The cost of insurance is often a critical factor driving subcontractor pricing.
While alternative risk transfer schemes—such as consolidated insurance
programs—have grown in popularity, the typical upstream/downstream structure
where owners and general contractors contractually require downstream entities
to procure insurance remains a common approach.
Acknowledgment
The author would like to acknowledge and thank
coauthor Nicole C. Bikakis, for her contributions to this commentary.
Parties to upstream/downstream structured subcontracts often assume that
carefully crafted insurance requirements on an executed contract are sufficient
to ensure the designed risk transfer scheme executes properly. However, this
overlooks a critical step: vetting the insurance program, which requires both
parties collaborating to scrutinize the downstream insurance contracts to
ensure compliance.
The need to vet downstream insurance is underscored by the reality that not
all parties have the resources to ensure that their insurance programs comply
with the insurance requirements in their contracts. Though far from a universal
truth, smaller contractors often lack the internal time, dedicated staff, or
experience to appreciate fully the complicated nuance of their insurance
program or the full scope of their risk exposure. Smaller subcontractors that
cannot afford an in-house risk management team or outsourced risk management
services typically rely on their brokers to procure the coverage demanded of
them in their contracts.
However, smaller unsophisticated brokerage firms or agencies are not always
attuned to evolutions in the coverage landscape, which can range from the
identification of coverage issues latent in specific endorsements to the
creation of new legal precedent impacting policy language construction.
Meanwhile, insurers often will introduce a slew of exclusionary endorsements
into a subcontractor's program, irrespective of the subcontractor's
risk profile or awareness, making it incumbent on the subcontractor to identify
problematic endorsements and negotiate their removal.
For example, a contract with a roofing subcontractor on a residential
project will typically require the subcontractor to procure commercial general
liability (CGL) insurance covering liability arising out of its work and add a
host of entities, including the owner and general contractor (GC), as
additional insureds on a primary and noncontributory basis. If the GC were to
obtain and review the subcontractor's full CGL policy, it would not be
unusual for the GC to find the following troublesome endorsements.
- Additional insured endorsements with privity language limiting coverage
to the entity in direct contractual privity with the subcontractor, which is
typically the construction manager or GC and not the owner or other upstream
parties listed in the contract
- Height exclusions precluding coverage for liability arising out of work
above three stories
- Exclusions precluding coverage for liability arising out of residential
projects
Ensuring Compliance
An unanticipated work scope can also contribute to the challenge of
complying with insurance requirements. Although subcontractors might engage in
various scopes of work for a variety of projects, their insurance programs may
not be revisited midyear or on a project-to-project basis to ensure compliance
with individual contracts. Though not without cost, the most obvious solution
is usually the best one: to review the subcontractor's insurance and, when
problematic or insufficient endorsements are encountered or the absence of
necessary endorsements realized, work with the subcontractor to rectify the
coverage deficiencies and obtain proof of same.
While it may seem like the onus to ensure compliance with contractual
insurance requirements should fall on the subcontractor, in practical terms,
this is a challenge to be borne by all parties because failure to procure the
required insurance can create costly problems for upstream parties.
When the intended risk transfer fails (i.e., a GC or owner is unable to
obtain additional insured coverage in the face of a third-party liability
claim), upstream parties are then saddled with the cost to defend and indemnify
the third-party claim, in addition to the cost of bringing a claim against the
subcontractor for breach of contract, all of which add delay and cost to the
project. This problem is exacerbated further depending on the jurisdiction the
GC or owner is in. For example, if operating in New York, the state's labor
laws paired with the phenomenon of high jury verdicts make the value of
subcontractor insurance paramount.
Having established that a signed contract with broad insurance provisions is
not enough to ensure risk transfer, the question arises of how to practically
implement a subcontractor insurance vetting process that will not in itself
create exorbitant costs and delays for projects. For owners and GCs hiring
dozens of subcontractors, it is no doubt a challenge to collect and review
subcontractors' insurance policies and effectively monitor the correction
of coverage deficiencies. Nonetheless, as is the case with all costs associated
with risk management, the savings realized in transferring risk downstream will
outweigh the costs associated with administering a subcontractor insurance
vetting program. The focus should be on what program format is most suitable
given the size and sophistication of the upstream entity in need of the vetting
process.
