When relying on service providers, make sure all contingencies are covered before you sign on the dotted line. Some front-end legwork is required, but the payback may be well worth the effort.

by Natalie Kingston, Akiba Stern

The basic premise of an outsourcing transaction is that one company will rely on another to take over and manage one or more of its business functions. It goes without saying that relying on another company in this way creates a number of significant risks that must be properly identified and adequately managed for the arrangement to be a success.

With careful planning and preparation, it is possible to identify and put in place checks and measures that will provide the customer with sufficient levels of protection and reassurance, all the while giving the service provider the guidance it needs to adequately meet client expectations.

One of the most critical risk-management steps that an outsourcing customer can take is to ensure that its chosen service provider has in place, or is willing and financially able to obtain, the necessary types and levels of insurance coverage to suit the risks to the service provider from the customer’s business.
Just as the kinds of risk in a particular outsourcing transaction will vary depending on the type of business and the functions being outsourced, so, too, will the types of insurance. And as with everything these days, there are plenty of different types of insurance coverage from which to choose. As a starting point, it is helpful to have in mind the minimum coverage that service providers usually carry. For a typical business process outsourcing, these generally include:

• Commercial general liability, covering claims for bodily injury, property damage, contractors’ completed operations, and contractual liability. There is also insurance covering the service provider’s indemnification obligations contained in the outsourcing agreement;
• Professional liability and errors and omissions insurance, covering claims for damages due to error or any willful, unlawful, or negligent act or omission by the service provider or its personnel;
• Products liability insurance, covering claims for bodily injury and property damage; and
• Umbrella and excess liability coverage.
In addition, there may be a number of other insurance coverages which, depending on the services being provided, should be carried by the service provider.

These can include:
• Directors and officers liability insurance to protect against claims resulting from wrongful acts of the directors and officers of the service provider;
• All risks property damage, to protect the assets used in providing the services;
• Business automobile liability;
• Workers’ compensation insurance, or if not required by statute, private health insurance for the service provider’s employees;
• Business interruption insurance;
• Employee dishonesty and computer fraud, for which coverage should include the assets of the customer irrespective of its location; and
• Intellectual property infringement insurance.
Once the required coverages have been negotiated, outsourcing customers can take a number of additional steps to ensure that they obtain the appropriate measure of protection from the agreed coverages.

First, the required insurance coverage should be placed and kept with an
insurance company that is rated at a level acceptable to the customer, usually at least “A-” in Best’s Insurance Guide.

In addition, and if appropriate in the circumstances, each insurance policy should:
• Designate the customer as an additional insured and stipulate that no act or omission of the service provider will affect or limit the obligation of the insurer to pay the customer the amount of any loss sustained;
• Provide at least 30 days’ notice to the customer of any cancellation or material modification of the coverage provided;
• Provide that all deductibles will be paid by the service provider and not the customer;
• Be primary and non-contributing with respect to any other insurance or self-insurance which might be maintained by the customer;
• Contain a waiver of subrogation (i.e., the insurer relinquishing its rights to recover damages in the customer’s name against the service provider);
• Contain a waiver of any insured-versus-insured exclusion regarding the customer (i.e., prohibiting a provision that prevents the additional insured from bringing claims against the policyholder under the policy, thereby enabling the customer to bring claims against the provider under the policy; and
• To the extent possible, allow the customer to settle any claim it wants to settle to prevent the insurance company fighting a claim even if the customer wants to settle. For example, if the insurance coverage is $1 million and the settlement offer that the customer is prepared to accept is $900,000, the insurer may prefer to take its chances at trial since its maximum exposure is nearly what it will pay in the settlement.

Negotiation of the insurance provisions takes place early in the deal. Too many customers make the mistake of leaving these negotiations until the last minute. If the selected service provider is not willing or able to obtain adequate coverages, it is better for the customer’s risk managers to know that as soon as possible, so that the risks can be otherwise mitigated or alternative arrangements made.

Natalie Kingston is an associate in Morgan Lewis ’ business and finance practice and is a member of its Global Outsourcing Group.