Starting a new business venture can be a daunting task with numerous hoops to jump through. One of the most challenging aspects of this process is understanding and navigating the insurance requirements outlined in contracts. It’s common for entrepreneurs to wonder why insurance is even needed in their contract, if the coverage limits are appropriate, or how to successfully negotiate these provisions. In this guide, we aim to demystify the insurance requirements in contracts and provide a clear, step-by-step roadmap for approaching negotiation. By the end of this guide, you’ll have a deeper understanding of the insurance requirements in your contracts and will be able to make informed decisions about the level and type of coverage needed, without being over-insured or paying for unnecessary coverages. This will give you the peace of mind that you, your business and third parties are protected.

Why insurance requirements exist in the first place, and why negotiation is often critical

Insurance requirements in business contracts may seem like an added burden, but they serve an important purpose. Insurance assures that all parties involved have the necessary risk management measures in place to protect themselves and others in the event of a contract breach or negligence. These requirements, whether in the form of insurance coverage, indemnification language or hold harmless agreements, provide a safeguard against potential litigation or third-party payouts. It’s important to understand the significance of insurance requirements and the role they place in protecting your business and its partners.

The requirements usually state the specific policies and limits. Limits are required to ensure there is enough coverage for a “worst case scenario” and are set based on the perceived level of risk or exposure that one party has to the other. The specific requirements and policies are established to mitigate that risk and protect both parties. Factors that contribute to exposure include potential third-party injuries, data breaches and financial investments. These factors are all considered when determining the appropriate insurance limits for a contract or relationship. Additionally, the industry and type of business also impact insurance limits. 

However, it’s important to be aware of red flags and pitfalls when entering into contracts. A common example is that insurance requirements are incongruent with the exposure at hand. Let’s say a tech startup is entering into a small enterprise contract for a beta test with a Fortune 500 client. The Fortune 500 company wants them to carry the same level of insurance requirements as their larger enterprise partners. In this case, it would be beneficial for the startup to negotiate the limits of the insurance to align them with the actual exposure and risks involved. Negotiating the insurance requirements can help the startup to avoid unnecessary costs and ensure they are adequately protected without overburdening resources. 

Another instance where it’s important to negotiate an insurance requirement is when the coverage has no relevance to the business contract. For example, the contract requires general liability coverage, which covers bodily injury and property damage, but there will be no in person engagement. Or the contract requires having commercial auto coverage when there are no automobiles used in the contractual agreement. On the other hand, requirements that do make sense are obtaining cyber coverage when sharing data, or errors and omissions coverage that protects both parties from software failure and downtime. Lastly, if there’s ancillary professional services performed like medical malpractice, lending liability or real estate professional services, there is coverage that can also provide protection in a business contract. 

In short, the biggest pitfall is overpaying for insurance coverage that doesn’t reflect the level of risk involved. If the perceived risk is low, then negotiate the requirements. Another approach is to work with an insurance advisor who can assist in understanding what an appropriate level of coverage would be for your company and provide guidance in redlining the contract for the negotiation process.  

How to effectively execute the negotiating process for the best outcomes

1. Review and redline the contract

The insurance requirements in a contract should be reviewed in great detail to pinpoint red flags and be sure to redline (noting edits or revisions in red) requirements that you wish to negotiate.

2. Understand real risk

Working with an insurance advisor to understand your real risk is crucial in ensuring that you have the appropriate coverage in place before entering contract negotiations. An insurance advisor can help you identify potential risks specific to your business and industry and advise you on the types of coverage you should consider to protect against those risks. By getting coverage in place “out of the gate,” you are positioning yourself in the best possible way to enter contract negotiations. You will be able to demonstrate to the other party that you are a responsible and prepared business that takes risk management seriously. Additionally, having coverage in place before redlining the contract allows you to be more flexible in negotiations, as you can offer different levels of coverage to meet the specific needs of the contract. Working with an insurance advisor and getting coverage in place beforehand is a best practice that can help protect your business and improve your negotiating position.

3. Determine the opportunity cost of the contract

Think about opportunity cost: the potential benefits or revenues that must be forgone to pursue a certain action or opportunity. In the context of a contract, the opportunity cost would be the potential revenue that the business could have earned by pursuing other opportunities versus the revenue that will be generated by the contract in question. 

It's important to consider the cost of insurance when evaluating a contract. The cost of insurance is a factor that should be considered when determining the overall profitability of the contract. If the cost of insurance is high relative to the revenue generated by the contract, then it may not be worth pursuing. However, if the revenue outweighs the cost of insurance, then it may be a good opportunity for your startup. Ultimately, the decision on whether or not to pursue a contract will depend on a variety of factors, including the opportunity cost and cost of insurance.

4. Don’t agree to coverage that isn’t relevant to your contractual relationship

To reiterate, it’s important to only agree to relevant coverage, as unnecessary coverage can add additional cost without any benefit. Agreeing to an insurance policy that is unnecessary is a waste of money.

5. Refrain from over sharing your limits

It’s important to only share the specific limits of insurance required by a contract and not to disclose any additional coverage that may be held. This can be done by obtaining a certificate of insurance that only shows the required limits of coverage. For example, you may be required to have $10 million limit in cyber and errors and omissions coverage in one contract, but only $3 million may be required in another contract. The party with the $3 million contract does not need to know you hold significantly more liability coverage than what is specified in your contract. Instead, obtain a certificate of insurance to represent the $3 million requirement only. 

6. Remember that negotiation should have rationale

When negotiating, it’s critical to have a clear and logical rationale for the positions  you’re taking. This can help to build trust and understanding with the other party and increase the likelihood of reaching a mutually beneficial agreement. It’s also beneficial to have a clear understanding of the needs and priorities of the business, as well as those of the other party, to effectively communicate your reasoning and come to a compromise.

Using the same example above, you could say, “We understand you wish for us to carry these limits, but we already carry $3 million in coverage. When the contract value increases from $50,000 to $500,000, then we will agree to increase the limits of our program.”

Importance of insurance requirement management

Having a partner or team member who understands the complexity of your relationship with clients can be very beneficial when managing the negotiation process. This person can help you navigate the nuances of client servicing, which is an essential aspect of the insurance industry. 

• Maintain a fast upgrade process. This means having a system in place that allows for quick and easy updates to insurance coverage as needed.
• Streamlining the Certificate of Insurance (COI) process. Traditional carriers can take several weeks to process COIs, so it’s important to have a process in place that minimizes delays.
• Develop a plan of action with the insurance provider including ensuring key agreements are in place, such as “blanket additional insured” language, and having COIs available at contract signing. This helps ensure that clients are protected and all legal requirements are met.

How Vouch Serves as a Dedicated Partner Throughout the Process

Managing insurance requirements can be a complex and time-consuming process, but at Vouch, our Insurance Advisors are experts at understanding the precise needs of tech startups. Not only can they advise you throughout the negotiation process and manage the insurance requirements while understanding your insurance needs, but the Vouch legal team can redline the contracts and assist throughout the process. 

In summary, avoiding costly snags with insurance requirements in a business contract doesn’t have to be overwhelming. Throughout the process and as you scale, Vouch will help make the process efficient and manageable while providing the peace of mind that you’re entering the contractual agreement informed and protected.