Contractual risk transfer (CRT) is a risk management technique that allows a business to shift potential liability to another party through a noninsurance contract or agreement. This mechanism aims to transfer risk to the party that is better equipped to manage and control it. While insurance is the most common method of risk transfer, CRT offers an additional tool for businesses to manage their risks effectively, and it can help reduce insurance claims and premium costs.
CRT is typically used in situations where one party is performing work on behalf of another, such as through subcontracting arrangements or when duties are assigned through supplier, sales or lease agreements. For instance, a landlord may hire a building maintenance company to upkeep the property; CRT can help ensure the maintenance company assumes liability for any damages resulting from its negligence. Similarly, a general contractor may leverage CRT so that a subcontractor assumes liability for any losses incurred as a result of faulty work at a job site.
Common tools used in CRT include hold-harmless agreements, indemnification agreements, waivers of subrogation and requiring companies to be named as additional insureds on another party's insurance policy. Here’s a breakdown of these terms:
- Hold-harmless agreements release one party from responsibility for the actions of another.
- Indemnification agreements specify how compensation will be provided if a third-party claim is filed.
- Waivers of subrogation prevent one party's insurance company from seeking recovery from the other party's insurer.
- Additional insured status on another party's insurance policy allows a business to receive coverage from the initial party’s policy.
When utilizing CRT, it’s important for companies to request a certificate of insurance (COI) from parties that may pose liabilities and to ensure those parties name their companies as additional insureds. It’s also best to request copies of additional insured endorsements. Additionally, companies should be aware of any state laws regarding CRT and consider seeking legal advice to make sure their agreements are appropriate, compliant and effective.
CRT can help businesses reduce insurance claims and costs by transferring risks to parties better suited to manage them. Alongside insurance, CRT can be a valuable component of a business’s comprehensive risk transfer strategy.