Essentially it's a square surrounding the character which can be drawn on whenever a blood spurt passes on top (a 'surface' in GameMaker terms). The character sprite is then used as a stencil to cut the surrounding edges of the square, leaving only the interior visible (I use 'blend modes' to do this). This is drawn over the top of the character to create the impression of being covered in blood.
It's similar to the approach used in this game: