"Proper Supplier Insurance...Mitigating Contractual Risk" - by Mark Trowbridge, CPSM, C.P.M., MCIPS

Enterprise Risk Management (ERM) is a management philosophy sweeping through today's companies (and governmental organizations) as senior executives have escalated their focus upon operational exposures.  This theme is very broad, and touches every aspect of organizational performance.  But no aspect of operation is more exposed to risk than that of Supply Management; wherein core elements of enterprise performance happen outside the direct control of the organization.  Our important role as procurement leaders entails contracting, orchestrating, and managing supplier-performed operations which are directly-controlled by our suppliers. 

Let's face it.  Significant risks do exist; even in the best-managed supply chains.  Top procurement groups are taking actions to minimize the impact of those risks, but even the best cannot eliminate all risk exposure.  A top-performing supply chain must place responsibility and accountability into the hands of carefully-selected suppliers.  John A. Shedd once said, "A ship in harbor is safe; but that's not what ships are built for.

Numerous procurement methods exist today to mitigate risk in the supply chain.  Careful selection of optimal suppliers, performance-based contracts, due diligence in auditing supplier financial and business security, contractual language limiting and indemnifying against potential liability...each method is worthy of its own article.    

This article will discuss an important way to mitigate risks in the procurement field; which is to require our suppliers to carry policies of insurance.  Procurement groups require their suppliers to carry insurance for two reasons:  First Reason - Suppliers should carry insurance to ensure that they will remain in business and continue to support us, their customer, even if a financial or operational loss is incurred.  Second Reason - A supplier's insurance coverage can provide an additional layer of risk protection for the buying organization; over-and-above the supplier company's liquid value that guarantee their liability and indemnity obligations under our contract.

Having suppliers provide insurance coverage is not a simple matter.  Our contract language must carefully harmonize complex matters like limitation of liability, hold harmless, and indemnification with the required protections of the supplier's insurance policies.  Complicating matters further, the supplier's insurance coverage is provided by a third-party carrier which has its own protective language written into their policy documents. 

In the contract templates and clause libraries which my firm designs and develops for many corporate and governmental organizations (working with their procurement, legal and risk management leaders), there are certain types of insurance coverage which are at a core of contractual language:

Commercial General Liability (CGL) provides general protections covering the supplier's business operations;

Product Liability Insurance is sometimes part of CGL coverage, but other times not; and can be separately called Product Liability Claims-Madecoverage.  So this should be described as a requirement in the correct context;

Employer's Liability Insurance covers risks associated with the supplier's employment of personnel.  In certain countries, additional coverage also may relate to the employee base.  For example, in the USA, Worker's Compensation coverage is required in most states by statute. 

Automobile Liability Insurance covers the operation of the supplier's vehicles, but needs to be carefully written to cover owned, hired, and non-owned vehicles.  But careful review is needed to determine whether the supplier's coverage includes freight carriers which may deliver to the customer's locations.

Other types of insurance coverage may also be required on a case-by-case basis, such as Professional Liability Insurance (covering design or advisory issues inherent in services like architecture, engineering, consulting, medical, legal) or Aircraft or Maritime Liability Insurance.  A recently-evolving category of insurance now being incorporated into technology provider relationships is Cyber Liability Insurance (covering data breaches).

But just having insurance coverage in the right classifications is not enough.  Many other important aspects should be required of the supplier's coverage.  These include the following:

Direct Protection - The buying organization should be listed by the supplier's insurance provider as an "additional insured" on their policy.  This can be done on certain policy types, such as CGL or Automobile Liability, but not on others, like Employer's Liability or Professional Liability.  The nature of the coverage will determine whether "additional insured" coverage can be done.

Does Coverage Actually Exist? - Our contract with the supplier should be written to require them to provide evidence of insurance coverage, which may include a certificate of insurance, certain insurance industry forms (such as ISO forms), or even the ability to view the supplier's insurance policy documents.  The supplier's carrier should be required to provide updated insurance certificate whenever policies are renewed, changed, or terminated.  But it is one thing to put this into our contract; but quite another to have it happen.  Thus, top procurement groups are utilizing their Contract Lifecycle Management (CLM) technology tools to manage and stimulate action upon out-of-date supplier insurance certificates.

Multiple Ways to Skin a Cat - The supplier may fulfill their coverage responsibilities in a variety of ways.  These may include "umbrella" coverage that bridges several types of policies.  Or it may include "self-insurance" retained Insurance policies often are structured with separate limits "per occurrence" or "term limit".  So if the supplier's policy provides $1 Million USD "per occurrence" and $2.5 Million "term limit", but the firm has already submitted $1.7 Million in other claims during the present policy term, the policy will not allow a claim for more than $800 Thousand due to the term limit.  The combination of limits will always be viewed by the carrier to their benefit so must be delineated craftily.

The Deductible Trapdoor - It is important to understand what deductibles are written into the supplier's policies.  A deductible is the amount the policy holder is required to pay out-of-pocket before the insurance coverage kicks in.  In today's tight economy, many firms have increased their deductibles in order to reduce their policy payments.  Where this gets very tricky is if an event does occur, but the supplier firm fails to pay the deductible amount on the claim.  In that case, their insurance provider may refuse to pay out the coverage amount.  So some contracts give the supplier's customer as an additional insured (us) the right to pay the deductible amount ourselves. 

Be First In Line - A final principle to follow in contracting for supplier-provided insurance is to make sure their coverage is "primary" and not "secondary".  This principle parallels a requirement for the supplier's insurance coverage to include a "waiver of subrogation rights" (there's a snazzy phrase with which to impress friends at the next get together...).  This important requirement causes the supplier's insurance to pick up the full claim amount without trying to have the buying organization's own insurance pay first on a disputed claim.

Summary.   As I've worked with many leading Fortune 500 and Russell 2000 companies and governmental agencies to improve their contract templates, the matter of insurance often raises its ugly head due to the complexity of wording language and managing the supplier's performance of obligations.  Onerous insurance language can be a breaking point in our negotiations for important products and services at cost-effective cost levels.  But proper protections are needed to fit our organization's ERM priorities. Finding the proper balance is both an art and a science.

Strategic Procurement Solutions' leaders regularly help corporations and governmental agencies optimize their procurement contract templates.  Using our extensive library of clauses, we streamline and optimize contracts for review by your legal group.  We also present onsite training workshops like Strategic Contracting and Innovative Trends in Technology Contracting to teach these techniques.  Contact us at Contracting Services & Workshops for brochures about either of these training modalities.

About the Author - Mark Trowbridge, CPSM, C.P.M., MCIPS is one of Strategic Procurement Solutions founders. His 30+ years in procurement leadership began in the Manufacturing, Airline, and Financial Services sectors...culminating in a role leading three-quarters of the strategic sourcing activities, and all of the contracts management responsibilities, for Bank of America (then, the USA's third most-profitable company). During his final two years with Bank of America, Mark's areas of responsibility delivered a Quarter Billion Dollars in cost reductions. During the last 19 years, Mr. Trowbridge has worked in the consulting field with many leading corporate and governmental clients. His business travels have taken him throughout North America, Europe, the Middle East, and Asia. He is a frequent author on supply management topics, with articles appearing in publications like Supply Chain Management Review, Inside Supply Management, IFPSM's eZine, eSide Supply Management, and Strategic Procurement Solutions' own Best Practices in Supply Management Journal.  Mark's  is among the top 1% Most-Viewed LinkedIn profiles.