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As you dig deeper into your construction insurance policy, you may come across the terms first-party insurance and third-party insurance. Mastering the difference between these two concepts is crucial to understanding how different types of construction insurance protect you. Fortunately, the difference is very straightforward.
First-party insurance provides compensation directly to the insured individual or business, whereas third-party insurance provides reimbursement to another party when the insured person or business is liable for damages.
Read on for more everything you need to know about first-party vs. third-party insurance in construction.
The difference between first-party and third-party insurance
First-party insurance provides compensation directly to the insured individual or business. For example, if your insurance policy covers your equipment, any damage that is covered will lead directly to you getting reimbursed for repairs or replacement.
Third-party insurance, also known as liability or casualty insurance, protects insured individuals or businesses in situations where they may be liable for damages to another person or business — the third party. For example, if you damage a customer’s property while performing electrical repairs, liability insurance may cover the cost of damages to the customer’s property.
|First-party insurance||Third-party insurance|
|Definition||First-party insurance provides reimbursement to the insured individual or business for covered claims during the coverage period.||Third-party insurance provides compensation to other individuals or businesses (third parties) when the insured individual or business is liable for damages.|
|Common contractor policies||Workers’ compensation, commercial auto, commercial property, and builder’s risk||General liability and professional liability|
|Example||A building in progress, insured by builder’s risk insurance, is damaged by a fire. The general contractor who bought the insurance policy is reimbursed for damages.||A customer trips on a ladder belonging to a roofer on a residential job site. The roofer’s general liability insurance covers claims related to injuries related to the customer’s fall.|
A simple way to think about first-party and third-party insurance coverage is to ask yourself the following question: Who ultimately receives the financial compensation from the policy?
With first-party insurance, the policyholder receives compensation, but with third-party insurance, someone else that the policyholder is liable to receives compensation.
However, both forms of insurance are known as risk transfer policies in construction insurance because they shift risk away from the policyholder and onto the insurance company — an excellent prospect for contractors working in complex and risky fields.
First-party insurance examples
There are a number of first-party insurance policies that are common in the construction industry. Taking a closer look at each type of policy makes it easier to understand how the first-party — the policyholder — is reimbursed for particular types of claims.
- Workers’ compensation: Legally required, workers’ compensation provides construction businesses with reimbursement for employee medical costs, lost wages, and lawsuits when an employee is injured on the job.
- Commercial auto: When company vehicles are damaged — or employees driving those vehicles are injured — commercial auto provides reimbursement to the policyholder.
- Commercial property: If a construction business’s insured property is damaged, it can file a claim for reimbursement from the insurance carrier.
- Builder’s risk: Also called course of construction insurance, builder’s risk provides reimbursement to policyholders for damage to buildings that are still under construction.
In these and other cases involving first-party policies, the construction business is receiving reimbursement directly for claims that are covered by the policy.
Third-party insurance examples
The two most common third-party insurance policies in construction are general liability insurance and professional liability insurance, also known as errors and omissions (E&O) insurance. Both of these policies cover contractors in situations where their work leaves them potentially liable for damages to a third party.
- General liability insurance: Required for most construction jobs and for many state licenses, general liability insurance protects the policyholder from claims that their work led to third-party property damage or bodily injury.
- Professional liability insurance: Common among most contractors, professional liability insurance offers coverage in situations where a third party claims that a contractor’s work led to financial losses.
Liability insurance is vital for most construction businesses, as the financial losses that come from a liability claim — including potential legal fees and settlements — can be significant. Although the compensation these policies provide goes to third parties, the policyholder benefits by mitigating the risk of massive financial losses from a liability claim.
In this way, third-party insurance is similar to bonds, which many construction businesses are required to have when working on government projects.
For example, payment bonds are purchased by general contractors to ensure that subcontractors are paid for their work — protecting owners from potential lawsuits. And performance bonds, which are purchased by subcontractors, ensure that work will be completed for the GC and owner, even if the subcontractor leaves the job unfinished. In both cases, a third party (not the contractor who secured the bond) receives the benefit of the bond, which effectively functions as a form of insurance.
Bad faith insurance claims
When a policyholder makes a claim with their insurance carrier, the carrier has a responsibility to investigate the claim and provide payment if obligated. This responsibility exists for both first-party and third-party insurance policies, since either kind of claim could result in compensation for the affected party.
If a contractor believes that their insurance carrier has misrepresented contract terms, willfully avoided providing reimbursement, or is otherwise failing to live up to its contractual obligations, they are generally able to file a claim that the insurance carrier is acting in bad faith.
Importantly, an insurance company that has made a simple mistake or has correctly denied a claim based on the contract cannot be held in bad faith. Additionally, not all states have laws enabling policyholders to make bad faith claims. In some cases, states allow for bad faith claims for first-party claims but not third-party claims, so it’s best to consult a construction attorney for more information about your specific situation.
Construction insurance coverage is key
With a firm knowledge of first-party and third-party insurance, you’ll be able to take a closer look at specific construction insurance types and the benefits they provide to construction businesses.
While the initial cost of construction insurance may seem burdensome, the ability to mitigate risk, avoid costly liability claims, and get reimbursed for covered damages ultimately helps contractors stay in business.