FAR 31.205-19, Insurance and Indemnification, provides fairly comprehensive coverage on the allowability and unallowability of various types of insurance. Coverage that the contractor is required to carry under the terms of a contract or coverage maintained in connection with the general conduct of its business are generally allowable. Of course, types and extent of insurance must follow sound business practices and the rates and premiums must be reasonable.
Section (e)(3) of this cost principle however makes the cost of insurance to protect contractors against the costs of correcting its own defects in materials and workmanship, unallowable. This prohibition has been around since 1981 and is based on Public Law 97-12. However, while insurance for these activities are unalloable, the cost of the activities themselves may be allowable.
FAR 31.205-39, Service and Warranty Costs states that costs arising from fulfillment of any contractual obligation of a contractor to provide services such as installation, training, correcting defects in the products, replacing defective parts, and making refunds in the case of inadequate performance, are allowable when not inconsistent with the terms of the contract. So it would seem that service and warranty costs are generally allowable but the purchase of insurance to cover a contractors liability for service and warranty costs are not allowable.
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