Indemnification vs. Insurance

According to David Shuey, executive vice president of Life Sciences for Willis Group Holdings plc, a global insurance broker, a common misconception is that insurance and indemnity address identical issues. They don’t, he maintains.

“Insurance is simply a financial backstop for some of the indemnitor’s obligations in a contract,” Shuey said.

For example, indemnity agreements often cover intellectual property, willful misconduct, protocol deviations and other obligations where insurance is unavailable or impractical. He has often seen contract language requiring indemnitors to “purchase insurance with broad form contractual liability that covers the indemnity obligations of this contract.” Shuey maintains that it is not possible to buy an insurance policy covering all contractual obligations, so nobody can comply with such contract language.

Shuey also observed that disputes can arise regarding the timing of the indemnitor’s obligation to defend and/or pay defense costs. The reason is that contractual indemnification provisions often do not impose upon the indemnitor (at least not clearly and effectively) the obligation to immediately defend or fund an indemnitee’s defense when allegations trigger an indemnitor’s obligations.

Linda Schultz, medtech product manager at OneBeacon Insurance noted, “The effectiveness or advisability of non-insurance contractual transfers in a product liability risk management program depends on where in the chain of commerce the medical device company is located.”

For example, she thinks a contract manufacturer’s need and/or ability to negotiate these contractual terms differs from an OEM, a licensor or a distributor. The purpose of the contract or agreement also determines whether indemnification and hold/harmless is advisable and possible, she said. The key to effective analysis lies in involving experienced contract reviewers and drafters, partnering with counsel and knowledgeable insurance partners.

Other issues to consider when pondering non-insurance contractual transfers:
Who controls claim defense? The standard answer is: “We do!” In other words, you may get another firm to defend you in a liability claim. With that, though, comes the right for them—not you or your insurer—to control the claim defense. This includes everything from selection of counsel to making sensitive defend-or-settle decisions.

You, however, may not want to relinquish the right to choose your own attorney. Or, maybe you want to fight a dubious claim, but the indemnitor’s carrier wants to settle. Perhaps there are clashing interests between the indemnitor and the indemnitee. Whose interests will the indemnitor’s defense attorney put first?

If these questions make you squirm, they should. What you get in contractual protection you may relinquish in claims control. It’s a “package deal” when riding the coattails of another company. This is not to say that you should decline or forgo such promises. It does suggest, however, that the bitter mixes with the sweet. Beware of these negatives. Enter into the situation with open eyes. In some cases, the protection gained may outweigh concerns about relinquishing claim control. In other circumstances, your discomfort with relinquishing control may exceed the benefits of riding an indemnitor’s coattails.

How solvent is the indemnitor? If the indemnitor goes belly up, will there be sufficient assets to pay claims? If the manufacturer self-insures but skirts insolvency, having an airtight “hold harmless” in an indemnitee’s favor means little. Suggestion: Research the financial condition of the indemnitor. Do audited financial statements show financial health? What does Dun & Bradstreet say about its solvency?

What companies has the indemnitor favored? If an indemnitor has a wide market, and commonly indemnifies other firms, other “wannabe” beneficiaries may seek protection under the indemnitor’s
liability policy. This may dilute or reduce the available coverage for the indemnitee’s enterprise. An indemnitee may have planned on an intimate dinner for two, only to learn that the host has invited a horde. In this case, the hors d’oeuvres are quickly depleted. Suggestion: Ask the indemnitor for a list of other companies it has agreed to hold harmless.

Maintain your own liability insurance coverage. Look to the indemnitor, but don’t put all your risk management eggs in one basket. You still may need to insure for claims and lawsuits. Having insurance plus indemnification agreements is the risk management equivalent of wearing both a belt and suspenders.

Attorney Jeff Kiburtz of Shapiro, Rodarte & Forman of Santa Monica, Calif., believes that non-insurance contractual risk transfer is (and should be) a key part of risk management programs. In addition to the broader scope of risks for which non-insurance indemnity is available, many large companies self-insure significant portions, if not all, of their product risk. This drives interest in contractual indemnification provisions to transfer product risk to contracting partners and—if insured—their insurers.

Kiburtz conceded, though, that the lack of broader interest may be that—as one California Court of Appeals put it—non-insurance indemnity “is a topic so deadly dull that it makes insurance look interesting.”¹ Medical device firms in today’s times are like skydivers, in a sense. With attention to these tips, though, they can be confident of safe landings when it comes to risk managing liability exposures. Wrapped up in a pack, it’s hard to tell whether your lifelines are in working order. Closely analyze any documents offered by indemnitors; avoid the cursory review that may characterize such transactions. When you rely solely on an indemnitor, you are jumping out of the plane with no equipment.

Time to check your product liability ripcord and jump. Does your liability protection “pack” contain a parachute, or a kite? Is it for function or for show? This article can help you find out, before it’s too late.

Happy landings!