October 11, 2017

Indemnification vs. Insurance

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What is the difference between indemnification and insurance? They work best together but serve different purposes. Think of them like a belt and suspenders approach for keeping companies covered from losses. Understanding the unique function of each is important for any risk management strategy. In this article, we clear up the confusion by showing indemnification and insurance in action. 

Defining Insurance and Indemnification

Insurance transfers risk from one party to another in exchange for a premium. Through the policy contract, the insurance company agrees to provide financial protection or reimbursement for losses to the policyholder. Insurance hedges against the cost of claims caused directly by the insured or other affiliated third parties. 

Indemnification involves three parties: party one (indemnitor) makes a promise of financial protection to party two (indemnitee) for any potential legal liabilities and claims issued by a third party. Should a loss occur, the indemnitor agrees to pay for the damages sustained by the indemnitee. The provision works to transfer the risk of third-party claims to the entity most capable of controlling that risk. 

Similarly, both insurance agreements and indemnity provisions require one party to stand good for another financially. Insurance companies, tenants, and vendors all can act as indemnitors as well. So let’s take a deeper dive to explore the finer points that make these two terms different. 

A Closer Look: Indemnification

The indemnification clause, also known as the hold harmless agreement, is common in construction contracts. Property owners or general contractors often include them in agreements with subcontractors to ensure the downstream parties financially cover the losses they are most likely to create. 

An important aspect of the hold harmless or indemnification clause is that it does not transfer the cause of the liability, but does transfer the financial responsibility for the liability as guided by each individual state’s statutes. The indemnity provision does not relieve the indemnitee from liability to the third party. The indemnitee may be found liable to the third party for bodily injury or property damage. However, the hold harmless agreement provides the indemnitee a legal right to collect from the indemnitor for the damages paid to the third party.

Indemnification in Action: 

Best Property Management has a lease agreement clause that Real Good Restaurant will “hold harmless and indemnify for any and all injury or damage that takes place on the premises of the tenant, unless injury or damage is caused by the sole negligence of the landlord.” 

A fire breaks out in Real Good Restaurant injuring one of the patrons. The patron sues both Real Good Restaurant and Best Property Management for her injuries. At trial, the court rules Real Good Restaurant 30% liable and Best Property Management 70% liable for the damages and awards the patron $600,000. 

Real Good Restaurant pays $180,000 and Best Property Management pays $420,000 to the patron. Best then immediately enforces the indemnity provision for a full reimbursement from Real Good Restaurant. Because the eatery had agreed to indemnify “for any and all injury or damage” except for the sole negligence of the landlord, they owe Best Property Management $420,000. 

A Closer Look: Insurance

Contractual liability is addressed as part of a standard commercial general liability (CGL) insurance policy. This provides coverage of the insured’s indemnity obligation “for liability for damages assumed in a contract or agreement that is an ‘insured contract,’ provided the bodily injury or property damage occurs after the execution of the contract or agreement in which the liability of others was assumed.” 

Insurance in Action:

Real Good Restaurant’s CGL insurance policy reimburses $420,000 to Best Property Management on its behalf for the patron’s court award. The payment is not statutory, or court ordered, but derived completely from the lease agreement’s indemnity provision in which the restaurant assumed the property management company’s liabilities. Had the restaurant not had insurance coverage, the $420,000 reimbursement would be an out-of-pocket expense. 

Where Insurance and Indemnification Meet

Both indemnification and insurance transfer risk and guard against financial losses, but they do so differently: 

  • Indemnification transfers risk between contracting parties through a non-insurance agreement. 
  • Insurance transfers risk from one party to another in exchange for payment. 

The terms of an indemnification clause can dictate how an insurance policy responds to hold an indemnitee harmless. It is important to note that a liability covered under an indemnity provision can exceed the indemnitor’s insurance limit. Indemnitees should always verify the indemnitor has active insurance coverage with an adequate financial threshold when executing an indemnification agreement in the contract. 

Rely on Indemnification Experts Who Understand the Difference

Does your company’s compliance and risk management team know what items can be confirmed via a review of insurance documents, policies, and endorsements compared to those relying solely on the indemnification agreement? Most compliance administrators are not trained insurance professionals with the perspective needed to confirm applicable coverage without requiring indemnification protections that some insurance policies cannot guarantee.

myCOI is a cloud-based software solution that exists for one reason: to help you handle the everyday tasks of managing certificates of insurance (COIs) and protecting your company against underinsured claims, costly litigation, and failed audits. The software and certificate tracking services are combined into an easy-to-use solution developed and supported by a team of insurance professionals and built on a foundation of insurance industry logic. myCOI automates the COI communication process and ensures you remain protected. See how we stack up against other certificate of insurance tracking software providers. 

Indemnification: Ready to Learn More?

Interested in learning more about indemnification and other tactics for minimizing risk at your job site or property? Check out our eBook “10 Tips for Effective Contractual Risk Transfer.”

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