Top Five Insurance Issues Impacting Your Contractor Client— What They Don’t Know Is Hurting Them!
By: Jonathan A. Cass and Carl L. Engel
General contractors can take steps to bolster their insurance coverage while cushioning their policies against rate hikes.
Construction projects can be dangerous places; sometimes people get hurt and property gets damaged. Therefore, having the right insurance is important. But why should surety producers care about their contractor clients’ insurance program? Because contractors who do not pay attention to their insurance programs can fail to effectively insure risks associated with their business or push that risk down to subcontractors (or subcontractors can fail to push that risk down to sub-subcontractors). When that happens, they assume uninsured risk, which can impact their balance sheet and financial performance. In particular, the five issues below, counting down from least to most important, involving commercial general liability (CGL) policies and insurance requirements in construction contracts, can trip up unwary contractors and subcontractors.
5 – Flow-Down Requirements
A “flow-down” clause is a provision in a construction contract that imposes the same obligations on the subcontractor as are owed by the general contractor to the owner. In other words, the clause causes the general contractor’s obligations to the owner to “flow down” to the subcontractors. In the context of insurance, a flow-down clause can bind the subcontractor to the same requirements to obtain insurance coverage as are imposed upon the general contractor in its contract with the owner. Therefore, when signing a subcontract with a flow-down clause, it is important for a subcontractor to understand the insurance requirements of the owner/general contractor contract. If there is a discrepancy between these requirements, and the subcontractor fails to fully comply with the more rigorous requirement, a subcontractor potentially exposes itself to a claim that it failed to obtain the appropriate insurance coverage.
4 – Waiver of Subrogation
Subrogation is the principal by which an insurance carrier may recover amounts paid to its insured from the third party that caused the covered damage. In other words, subrogation allows an insurance carrier to sue the entity that caused damage to its insured, as though it had stepped into the shoes of its insured. Although CGL policies give the carrier the right to subrogate when it pays a claim, the policy also allows the insured to waive that right of subrogation through a written contract. Accordingly, if an owner is contracting with a general contractor, or a general contractor is contracting with a subcontractor, it makes sense for the owner and general contractor to include a “waiver of subrogation” in their respective contracts. Doing so will, for example, prevent the subcontractor’s insurance carrier, which pays out a claim on behalf of the subcontractor, from successfully pursuing a subrogation action against the general contractor to recover damages that were actually caused by the general contractor’s negligence. By requiring the waiver, the general contractor has protected its own insurance policy from exposure to that subrogation
claim, which can positively impact future insurance costs.
3 – Per Project Aggregate
A CGL policy includes a dollar limit for coverage provided by the policy, typically with an “each occurrence” limit of $1 million and a “general aggregate” limit of $2 million. This means that the insurance carrier will pay up to $1 million for each occurrence that leads to a claim, but no more than $2 million total, no matter how many claims are made under the policy. Once that $2 million is paid out, the policy is considered exhausted. How does a general contractor ensure that each of its subcontractors will have the full “general aggregate” coverage limit of $2 million for any claims that may be brought against the subcontractor while working on the project? What happens if that subcontractor was already involved in two significant personal injury claims while working on a prior project? The general contractor can protect itself by requiring that the subcontractor’s policy include a “per project” aggregate. When aCGL policy is endorsed with a “per project” aggregate, it means that the policy provides the $2 million general aggregate for each project. By requiring a “per project” aggregate, a general contractor does not have to worry that subcontractor may end up exhausting its policy on claims from other, unrelated projects.
2 – Contractual Indemnification Exclusions
Under normal circumstances, a CGL policy does provide coverage for indemnification obligations assumed in a contract. In other words, if a subcontractor agrees in the subcontract to defend and indemnify the general contractor against claims arising from the subcontractor’s work, then the subcontractor has coverage under its CGL policy for that obligation. However, sometimes insurance carriers will limit or eliminate such coverage by modifying the CGL policy’s definition of an “insured contract” through an endorsement. If this occurs, the subcontractor will not have insurance coverage for the indemnification obligation to which it agreed in the subcontract. To avoid this outcome, a general contractor should require in its form subcontract that the subcontractor’s CGL policy not include any endorsements that limit contractual indemnification coverage. Additionally, a general contractor should require that each subcontractor provide a copy of the CGL policy’s declarations and forms pages, so the general contractor can confirm that the policy does not include such an endorsement. To protect themselves, subcontractors should review their CGL (and excess) policies to confirm that the carrier has notsnuck in an endorsement that limits contractual indemnification coverage and leaves the subcontractor uninsured for the indemnification obligation that it has assumed.
1 – Additional Insured Coverage
The most important coverage issues revolve around additional insurance requirements. General contractors frequently require that their subcontractors name them as “additional insureds” on the subcontractors’ CGL policies. The purpose of this is to place the burden of covering a claim on the insurance carrier of the party that most likely caused the claim, that is, the subcontractor. Further, additional insured status allows a general contractor to avoid impacting its own insurance claim history and premium costs because the claim will be handled by the subcontractor’s insurance carrier rather than its own.
To successfully obtain additional insurance coverage, it is critical for the general contractor to require, in its subcontract, that the additional insured coverage be “primary and noncontributory.” This means that the subcontractor’s policy must provide coverage for a claim made against the general contractor before the general contractor’s policy is tapped.
Subcontractors must fully understand the additional insurance obligations that are required by the general contractor and must ensure that its policies provide the required coverages. However, even though it is the responsibility of the subcontractor to make sure that the general contractor is added as an additional insured as required by the subcontract, a general contractor should make sure that it happens. It can do so by requesting a copy of the subcontractor’s additional insured endorsements and confirming that it is listed as an additional insured thereunder and that the coverage is primary and non-contributory.
It is important for a contractor to always consult with its insurance agent or broker and an experienced construction attorney before entering into a contract for a new project. By doing so, a contractor can avoid subjecting itself to uninsured claims and the resultant financial damage.
Jonathan A. Cass is partner of the law firm of Cohen Seglias Pallas Greenhall & Furman PC. Cass Chairs the firm’s Insurance Coverage & Risk Management Group and helps his clients evaluate and manage their insured and uninsured business risks. He drafts, reviews, and advises on various risk-transfer related contractual clauses, including indemnification clauses and insurance requirements. He can be reached at jcass@cohenseglias.com or 267.238.4736.
Carl L. Engel is an associate with the law firm of Cohen Seglias Pallas Greenhall & Furman PC. Engel represents businesses against insurance companies who refuse to cover losses arising from industrial and construction accidents. He also counsels large corporations, closely-held businesses, and individuals in a wide range of commercial contract matters before state and federal courts and arbitration tribunals. He can be reached at cengel@cohenseglias.com or 267.238.4758.
