Risk Transfer and Indemnity Agreements

Risk Transfer

In the past we have written about the need for every business, regardless of size, to have a risk transfer plan in place and to be strategic about indemnity agreements.  To understand this a bit further, let’s first define in basic terms what each of these elements of the conversation are.

Let’s start with risk transfer.  What we’re really talking about is contractual risk transfer; which is the ability one party to transfer certain risks to another party via a contract, this is commonly done via an indemnity agreement embedded within an operative contract, purchase agreement, or some other form of engagement letter.

In its most basic sense an indemnity agreement says that you will agree to hold the party you are engaging with, harmless from any and all claims which may arise from the performance of the agreement you are signing, or from your ongoing business relationship.

In a broader sense I want you to think of risk transfer as a “process” you will engage in when you enter into agreements with third parties such as suppliers, contractors, service providers, and other vendors.

Let’s take an example of what we’re talking about with regard to Risk Transfer:

Let’s say you are a food processor – your company; Mr. Pickle makes pickles of all types and can be found in supermarkets and big box stores across the region.  Your sales department lands a large supermarket chain as a customer after years of tying to sell them your line of pickles and once the handshakes are done, the supermarket sends you a new vendor package which contains all the insurance requirements, quality control requirements, and dozens of other documents to fill out and sign – including a contract which includes an indemnity agreement.

You send the insurance requirements to your insurance broker who hopefully reviews it carefully and informs you that you do or don’t have all the needed coverages and limits required for this customer.  Once that is done they send the required certificate of insurance to the supermarket’s risk management department, or their vendor contracting department.

An important step in the risk transfer process is to have your general counsel our outside counsel review the documents before they are returned to the supermarket to make sure there is nothing out of the ordinary and that everything is in compliance with your risk tolerance and insurance structure.

You have now completed the engagement process with this new customer and the increasing revenue of your pickle sales is to be celebrated!

Not so fast.

What we’ve got to realize here is that it is great that you’ve got a new customer which will help grow your business and your sales, but what we also must recognize is that you’ve now accepted some potentially stringent liabilities with this new agreement.  Are you prepared for those liabilities and are there downstream business partners that you need to know more about and have them on the same playing field as you before you move forward?

The answer is yes, all your suppliers and service providers should be treated as if they are a party to the big new contract you just signed.  Here’s what I mean.

As a pickle manufacturer you rely on several key suppliers – vegetable wholesalers, vinegar and spice sellers, and jar manufacturers just to mention a few.  What if one of these suppliers doesn’t have insurance and sells you a substandard product which results in claims being filed against you?  What if you’re dragged into a lawsuit and you’re the only one with the resources to pay for the claim, even if it wasn’t your “fault”?  Because your company has signed a strong indemnity agreement with the supermarket all these claims or lawsuits are going to be primarily YOUR problem, which of course you don’t want.  To help mitigate these risks you need to have a programmatic method to transferring risks back to your suppliers, vendors, contractors and others much in the same way the supermarket did with Mr. Pickle; on top of having a comprehensive insurance program.

This risk transfer program will engage all of your up and downstream parties by contract and require them to provide you proper insurance documentation.  It can be a lot of work to get set up and maintained because you need to track all of your provider’s insurance renewals and obtain updated renewal certificates of insurance, but not having a program can be a disaster.

Here are two examples of claims Mr. Pickle which can be triggered by other parties, but which the company is going to be responsible for.

  1. A spice manufacturer/provider failed to inform Mr. Pickle that a certain spice which is contained in almost all of Mr. Pickle’s jars was processed in a machine that also processed peanuts, a known allergen. Several consumers of pickles became very ill due to a peanut allergy and sued Mr. Pickle directly.  In addition, many of the supermarkets which carried Mr. Pickle’s pickles had to clear the shelves of the product due to the contamination and submitted the costs of the product destruction to Mr. Pickle for reimbursement.  While Mr. Pickle’s insurance policies may pay for most of these claims – if they had sufficient limits of coverage – there’s a lot of lost time, damaged reputations, and lost profits that will occur.  With a solid risk transfer program in place Mr. Pickle could tender these lawsuits and associated losses back to the spice manufacture and ultimately save themselves a lot of money, time and effort.
  2. In our second example, Mr. Pickle doesn’t own a fleet of trucks, so he hires a trucking firm to pick up pallets of pickles at his factory and deliver them to Mr. Pickle’s customers – including the big new supermarket customer discussed earlier. During the course of delivery at the supermarket the hired truck driver is distracted and accidentally strikes a pedestrian in the parking lot causing serious injuries to the pedestrian.  The pedestrian of course sues the trucking company and the supermarket (the premises where the accident occurred) directly.  The supermarket turns around and sues Mr. Pickle through the indemnity agreement the supermarket had Mr. Pickle sign.

In this scenario, Mr. Pickle doesn’t really have direct liability or “fault” in this accident, but due to the contractual relationship they have with the supermarket they are dragged into the suit.  While Mr. Pickle’s insurance coverage should respond, if they had a contract with the trucking company, including an indemnity agreement they could pass this suit back to the trucking firm, which actually caused the claim.  Doing so would save Mr. Pickle and their insurer from most of the expenses and reduces the chances that Mr. Pickle will face increasing rates on their next renewal due to loss experience.

As you can see engaging your supply chain and distribution chain in an effective risk transfer program can help minimize risk for your organization.  The objective is to shield your company from unwarranted losses, and reduce the impact claims can have on your loss ratio and resulting renewal premiums.

To find out more about how you can create an effective risk transfer program in your organization, give me a call, or drop me an email and let’s talk!

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