Would You Sign a Contract Without Knowing If You’re Truly Protected?
Signing a multimillion-dollar contract with a business partner, only to later discover they lack sufficient insurance for potential claims—or worse, their insurer goes bankrupt—can leave you responsible for damages, legal fees, and financial burdens that a well-crafted insurance clause could have prevented.
This scenario happens more often than you’d think, and it’s why insurance provisions in contracts are not just a formality—they’re a critical safeguard for your business. Let’s break down what you need to know about insurance requirements, policy limits, and additional insured status so you don’t get caught off guard.
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Why Insurance Matters in Contracts
Contracts often include insurance obligations that require one or both parties to maintain adequate coverage. Why? Because if something goes wrong—like an injury on a construction site, a product defect, or a data breach—the responsible party may not have the money to cover damages. Insurance acts as a safety net, ensuring that financial liabilities are covered.
Example: A small business signs a lease for office space. The landlord requires the tenant to have general liability insurance to cover potential accidents, like a visitor slipping and falling in the office. Without this clause, the landlord could be held liable for damages that should be the tenant’s responsibility.
Types of Insurance That May Be Required
Depending on the type of contract, different kinds of insurance may be needed:
General Liability Insurance – Covers bodily injury and property damage claims.
Employer’s Liability Insurance – Protects businesses if an employee sues over a work-related injury.
Workers’ Compensation Insurance – Covers medical expenses and lost wages for injured employees.
Professional Liability Insurance – Essential for consultants, lawyers, and tech companies in case of claims for errors or negligence.
Cyber Liability Insurance – Covers data breaches and cyberattacks (especially important for SaaS and e-commerce businesses).
Example: A software company provides cloud storage services to businesses. Their contract includes a cyber liability insurance requirement in case a security breach leads to customer data exposure. This ensures that both parties are protected from financial fallout.
Understanding Policy Limits: How Much is Enough?
Insurance policies set limits on how much they will pay out for claims. There are two major types of limits:
Per-Occurrence Limit – Caps the amount paid for a single event or related series of events.
- Example: If a company has a $1 million per-occurrence limit, and a fire causes $1.5 million in damages, the company would have to cover the extra $500,000 out of pocket.
Aggregate Limit – Caps the total amount an insurer will pay for all claims combined during the policy period.
- Example: A construction firm has a $5 million aggregate limit for the year. If they already settled multiple claims totaling $5 million, any new claims won’t be covered.
Why This Matters: If limits are too low, a business may not be fully covered, leaving them financially exposed. That’s why lawyers negotiate specific insurance limits to match the risks involved in a contract.
Why “Additionally Insured” Status is Critical
Sometimes, businesses want extra protection by being named as an “additional insured” on the other party’s insurance policy. This means they get direct rights under the policy, without needing the other party’s permission to file a claim.
Example: A retail store hires a security company. The store requires the security firm to list it as an additional insured on its liability policy. If a customer sues due to a security guard’s negligence, the store can seek coverage directly from the insurance provider, instead of relying on the security company to handle the claim.
However, there’s a catch: Additional insureds are subject to the same policy limitations as the named insured. That’s why companies should still maintain their insurance coverage.
Quality of Insurance: Not All Policies Are Created Equal
Even if the other party has insurance, it won’t help if the insurer goes bankrupt or has a bad track record of denying claims. That’s why businesses should require the insurer to have strong financial ratings from agencies like:
- A.M. Best Company
- Standard & Poor’s
- Moody’s
Example: A logistics company signs a contract with a trucking firm that carries cargo insurance. Before finalizing the deal, the logistics company’s lawyer checks the insurer’s rating and finds that it’s been downgraded due to financial instability. The lawyer insists on using a more reputable insurer to reduce risk.
Nonrenewal, Material Changes, or Cancellation: The Hidden Risk
What if the insurance policy gets canceled or changed without your knowledge? This could leave your business exposed without warning.
To prevent this, contracts should require at least 30 days’ advance notice before:
- The policy is canceled.
- The policy is not renewed.
- A major change reduces coverage.
Example: A manufacturer has a supply agreement with a factory. The factory’s insurance covers product liability claims. If the factory fails to renew its insurance and an accident happens, the manufacturer could be on the hook for damages. A 30-day notice requirement gives the manufacturer time to arrange alternative coverage.
How to Protect Your Business
Never assume the other party has enough insurance—always verify policy limits and coverage.
Push to be named as an “additional insured” for direct claim rights.
Require insurance policies from reputable companies with strong financial ratings.
Make sure liability coverage includes legal defense costs separately (outside policy limits).
Demand 30+ days’ notice before any cancellation or changes to coverage.
Best Practice: Always involve your company’s risk management team to review insurance clauses before signing a contract.
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In Sum
A well-drafted insurance clause is not just a contract formality—it’s your first line of defense against unexpected financial losses. Whether you’re negotiating a business partnership, vendor contract, or lease, ensuring proper insurance coverage can save your company from major legal and financial risks.
Before signing any agreement, ask yourself:
- If something goes wrong, is there enough insurance to cover the damage?
- Who is responsible for maintaining coverage—and what happens if they don’t?
- Does the insurance policy match the risks involved in the contract?
