Why Subcontractor Default Insurance is an Alternative to Bonding
Construction is risky when working with numerous third-party contractors to get a job done. What happens if a subcontractor defaults and does not finish a job? Are you left to do the work on your own? Who pays for unfinished work or the cost of hiring a new subcontractor? These are some questions contractors must deal with when working with third parties.
To remain safe, General Contractors or at-risk Construction Managers can use specific tools to mitigate the risk of default of their subcontractors. Subcontractor Default Insurance (SDI) is one of the most useful methods to implement and a potential alternative to Surety Bonds.
Keep reading, we are going to guide you through a solution that will cover your individual construction project needs. As an added bonus, we have included a free guide to help you decide if SDI coverage is right for you.
What is Subcontractor Default Insurance?
Subcontractor Default Insurance is a type of insurance coverage for contractors that helps pay for economic losses when a subcontractor defaults on work they promised to do. SDI can potentially provide cost savings to the general contractor and provide more control in the event of a default of a subcontractor.
This coverage does not mean a subcontractor can get out of their contract. They are still liable for the work they promised to do, but the contractor is the one who deals with the financial repercussions. Because of this liability that contractors carry, subcontractor default insurance helps pay for specific situations like:
- Finding a new subcontractor to complete the job.
- Payments for finishing the job late.
- Redoing work that does not meet standard requirements.
Subcontractor Default Insurance covers your company for any costs associated with a subcontractor not completing the work they promised to do.
Every situation is unique, but the perception is that sureties do not move quickly in the event of a default. SDI is deemed to provide the general contractor the ability to react quickly to correct a situation. The goal? Keeping the project on track.
In a Surety Bond default, the general contractor risks being in breach of the Surety Bond agreement if they act on their own, even if the general contractor deems its actions to be in the best interest of the project.
As you can see, while Subcontractor Default Insurance is a great coverage option, it is important to understand Surety Bond options to guarantee you have the right coverage for your projects.
What is a Surety Bond?
Unlike SDI coverage that only involves two parties, a subcontractor Surety Bond is an agreement between you, the subcontractor, and the surety bond company. According to the National Association of Surety Bond Producers, “a surety bond is a promise to be liable for the debt, default, or failure of another. It is a three-party contract by which one party (the surety) guarantees the performance or obligations of a second party (the principal) to a third party (the obligee).”
At this point, you have probably heard about subcontractor Surety Bonds and you might even have used one yourself! But what is a subcontractor Surety Bond? Next Insurance Magazine defines it as: “a deal that you make with the subcontractor and a surety bond company to make sure that you won’t lose out if your subcontractor defaults.”
Next Insurance Magazine defines two distinct types, performance bonds, and payment bonds.
- Subcontractor Performance Bonds: The Surety Bond company promises to finish the work if the subcontractor defaults. This helps protect the project owner and the general contractor on the project.
- Subcontractor Payment Bonds: This bond protects everybody under the subcontractor including, sub-subcontractors, laborers, and suppliers. The bond assures these parties receive payment even if the subcontractor defaults.
If you decide to go with a Surety Bond, remember that when you think a subcontractor has defaulted on a project, you must open an investigation with the bond company. They are the ones who will determine if there was a breach of contract.
It is also important to point out that with a Surety Bond, the bond company handles finishing a project when a subcontractor defaults. This is an important aspect to consider if you are working on many projects and do not have the time to find new subcontractors.
Should I go with SDI or a Surety Bond?
There is no cut-and-dry answer to whether Subcontractor Default Insurance or a Surety Bond is a better coverage option. Let us look at some key points from each that should help you decide which better fits your needs.
Subcontractor Default Insurance Key Points
- You decide when there is a breach of contract.
- You decide who to hire to finish the work.
- Agreement between you and the insurance company for payment.
- Only provides coverage for the policyholder.
- The policy limit does not always cover the cost of the subcontractor’s contract.
- Quicker payment.
- Lower premium.
- High deductible.
Surety Bond Key Points
- You open an investigation with the bond company, and they decide if there is a breach of contract.
- The bond company is responsible for finishing the job.
- Coverage for contractors, subcontractors, and anybody else working below the subcontractor.
- Covers the entire cost of the project.
- More expensive.
- Low deductible.
Help Me Decide What Tool I Need to Protect My Company
Regardless of the size of your organization, proactively managing these types of risks is critical. Whether you are a primary contractor with subs or a subcontractor, be mindful of contract terms, in particular the definition of default. Know your options for mitigating your risk and involve your risk advisors and surety professionals in the conversation.
If you still need some help deciding if you need Subcontractor Default Insurance or a Surety Bond to protect your projects from a contractor defaulting, download this free guide. In it, you will find the pros and cons of SDI coverage and Surety Bonds that you can go back and reference whenever needed.