OPPI): Can insure the owners’ financial risks associated with purely monetary losses, which are generally excluded by general liability policies
  • Additional Insured: Including during the products-completed operations
  • SDI/Sub-guard: Can be used to insure the default risk of subcontractors
  • Liquidated Damages (LD): Though not a complete solution, by packaging the below policies, much of the LD risks can be insured and/or managed, at a potential cost savings. 

This will also expedite post-claim project delivery. Work with your developer, contractor, owner, insurance agents and carriers in a collaborative effort to risk-manage your contracts. Bottom line – the party intended to bear certain risks will in fact bear them.