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Contractual risk transfer: the risks and rewards for public entities

Contractual risk transfer: the risks and rewards for public entities

From fire departments to school districts, public entities must strategically allocate resources to serve their constituents. One way to achieve efficiency is by working with outside vendors to obtain services or by partnering with other government agencies to share services. These types of agreements require written contracts to determine roles and responsibilities, and as beneficial as these agreements can be, they can also create new risks.

Contractual risk transfer can be a valuable solution to managing risks related to external service providers, allowing public entities to better navigate complex operational landscapes and allocate resources more strategically.

What is contractual risk transfer?

Through a legal agreement, contractual risk transfer places the financial responsibility of a loss on the organization or contractor that has the best ability to prevent or control the actions or incidents that led to damage or injury.

Put more simply, contractual risk transfer establishes a legal framework for accountability when working with outside businesses or organizations.

A contract that explicitly defines roles, responsibilities, and financial liability allows public entities to gain the benefit of a vendor’s services while removing much of the related risk. This provides better protection of both finances and reputation. 

Which public entities are likely to benefit from contractual risk transfer?

Contractual risk transfer is common and often valuable, but it’s also frequently misunderstood. Below, we outline some common examples of collaborations between public entities and external vendors, as well as the importance of transferring risk within those service contracts.

Detention facilities

Prisons and jails must provide care for the inmates in their facilities, and this includes medical care. While internal staff structure and duties vary from one county to the next, it is common for correctional facilities to rely on contracted doctors and nurses for medical care.

Since medical care is  highly specialized and requires extensive expertise, it is important that risk is transferred  from the detention facility to the service provider administering care and prescriptions through a contractual risk transfer.

Government entities

When several government entities combine resources to contract for specific services, they often gain cost savings, efficiency, and better quality than they could on their own. For example, an emergency communication system may be shared among public police, fire, and social services teams, allowing access to upgraded technology and a more efficient response. Such a partnership has obvious benefits, especially as budgets remain tight.

In the example noted above, we see another highly specialized area of expertise, with obvious risks. If a communication system or its underlying technology fails or is hacked, the results could be disastrous. A contractual risk transfer focuses the responsibility for this service – and liability in case of failure – away from a public entity that is not tasked with the system’s maintenance and security.

Public schools

A school’s primary purpose is to provide a safe, engaging educational environment where its students can learn and thrive. This usually means accessing shared or contracted services like sports facilities or school buses. That’s just the beginning, though – with public schools in particular, there are numerous outside vendors supporting them,  including janitorial staff, food service providers, plumbers, and HVAC teams. In addition, school facilities are often used for outside activities, athletics, and fundraisers.

These types of service and facility utilization are common and ensure a school, district, and community benefit from a broad range of externally managed services. In these circumstances, contractual risk transfer agreements can protect the schools from potential claims.

What are common components of contractual risk transfer?

These are the most common components of contractual risk transfer agreements.

Hold Harmless agreements

A waiver of liability or hold harmless agreement is a common feature in contracts between a public entity and a service provider. It defines the contractor’s liability in cases of negligence resulting in losses, including loss of income, bodily injury, or property damage.

The degree of enforceability for hold harmless agreements varies considerably by jurisdiction, depending on case history, state or local statutes, and the particular details of the event.

To help ensure the enforceability of a hold harmless agreement, it should:

  • Be a stand-alone document
  • Be clear and unambiguous
  • Specifically state that by signing, the participant relinquishes rights of recovery for the service provider’s “negligence”
  • Explicitly define the risks involved

Indemnity and defense

These provisions also are common in business contracts, and are important for clarifying that the person or organization paying the loss will indemnify and defend the organization for whom the loss is being paid.

Broad-form indemnity provisions transfer liability regardless of fault, while other, more limited indemnity provisions, transfer liability according to each party’s contribution or fault for a loss.

Additional Insured status

It’s important to review any additional insured endorsement in a contract, and ensure that a qualified legal professional assists you, since these endorsements may vary from one contract to the next.

For example, some additional insured endorsements apply only when the named insured is alleged to be negligent, while others are tied to ongoing operations and not completed operations. Still others apply only on an excess basis. The variety and complexity of these endorsements make qualified legal review of a contract even more important.

Insured specification

This term simply means a contract must identify the types and minimum limits of coverage that the public entity and the vendor must maintain. This typically refers to general liability and commercial auto coverage, though business contracts also often require proof of other lines of coverage such as workers compensation, auto liability, and an umbrella policy. 

How can public entities best address contractual risk?

The process of managing contract creation, negotiation, and execution is a vital part of the contract management process. Each contract with an external service provider will be unique and bring its own complexities; where does responsibility begin and end for the services provided, and how are claims of negligence or loss divided between the contracting parties?

Contractual risk transfer should address questions like these to effectively address unforeseen issues. Therefore, it is advised to always consult with legal counsel with expertise in contract law.

While our team does not provide legal advice, all public entities can benefit from the work of an experienced insurance provider. Liberty Mutual understands the importance of identifying and managing risks related to uncontrolled conditions or negligence by other parties.

Our Public Entity team is ready to provide assessments and reference points to help your public entity understand your areas of risk and help guide discussions with your own legal counsel. Learn more on our public entity page.

This website is general in nature, and is provided as a courtesy to you. Information is accurate to the best of Liberty Mutual’s knowledge, but companies and individuals should not rely on it to prevent and mitigate all risks as an explanation of coverage or benefits under an insurance policy. Consult your professional advisor regarding your particular facts and circumstance. By citing external authorities or linking to other websites, Liberty Mutual is not endorsing them.