Does Your Insurance Actually Cover the Risks You Have Accepted Under Your Contracts?

Does Your Insurance Actually Cover the Risks You Have Accepted Under Your Contracts?

Many businesses manage risk through a combination of contractual protections and insurance.

But those two risk-management tools do not automatically align.

A business may have substantial insurance and carefully negotiated commercial contracts, yet still face a significant uninsured exposure because the liabilities it has accepted under its contracts do not match the risks its insurer has agreed to cover.

This issue can arise in almost any industry.

The starting point is a relatively simple question:

If something goes wrong and we become liable under this contract, will our insurance actually respond?

The answer is not always as straightforward as looking at the headline limit on an insurance certificate.

The Gap Between Contracts and Insurance

Commercial contracts allocate risk between the parties. Indemnities, warranties, liability caps and exclusions determine who bears the financial consequences when something goes wrong.

Insurance performs a different function. It transfers specified risks to an insurer, subject to the terms, exclusions, limits and conditions of the policy.

A business can therefore agree to assume a liability that falls outside its insurance cover.

For example, a contract might expose a supplier to $2 million of liability for a particular event. The supplier holds a $10 million liability policy and assumes the exposure is adequately insured.

That assumption may be wrong if:

• the particular type of loss is subject to a lower sub-limit;
• an aggregate limit has already been partly or wholly exhausted;
• the policy excludes the relevant liability;
• the liability only exists because the business agreed to assume it under the contract;
• the policy requires contracts to be entered into on particular standard terms;
• a negotiated contract was required to be disclosed to, or approved by, the insurer; or
• the insured has not complied with a condition or requirement of the policy.

The important question is therefore not simply “How much insurance do we have?”

It is:

How much insurance is available for the liabilities we have actually agreed to accept?

A Recent Example: Transport and Logistics

We recently considered this issue when advising a client in the transport and logistics sector. The matter highlighted two problems that can arise when contractual liability and insurance are considered separately.

1. Headline insurance limits can be misleading

An insurance policy may carry a substantial overall limit but impose much lower limits for particular categories of claims.

This is especially relevant in transport and logistics, where different limits may apply to loss of or damage to cargo, high-value goods or other specified risks.

The distinction between per-occurrence and aggregate limits is also critical:

• a per-occurrence sub-limit generally caps the amount available for a single event, subject to the policy wording; and
• an aggregate sub-limit caps the total the insurer will pay for that category of claim across the entire policy period.

Consider a transport operator carrying $1 million of goods under a customer contract that exposes it to the full value of those goods. If the cargo sub-limit is $500,000, there may be a $500,000 uninsured exposure.

The position is more serious where, for example, a $250,000 annual aggregate sub-limit applies to high-value cargo. A single claim could exhaust the cover for that category for the rest of the policy period.

The headline policy limit tells only part of the story.

2. The insurer may expect you to contract on particular terms

Some policies require the insured to do business on standard terms and conditions that have been provided to the insurer. If the business enters into a separately negotiated customer contract, that contract may need to be disclosed to and approved by the insurer.

This creates a real practical risk.

A commercial team might negotiate a major customer contract with different indemnities, liability caps or risk allocations. The contract may be commercially sound and properly approved within the business.

But has anyone checked whether the insurer has agreed to cover work performed on those terms?

Depending on the policy wording, failing to obtain the required approval could leave a substantial exposure uninsured.

This is particularly important for businesses that have grown from trading on standard terms to regularly signing bespoke agreements with larger customers.

It also highlights the importance of the standard terms themselves. If cover depends on the business using them, those terms must remain appropriate, legally compliant and consistent with the basis on which the insurance was arranged.

This Is Not Just a Transport Industry Issue

The same issue can arise wherever a business uses insurance to manage the risks created by its commercial activities. For example:

• a professional services firm may give contractual warranties or indemnities that extend beyond its professional indemnity cover;
• a technology provider may accept liability for data loss, privacy breaches or cyber incidents without checking that it aligns with its cyber or professional indemnity insurance;
• a construction contractor may agree to broad indemnities without considering the exclusions and contractual liability provisions in its insurance program; and
• a manufacturer or distributor may accept product liability, recall or consequential loss exposures that are excluded or sub-limited.

In each case, the underlying point is the same.

The contract determines the liability. The insurance policy determines whether, and to what extent, the insurer will fund it.

Those documents need to speak to each other.

A Practical Review: Six Questions to Ask

Businesses should periodically compare their material contracts against their insurance arrangements. That review should ask:

1. What liabilities have we accepted? Identify material indemnities, warranties, liability caps, exclusions and other contractual risk allocations.
2. What does our insurance actually cover? Look beyond headline limits to sub-limits, aggregate limits, exclusions, deductibles and policy conditions.
3. Are there contractual liabilities that fall outside the policy? In particular, check whether the policy excludes or restricts liabilities voluntarily assumed under contract.
4. Does the insurer need to approve particular contracts? Confirm whether the policy assumes you trade on specified standard terms, and whether bespoke agreements must be notified or approved.
5. Have all policy requirements been satisfied? Check requirements on standard terms, notifications, risk-management procedures and time limits.
6. What is our potential uninsured exposure? Compare the maximum realistic contractual exposure with the insurance that would actually respond.

The Takeaway

Contracts and insurance should form part of the same risk review. A substantial insurance limit provides limited comfort if the liability your business has accepted falls outside the cover available.

Eliminating every uninsured risk may be commercially unrealistic. What matters is identifying the exposure and making an informed decision before a claim arises.

At Nine Dots Legal, we advise businesses on contractual risk allocation, indemnities, limitations of liability and the interaction between commercial contracts and insurance requirements.

If your business is entering a significant customer contract, changing its standard terms or reviewing its insurance arrangements, our Commercial + Corporate Team would be pleased to assist.