Subcontractor Default Insurance: A Contractor Smart Tool
Every time you are planning to use a subcontractor, the potential for default is always there but not only that, the terrible consequences and loss of time and money will have a direct impact on your business operations. However, since the 1990's there is a tool, a nice alternative that you can have in order to protect and have a relief when a subcontractor defaults, it is called the Subcontractor Default Insurance (SDI), also referred to as SubGuard.
Subcontractor Default Insurance
A Subcontractor Default Insurance provides relief for contractors when a subcontractor has its contract terminated by default. This type of insurance provides unique benefits when compared to a traditional default process, that will normally require litigation and delays that will significantly affect contract schedule. A Subcontractor Default Insurance (“SDI”) can be considered as an alternative to surety bonds.
When an owner requests an SDI coverage, it will receive a commitment by the general contractor and the company offering the service, that they will be partially responsible in the event of a default, but only in the portion related to completion of work. The SDI works when the insurance company provides additional coverage to the general contractor against losses arising out of the default of subcontractors, replacing the performance bonds of the subcontractors. SDI is not a substitute for a payment bond. If the general contractor becomes insolvent or just refuses to pay the subs, the subs have no recourse to the SDI policy.
How It Works
The SDI is a very simple insurance tool that works when the general contractor acquires the policy for a determined amount of money over a specific period of time. The insurance company and the contractor establish a deductible that must be paid by the general contractor. before the policy cover claims related to the work being performed by the subcontractor.
Both, the contractor and the insurance company agree on a co-pay, the percentage related to what the insured will pay after the deductible and will establish an aggregate value, the maximum amount the insured will have to pay for a claim arising during the policy period. Once this has been established, the contractor will qualify subcontractors, typically after a rating and qualification process, that will present the lower risk for that particular project. There is no payment bond right of subcontractors and suppliers.
The SDI offers the following benefits:
- Reduced premium costs
- The contractor has control over the qualification of subcontractors
- When a subcontractor defaults, there is no waiting period neither the need to conduct an investigation by the surety
- It offers coverage of entities otherwise unqualified for a bond.
- Minimizes the risk form an underperforming contractor
- Diminishes the delays when a subcontractor goes on default
- SDI provides an incentive for the contractor to improve its subcontractor prequalification process
- Contractors using SDI more proactively manage poor subcontractor performance
- The policy covers direct and indirect costs associated with the work being performed.
Affecting the Subcontractor
In order to qualify subs under the SDI, the general contractor will qualify and rate their performance using different information. Normally a contractor will issue an RFQ process asking their subs to provide financial information, past performances, EMR rates, quality plans, schedule management plan, and project execution plan. This information along with the staffing plan for each project will be considered and be used to determine whether the subcontractor meets the standard qualification process from the GC.
Once a contractor is qualified, the GC must be proactive in monitoring the schedule and performance of the subcontractor at the job site. it is possible that the subcontractor fails to meet the GC's qualification process, and in that case, then the subcontractor will not be able to participate in the Subcontractor Default Insurance program, so losses from the sub will not be insured under this policy.