The Basics of Risk Transfer

The goal of risk management in construction contracts is to transfer risk to the party that is closest to it and therefore best able to manage it and control losses. On the construction site, this often means subcontractors. Thus, project owners will push risk downstream to general contractors, who will, in turn, push the risk down to their subcontractors.

The two key methods of risk transfer in construction contracts are indemnity and insurance provisions. Indemnity provisions typically require the downstream party to pay for the liability (and often the defense) of the upstream party. Insurance provisions typically require the downstream party to purchase insurance covering itself and the upstream party, which is generally accomplished through "additional insured" coverage. As an additional insured, the upstream party is entitled to defense and indemnity for claims related to the downstream contractor's work. When done properly, the downstream contractor's insurer assumes some of the risk of losses related to the work.

Indemnity and insurance provisions in construction contracts are complementary as each is intended to protect the contractor and other upstream parties from losses related to the subcontractor's work. Many contractors mistakenly assume, however, that because they have an indemnity provision covering certain liabilities in their subcontract, they will also have coverage under their subcontractor's insurance policies for those liabilities. That is not always the case. Indemnity and insurance are separate and distinct forms of risk transfer. The scope of insurance coverage is defined by the subcontractor's insurance policy—in particular, the additional insured endorsement attached to its policy—not the indemnity provisions of the subcontract.