Should You Purchase Subcontractor Default Insurance?

If you’ve always relied on performance bonds to guarantee that your subcontractors fulfill their contracts, you might want to look into subcontractor default insurance. This attractive alternative can provide you with valuable security in the event a subcontractor breaches contract while lowering your premium costs, eliminating the surety investigation period, and allowing you to work with entities that might not qualify for a bond.

The Cost

Subcontractor default insurance—also known as an SDI policy—includes a deductible and co-payment. For this reason, you can purchase it for as little as 50 percent of the cost of a bond premium, which generally runs between 1.0 to 1.25 percent of the value of the subcontract. While SDI policies usually have limits that are less than the total value of the project’s subcontracts, they also provide coverage for indirect default losses including liquidated damages. Performance bonds rarely cover such indirect damages.

The Parties

Performance bonds set up relationships between three parties: the surety (bonding company), the principal (subcontractor) and the obligee (the contractor). A SDI policy reduces the number of involved parties to two, eliminating the surety and removing the surety investigation period should the contractor file a claim. Because the SDI insures the performance of the subcontractors, the insurance carrier will compensate you directly for any costs associated with a subcontractor default. Additionally, one policy can cover all of the subcontractors you use on your project.

When you use performance bonds, the bonding company must investigate claims resulting from the default of your subcontractor. This can cause major delays and often results in cost overruns. Should the surety accept the claim, they then have the power to dictate how it is resolved. They may forfeit the bond’s penal sum, pay for a new subcontractor, finance the defaulted party or, on rare occasions, allow you to proceed as you see fit.

Subcontractor Qualification

When you use a performance bond, the surety company screens the covered contractor. They analyze the contractor’s financial viability, credit history and past job performance. If the bonding company deems the contractor acceptable, they are subsequently bonded. This can limit the contractors you are able to select for your projects.

SDI policies, on the other hand, allow you to work with whatever contractors you choose. You are responsible for any pre-screening. Insurers won’t examine your contractors to determine if they have the resources to perform the job you’ve hired them to complete. But you’ll no longer be limited to selecting from large contractors with extensive track records. You can use smaller, less experienced companies if you feel they are the right choice for your job.

Are you interested in learning more about subcontractor default insurance? Please don’t hesitate to contact us for further insight or to discuss any of your construction-related insurance needs.