In any contractual relationship, it’s important for the parties involved to properly allocate their combined risks.
Contractual risk transfer identifies critical exposures and assigns responsibility for preventing and paying for losses — but it’s not always an easy process. However, protecting your organization’s assets and bottom line is worth the effort.
A critical challenge
Managing contractual risk can be challenging, increasingly so as additional insured status has been eroded over time. In 2013, for example, ISO introduced new additional insured endorsements to commercial general liability policies that restricted limits afforded to additional insureds to those specified in a contract. That has made the underlying contract — and the allocation of contractual risk — more important than ever before.
A few reasons why risk professionals should pay close attention to contractual risk:
- To answer leadership’s questions. After a loss or disruption, the first question from the C-suite usually is: “What does the contract say?” Risk professionals who properly manage the contractual risk process — in conjunction with their legal counsel — can confidently answer this question.
- To build better relationships. An organization that is known to be diligent in managing contractual risk can send a message to vendors, suppliers, contractors, and other parties that it is serious about risk management. And that can drive more risk-conscious behavior by those other parties, contributing to better results for everyone.
- To avoid protracted legal struggles. Resolving a dispute about the responsibility for managing risk can be costly and disruptive to your business.
To build a more effective contractual risk transfer program, organizations should consider the following best practices:
- Create standard contractual risk terms. These should be thoroughly vetted and regularly updated. They should include tiered requirements that stipulate higher limits of insurance for more hazardous operations undertaken by your company or a counterparty to a contract.
- Train procurement professionals. Your procurement team should understand these standardized terms and why they’re important to risk management.
- Require authorization to bend terms. Specific business reasons may occasionally require changes to contract terms, but there should be a protocol for such deviations.
- Establish guidelines for when to involve risk management. For example, you might require that risk management be consulted on any contract that exceeds a certain dollar value or falls outside the scope of normal activities.
- Enforce collection and review of certificates of insurance. No work should begin until you have all necessary certificates of insurance in hand.
For more on this topic, listen to a replay of the Marsh webcast, Fortifying Your Contractual Risk Transfer Program.
Janice Collins is a managing director in Marsh’s U.S. Casualty Practice.