HATR Consulting

In my experience, insurance provisions contracts are not well understood, even at top levels of organizations. Here’s a primer:

You may be most familiar with car insurance, and it’s a good starting point. You pay insurance premiums ($100s per month) to be insured against accidents. If you have an accident, you pay your deductible (maybe $1,000) instead of the $10,000 to $30,000+ to repair your car and maybe the other car involved. The trade-off is pretty straight forward – (a) in case you might face a huge expense, (b) you pay a comparably smaller amount towards insurance.

This concept also applies to commercial contracts; there’s an entire market around insuring organizations against accidents (not just car accidents). Two common types of policies are (1) commercial general liability insurance, similar to car insurance, covering against property damage and personal injury (“Blue Collar” insurance) and (2) professional liability covering against “paper” accidents (“White Collar” insurance). These policies are written in the millions of dollars. It’s common in contracts that a party be required $1Million or $2Million of either (or each) type of insurance.

But why is insurance contemplated in commercial contracts? Insurance is for your internal business operations, why would this be in a customer-facing contract? Two main reasons.

First, insurance is good evidence that you’re a serious company. It shows that you know what you’re doing: that you have the wherewithal to purchase insurance. It also shows you have the ability to stand behind your obligations – that if something goes wrong, you’re not going to go bankrupt because you don’t have the cash to cover the expense.

Second, additional insured endorsements. Say you own a roofing company. You purchase insurance to cover your personnel and your equipment. But you can also purchase an additional insured endorsement – the additional insured being your customer – so your policy also covers any damage done to the house or people living in it without your customer having to sue you first.

Depending on the deal (and the price), insurance may be included in a contract because the parties agree that, in certain circumstances, the vendor will effectively insure their customer while under contract. If you’re the customer, this saves you from relying on your own insurance should their be an incident (and saving you from paying a $100,000 deductible on your commercial insurance).

In the next post, I’ll discuss this second point – additional insured endorsements – and whether they’re right for the kind of contract you’re entering into.

Have questions? Let me know! Thanks for reading.