It’s not uncommon for other professionals—vendors, cities, partners, investors, etc.—to require specific insurance policies as a part of a contract, especially for VC-backed startups.
Our clients frequently approach us with scenarios just like this, and we don’t blame them. After all, understanding insurance requirements in contracts can be clear as mud.
In this article, we’ll explain some of the most common situations for insurance requirements and also why they occur in the first place. Knowing the reason these provisions are in such contracts will help to clear the mental fog as well as empower you to negotiate like a champ.
The Basics of Contractual Risk
As you may very well know, to transfer a portion of your risk is simply good risk management. The main driver in this transfer is so that you don’t wind up with empty pockets because you failed to consider a risk.
To lower your chances of paying for a loss, a strong indemnity agreement is recommended. Consider that this is a two-way street—safeguarding your own company and your client, too.
Here are the 5 vital steps to ensure proper contractual risk coverage:
1. Analyze the Risks and Relationships
Firstly, it’s critical for your clients to consider the scope of the contractual work. Keep in mind that simply because the job is small, that doesn’t mean the risk is also small. Even a small job or service has the potential for a big risk. This is one case where size doesn’t matter.
To properly manage risk, your client must approach the entire situation from the right angle, asking the right questions. They’ll likely consider items such as the qualifications of the contractor (you), who is responsible for what maintenance during the project, and what exactly is being accomplished through this particular job.
Remember, each situation is unique. Yet, considering what could go wrong is probably the best idea since sliced bread.
2. Use a Hold Harmless (Indemnity) Agreement
Once your client has effectively assessed the risk, the next step is to transform all safeguarding endeavors into the appropriate language. Meaning, contracts will likely contain a Hold Harmless agreement (aka Indemnity agreement).
Again, the purpose of using such language is to protect the client by shifting responsibility to your company, if possible. This type of agreement is interpreted broadly and therefore works in favor of your client, so the more specific the better.
Unsurprisingly, many startups work very hard to limit their obligations. Also, there are boundaries regarding the extent to which your client can be held harmless. Everyone is out to protect themselves, so it’s important to know how to navigate the twists and turns of the legal language.
3. Select the Appropriate Insurance Specifications
Your client’s use of a Hold Harmless agreement doubles as your promise to pay for claims that you cause. This is also where insurance specifications come into play.
Naturally, if through an agreement your company holds particular responsibility, you must have the funds available to pay up. For this reason, it’s important to have the right insurance coverage and in the appropriate amounts. But, more on this later.
4. Verify Insurance Coverage
For the love of all things contractual, get covered. It’s up to you (and your knowledgeable broker) to secure the appropriate insurance coverage. Keep in mind that your client will likely ask for two documents, which include the Certificate of Insurance and an Additional Insured (AI) Endorsement.
Furthermore, your client will be verifying that all your T’s are crossed and your I’s are dotted, so you need to do that as well. In short, know what you’re signing and why you’re signing it.
It’s not generally a good idea to alter the language or make unadvised changes to the policy language. Also, keep a sharp eye for expiration dates in regard to the time frame of your contractual work. Lastly, be transparent with what you have to offer your client, insurance and otherwise.
5. Report Claims Promptly
Diving into the VC-backed startup world, you’ve probably come to the realization that most official items don’t fit under the rug very well. Prompt and concise communication is the way to go—even with claim reporting.
With that said, you’ll likely be working hand-in-hand with your client to report any loss efficiently. Deadlines on claim reporting are often left undefined, so solid communication with your client is a must.
Why Are Insurance Requirements in Contracts?
As with most elements in a contract, insurance requirements help to safeguard both parties from certain damages. But, that’s just for starters.
Reduce Risk Exposure
Above all, insurance requirements in contracts serve to reduce your client’s risk of exposure. They don’t want to “lose out” because of a situation that happened on your watch, per se.
Keep in mind that clients often use very specific contractual phrases with a definite meaning. What this means is that you can often tell the professional facet being protected simply by the layout of the contract.
Some of the more common exposures include financial, reputational, and operational. Of course, most of your clients will be highly concerned with risks surrounding legal and compliance elements as well.
In business, especially commercial business, there’s a level of expected sincerity known as “good faith.” This is essentially an understanding that neither party will attempt to defraud the other.
Insurance requirements in contracts feed off of this good faith endeavor. Furthermore, they help to define and gauge the trustworthiness of both parties. Which, as you can imagine, helps to create a healthy professional partnership.
Qualifying Tool for Tenders or RFPs
After considering the various ways your client benefits from insurance requirements in contracts, it only makes sense for these requirements to be a part of the qualifying process, too. In fact, when vetting for the services you offer, clients often use insurance requirements as one of the more significant determining factors.
Granted, having a certain type of coverage doesn’t necessarily make you the company for the job. You also have to offer dynamite services or products, of course.
