The Biggest "GovCon" Misconception: Why Government Contractors "Have No Risk".
Updated: Feb 8, 2020
Generally speaking, there are two different types of relationships when contracting with the federal government (Department of Defense, Homeland Security, etc.)
1. Prime Contractor
The Prime contractor is awarded contracts directly from the federal government, and the contractual relationship is completely governed by the Federal Acquisition Regulation (FAR). There is a standard FAR Insurance Clause that is inserted into each contract, however, the insurance requirements are extremely minimal – usually General Liability, Auto Liability, and Workers Compensation.
Product Liability, Professional Liability, Cyber, Management liability, etc. usually are not addressed. As a result, insurance obligations are pretty much a non-issue for Prime contractors. Likewise, there is very little exposure when contracting with the federal government directly since the government is not going to sue a company for an error or omission, or product defect. The federal government will simply pull the contract and award the contract to another company.
For example, I knew a company that had a $100M, 5-yr contract designing systems and software for the Air Force. After years of missed milestones and one issue after another, the government pulled the contract and awarded it to another company, and that was that. Now there is still the issue of government immunity, which isn’t automatic. To use a real example, a weapons manufacturer for the DoD was sued by a service member’s estate when the weapon system malfunctioned during a training exercise and killed him. The Prime contractor was able to provide documentation that they designed the weapon system exactly as directed by the government. They even notified the government of a few potential design flaws, but these were ultimately given the stamp of approval – the benefit outweighed the cost in their mind. All this being the case, the decision of the court was in favor of the contractor and governmental immunity was provided and the case dropped. However, the contractor still had the defense costs. So, sometimes Prime contractors don’t think about this. Product liability insurance could have helped pay the defense costs.
The other type of relationship is a subcontractor supporting the Prime contractor. These relationships are just like any other B2B relationships, and this is where most of the issues occur. To go back to the example of the $100M software contract, the Prime contractor was never sued by the government… they just simply pulled the contract. However, if the Prime had reason to believe that their failure to perform was directly tied to a particular subcontractor, you better believe there will be a lawsuit seeking damages in the wake of losing a multi-million-dollar contract. It’s the sub to prime and/or prime to sub relationships where most of the insurance issues occur. It’s also where we run into more stringent insurance obligations. For example, Lockheed Martin might be the Prime contractor for the development and manufacturing of the F-22 Raptor fighter jet. There FAR insurance obligations with the Department of Defense will likely be the usual General Liability, Auto, and Workers Compensation – with minimal limits. However, the contract between Lockheed Martin and its subcontractors would likely include the full suite of insurance products, like Cyber, Professional Liability, & Product liability, along with much higher insurance limits, depending on the work performed.
Often times the insurance market place has very little appetite for federal government contracting and thus the more sophisticated insurance products like Cyber, Professional Liability & Product liability may be difficult to find at a competitive price. After all, what could go wrong building a weapons system or fighter jet? This is where independent agents specifically focused on the innovation space can really provide value
Defense Base Acts Insurance
Another key insurance item for Federal Government contractors is Defense Base Acts (DBA) Coverage. This is essentially overseas Worker’s Compensation insurance. It is an extension of the federal Longshoremen and Harbor Worker’s Compensation act. It covers employees employed at U.S. defense bases overseas in hostile work environments. DBA coverage is designed to provide medical treatment and compensation to employees of defense contractors injured during employment. The program is run by the U.S. Department of Labor. This coverage can be extremely expensive due to the high-risk nature and likelihood of claims. It is best practice when submitting bids for federal government work in the defense industry to include the cost of DBA insurance in your bids. An estimated DBA cost could be $3.50 to $4.50 per $100 of payroll in a high-risk area like Afghanistan in the early 2000’s. With the above in mind, an employee overseas making $100,000 in compensation could cost $3,500 to $4,500 just for DBA insurance. Again, this is where a specialized independent insurance agency dedicated to innovation can shine with assisting in accurate figures and coverage placement from insurers.