Insurance Basics

Over the span of my career, I’ve seen thousands of insurance sections in various contracts.  At the beginning (and at certain employers), I would have to run this section by the insurance people in the event of any changes to our template language.  But as time went on (and with a different employer), we really only paid attention to the need for insurance certificates and the actual amount of coverage listed.  Then one day, I found myself in charge and needed to set the policy for how we were going to handle this oft-ignored/misunderstood area of the contract.  So I brought in the insurance folks to talk with me about this interesting topic.  [Note:  What I’m about to tell you is what I’ve learned as a result of countless deals and several discussions with dozens of insurance agents.  But if your insurance folks advise you differently, just remember where your bread is buttered.  Hint: it’s not by me.]

Insurance Types

There are five basic types or categories of insurance policies: Commercial General Liability, Professional Liability (errors and omissions type), Excess or Umbrella Liability, Workers’ Compensation, and specific liability policies for particular types of work (auto, boating, construction, etc).  Your contract should at least list the first four and optionally include reference to any other policies necessary based on the work you (or your vendor) are performing.  There are, of course, some caveats.

  1. Not all professional services will qualify for Professional Liability policies.  It’s conceivable that you (or your vendor) will not be able to provide this type of insurance because of the nature of the work completed.  However, many insurance companies will interview the insured organization and “create” a Professional Liability policy for that service – the key is to simply ask.
  2. Excess or Umbrella Liability policies can’t exist without a primary Commercial General Liability policy on which to hang (hence the term “excess”).
  3. Workers’ Compensation is MANDATORY.  In fact, in most contracts, you’ll see this called out as statutory Workers’ Compensation.  In other words, if state law requires it, the insured must have it.  If the insured is a sole-proprietorship (ie: they are their only employee), this policy probably won’t apply.  Again, however, it’s based on the state’s law in which the work is being performed.
  4. Specific Liability policies aren’t always easy to determine up front.  Who today can guess that you’ll need “boater’s insurance” five years from now?  If you don’t list these policies in the master agreement, simply remember to add them to a particular Statement of Work when needed.

Insurance Limits

Typically, when talking about Insurance Limits, we’re really talking about the maximum dollar value of each policy.  Some organizations love to go for broke on this – asking for $10M minimum aggregate and $5M per occurrence, etcetera.  Lets break down the distinction and then talk about dollars.

  1. “Minimum aggregate” refers to the total amount of money recoverable under the specific policy regardless of the number of claims for the entire life of that policy.  If a $1M aggregate policy is claimed upon by 1000 people equally (over the span of the policy’s life), the most each person would get is $1000.  ($1,000,000 / 1000 = $1000).  But things don’t usually work out that way.  Rather, these same 1000 people might claim at different times during the life of the policy.  If the first of those thousand people recovers $900,000 from the $1M aggregate, there will only be $100,000 left to satisfy the other 999 future claims.
  2. “Per occurrence” then is a limit on the per-claim reimbursement/coverage.  The per occurrence limit is usually 1/2 the value of the minimum aggregate.  So if you have a $1M aggregate policy, you will then typically see a per occurrence limit of $500,000.  This partially helps with the problem from the end of the last section, where the first claimant receives an abundance of the value of the policy, leaving little remaining value to any other aggrieved party.
  3. Excess or Umbrella Liability policies usually only list a “not less than” amount which is almost always 2x the minimum aggregate of the Commercial General policy.  For our example here, if the CG had a $1M minimum aggregate, the Excess or Umbrella limit would be not less than $2M.
  4. Statutory Workers’ Compensation almost never lists an actual dollar limit.  Again, because it’s based on different state laws (which could change like the tides), most contracts simply state that the insured will meet the requirements of the law, whatever they happen to be at the time.

Dollar limits on insurance policies can get really interesting in a hurry, partially because of the nature of the work that many professional services organizations perform and partially because of the nature of insurance policies in general.  In most cases, I ask for insurance dollar limits that are far and above what I would ever expect the value of the work performed to be.  This freaks out my vendors – they worry that they won’t be able to get a $10M policy (or, more accurately, won’t be able to afford it).  But I have to remember something that they would rather I didn’t – that their single insurance policy is covering the work that they do for EVERYONE.

That’s right, the nasty little insurance secret that no one really wants to discuss is that almost 100% of the time, the policy that covers your work is also covering 100+ (or 1000+) other jobs.

But wait, you say, I am named as an additional insured.  That bumps me to the head of the line.  Not so fast.

Insurance Certificates and Additional Insureds

In almost all cases, the customer is able to get the insured to provide them an insurance certificate directly from the insurance company as proof of the existence of the policy.  And in many cases, the customer (as well as its officers, employees and agents) can also be added as additional insureds to the Commercial General Liability policy only (even if you want to be an additional insured on the other policies, most insurance companies won’t allow it).  The customer then asks to have the insurance certificate even state that the customer is a named additional insured entity.  What you don’t see, however, is all of the other additional insureds.

What you’re really looking for, then, is to find a way to make sure that the policy limits are going to cover the work that the vendor is performing for you – and making sure that you’re going to be able to fully recover that amount in the event a claim is properly brought.  The solution?  Ask the vendor to get a specific policy just for you – on a “primary and noncontributing basis” and including a waiver of subrogation in favor of you.  The vendor might still balk at this – you’re asking for an individual insurance policy.  But you can now decrease the policy limits to be more manageable because now you know that this policy is just for you.  So the overall cost to provide insurance to you for the work performed might actually be less than if you required the vendor to increase the policy limits to extraordinary heights.

Oh, and don’t forget that you want the certificate of insurance to indicate that the Excess or Umbrella Liability policy is a “following form policy”.  This means that if the excess or umbrella policy has terms or conditions that conflict with the Commercial General policy, the CG policy terms will control.  But there is some controversy given current insurance practices which may make this difficult.

Insurers

Many customers also want to be certain that the insurance company providing the policy is reputable.  There are different ratings institutions, but I prefer A.M. Best with a rating of no less than A-, Class X.  The A- means that they’re still in the Excellent rating category and the “Class X” is an indicator of their financial health (X is actually a Roman numeral) with an adjusted policyholder surplus of $500-750M.  This is to ensure that the money actually exists to cover the upper limits of any potential claim.

Policy Changes

Relatively speaking, insurance is easy to obtain.  It’s not always cheap, though, so there have been times where insureds have made financial decisions to decrease policy limits or change coverage types as a cost-savings method.  If you’re a customer, you want to know about this as it’s happening (and not at the start of the next year when the next insurance certificate arrives with lowered limits, leaving you to wonder when the change actually happened).  So always remember to include language in your insurance section that requires the insured party to notify the other of any changes to the policy within 30 days of any adverse change (you really don’t care too much if limits are increased).

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