The ideal, if not always practical, vetting process would entail collecting
full copies of all subcontractors' liability policies a couple months
before they begin work on the project, reviewing each for compliance with the
contractual insurance provisions, and keeping the subcontractors off-site until
each respective review is completed and any deficiencies corrected. Depending
on the size of the project, this setup may require devoting a full-time
employee to administering the insurance vetting project or alternatively
contracting this process out to a broker, risk management consultant, or
coverage counsel.
Challenges to Comprehensive Vetting
The time and effort that underlie a comprehensive insurance vetting process
should not be underestimated. Obtaining full copies of liability policies can
prove challenging, as incorrect or incomplete documents are often mistakenly
sent—certificates of insurance and/or policy declarations are helpful but not a
substitute for a complete policy. While the actual process of reviewing the
policies can generally be fixed, the time invested in the next step of
addressing detected coverage deficiencies will vary depending on (1) the
sophistication and resources of the subcontractor and/or broker representative
and (2) the flexibility of the insurer furnishing coverage. Even though the
requested insurance coverage is available in the market, the efficacy of
procurement can be tied to a subcontractor's bargaining power and the
insurer's risk assessment.
Given the practical time and cost constraints inherent in insurance vetting,
owners and GCs may consider only administering this process in connection with
contracts above a certain dollar value. For example, if a signage subcontractor
is only providing $3,000 of work for the project, it may not be cost-effective
to vet its insurance policies or realistic to expect it to dispense additional
premium to remedy coverage deficiencies. Additionally, the risk associated with
a subcontractor's scope of work may be another factor in considering
whether to subject that subcontractor to the insurance vetting process. The
risk profile of a subcontractor installing signage less than two stories off
the ground is likely less concerning than that of a roofing subcontractor, and
the resources associated with vetting the former subcontractor may be better
allocated to the latter.
Admittedly, collecting full policies from subcontractors can be document
intensive. At a bare minimum, the vetting process should require the submission
of (1) policy declarations and schedules of forms for all liability policies,
(2) copies of additional insured endorsements and primary and noncontributory
endorsements for the primary CGL policy, and (3) full copies of excess
policies, which are typically manuscript but significantly shorter than primary
policies. Having the declarations provides confirmation of the named insured,
policy limits, policy period, and the policy number, while the schedule of
forms enables identification of any problematic endorsements (e.g., titles such
as "Residential Exclusion" or "Limitation of Coverage for
Designated Work"), which can be requested on an as-needed basis for
review.
The additional insured and primary and noncontributory endorsements are
arguably the most important endorsements to review, as they set the foundation
for the owner or GC obtaining coverage under the subcontractor's policy and
thereby protecting their own insurance programs. Obtaining full excess policies
is typically the only way to confirm the requested coverage is being provided,
as they are often manuscript and a schedule of forms will not reveal
limitations in the excess coverage form.
Most critical to the success of any insurance vetting program is for the
administrator to be proactive and diligent in obtaining policy documents and
ensuring coverage deficiencies are being actively remedied. This may require
weekly calls with subcontractors or their broker representatives and,
potentially, direct calls with underwriters, as well as the implementation of
mechanisms for ensuring compliance, such as withholding payment or postponing
start dates pending verification of compliance.
For less-sophisticated subcontractors and/or brokers, part of the process
will involve educating the parties on the coverage issues. Ultimately, the
vetting process should improve the performance of the subcontractor's
insurance, who has a vested interest in ensuring its insurance program responds
to the insurance requirements it has contracted to procure. Thus, when
collaborating with subcontractors to address insurance deficiencies, it is
helpful for all parties to appreciate that proposed coverage remedies are not
merely a short-term benefit to upstream parties but rather help to guarantee
subcontractors get the insurance they purchased and mitigate against the need
for breach of contract disputes with upstream parties. Engaging in this type of
exhaustive review also helps the downstream entity in the long term, as many
common modifications will improve risk transfer for other projects.
Conclusion
A thorough and efficient subcontractor insurance vetting program can help
realize intended risk transfer and, with proper planning, be performed with
minimal to no impact on project scheduling. Moreover, awareness of the scope of
subcontractor coverage before a claim arises makes procurement of insurance
more transparent, allowing parties to demand sufficient coverage and to
proactively address potential deficiencies. In time, the implementation of
vetting programs has the potential to inform the standard quality of
subcontractor insurance programs, keeping insurers from attempting to issue
illusory or inadequate coverage, and in doing so benefits all contracting
parties to major construction projects.