However, it’s a no-brainer that your willingness to secure specific insurance coverages will elevate your standing on a client’s list of trusted contractors, especially when participating in broker RFPs. For this reason, insurance requirements frequently serve as a crucial qualifying factor in tenders or requests for proposals (RFPs).
Common Insurance Requirements in Contracts
Once you wrap your mind around why your clients include insurance requirements in contracts, it’s a good idea to know about the most common ones.
What Policies Are Required and Why?
This particular policy is required by almost all contracts. General Liability protects the 3rd party in the event that there is a bodily injury or property damage claim related to your product or services you provide for them.
Directors & Officers Liability (D&O)
Typically required by investors before funding or becoming a board member. D&O insurance is best practiced while operating in a highly regulated industry or developing a new industry.
Cyber Insurance is usually required to protect the information shared between you and the 3rd party. They want to make sure the company has the proper recourse to respond and mitigate a data breach efficiently.
Professional Liability Errors & Omission (E&O)
E&O Insurance protects the 3rd party in the event that there is a failure in the services or technology that you are providing. The policy will provide the company with a way to make a client whole after an error that results in a financial loss. Additionally, most policies include coverage for unintentional breach of contract.
If the customer is renting property to your company, they want to make sure it is protected in the event of a loss. Property insurance is required by most leases as the landlord’s property insurance does not cover the contents held by the renter.
Why Are These Policies Required?
For a company just starting out, a standard contract is going to require $1m occurrence in coverage for the coverages outlined above. As the contract size increases, many 3rd parties look for higher limits for General Liability and E&O/Cyber. Companies in industries such as healthcare, Saas, and Fintech can expect to see much higher E&O/Cyber limits in their contracts.
Often, 3rd parties request to be added as an additional insured to the General Liability and E&O/Cyber policies. This allows them to be covered under your policy in case they are named along with the company in a lawsuit arising out of the operations of your company.
Waiver of Subrogation
A Waiver of Subrogation policy works to prevent the carrier from going after the 3rd party in the event of negligence. This clause is usually included in lease agreements or other contracts with banking partners where there is limited exposure to negligence on the part of the 3rd party.
Primary and Noncontributory Language
This will allow your policy to be the primary and only responding policy in the event of the claim. This condition is also often found in leasing agreements.
30 Days Notice of Cancellation
As the name suggests, this will require the insurer to notify the 3rd party at least 30 days before in the event that the policy will be canceled.
Loss Payee or Loss Payable
Typically requested by a third party who is loaning you property or capital. The loss payee or loss payable provision allows the carrier to pay that 3rd party for the loss directly.
Who Usually Requests Insurance Requirements in Their Contracts?
It only makes sense that some clients will request insurance requirements in their contracts. However, some clients are far more predictable than others.
States, cities, and most governments fall into this category. As expected, these types of clients are among the most well-defined in terms of their contracts and professional connections. Meaning, few loopholes will exist in a relationship with them.
To drive this point home, consider that electric scooters are required to add cities as well as AI’s. And these aren’t the only types of clients that will request particular insurance requirements in contracts.
Vendors and service providers will follow suit. Unsurprisingly, these types of clients will be functioning in their own little niche—communications, storage, internet, etc.—and will likely be fairly specific in what they need from you as well.
As you may have imagined, landlords often make the list of those clients who frequently request insurance requirements in contracts. Any time real property is a part of a professional relationship, particular requirements ensue.
In addition to those listed above, many other clients are prone to making these types of requests from you. Naturally, it often depends on the size of the client whether they formalize it this way or not. This is especially true for those in healthcare, SaaS, or FinTech where there is the handling of large amounts of personal data.
What Should You Look Out for?
Most of the time clients will make reasonable requirements. And it only makes sense why they would need these protections in place. There are times, however, when some outlandish requirements should serve as red flags.
For starters, keep a watch out for unusually high minimum occurrence and aggregate limits. These aren’t typically a good sign and should be explored, at the least. It’s not necessarily that your client is trying to pull a fast one on you, it may simply mean that they’re ill-equipped to properly handle the professional partnership.
Policies that are unrelated to the contract scope are also a reason to push the “pause” button on the endeavor. While many clients are incredibly specific with their insurance requirements in their contract language, others will use scattershot policies in hopes they’ll cover every possible scenario under the sun. The point is to stick to the job at hand.
Along those same lines, don’t be afraid to give broad Hold Harmless language the boot. As mentioned before, your client will likely lean toward more broad language in the Indemnity agreement as this works in their favor. However, there is such a thing as too broad. When the language makes your head spin, consider that a red flag.
One more thing that should make your red flag list are indemnification provisions outside of the insurance requirements clause of the contract. Not only are these outlandish, as mentioned earlier, but they’re a risky way to do business.
Want to know more? Talk to us! You can contact us at firstname.lastname@example.org or create an account here in order to get started on a quote. Want to read more on the subject? Check out our recent post about Insurance Subjectivities.