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AMHIGLEY BUILDERS BLOG: Ensuring Risk Mitigation through Subcontractor Default Insurance


AMHigley employees give their technical expertise and insights into the construction industry. This month’s blog features Mark Vega analyzing the benefits of Subcontractor Default Insurance for a subcontractor, construction manager, and owner.

Ensuring Risk Mitigation through Subcontractor Default Insurance

enter image description here Mark Vega, Senior Vice President, Operations - 11 Years with AMHigley

In the realm of construction projects, risk mitigation stands as a cornerstone for success. Amid a complex web of subcontractor engagements and project intricacies, traditional bonding has long been the standard safeguard. However, a paradigm shift is underway, the alternative: Subcontractor Default Insurance (SDI) programs. SDI programs offer an excellent way to safeguard project schedules and reduce costs, benefiting both the construction manager and the owner.

Traditional bonding for subcontractors involves three parties: the bonding company, a subcontractor, and the owner. Bonds tie the sub directly to the owner. With an SDI program the construction manager is tied to the owner and the middleman is cut out of the process. The relationship is between the construction manager and an insurance company.

If a subcontractor were to default on a project, it can take weeks, if not months for a bonding company to step up and solve the default issue. With an SDI program, it takes only days for the subcontractor to be replaced which means that there is no significant impact on the overall performance and schedule of the project.

Subcontractors benefit the most from these programs, as they do not have to cover the bonding cost in their bids for the work. Construction managers charge the owner a smaller percentage compared to a bonding cost as well as assuming more risk for the project, taking the burden off subcontractors.

An SDI program also opens a project to subcontractors that might not have the traditional bonding capacity to complete the project. The owner can now utilize smaller/diverse subcontractors with higher risks, but the construction manager has more controls in place because of SDI. This is where a prequalification process comes into play. A prequalification requirement for subcontractors is put in place to evaluate three criteria: safety performance, financial strength, and field performance. Prequalification software can help with the process and bid management. The software will identify risks based on the evaluation criteria. The construction management team will then review the risks with the subcontractors to recommend the best fit for the project.

“In the 15 years we have been using Subcontractor Default Insurance, we have only had to default one subcontractor. The prequalification process we use allows us to choose the best subcontractor for the job and helps manage risks.” – Mark V.

Overall, SDI coverage goes beyond the standard coverage of a bond. since SDI covers indirect costs associated with a project, while bonding only covers direct costs. Indirect costs can include liquidated damages, extended overhead, acceleration of schedule/other bid packages.

As the economy continues to fluctuate, a recession is likely to come within the next few years. This can cause a massive impact on the industry and subcontractors. Since the industry feels a delayed effect of a downturn in the economy, subcontractors tend to go out of business 2-3 years after a recession. Therefore, when the economy comes down, the insurance company will look to a construction manager and their SDI to see what measures are in place to prevent issues. Since owners are not aware of how subcontractors are performing on other jobs, with SDI they are protected if a company were to go out of business.

It is the responsibility of a construction manager to push owners to use the best practices for a successful project. This involves using SDI to offer broad, consistent, and efficient coverage for defaults. SDI programs are a superior risk management tool for any construction manager and has numerous benefits to both subcontractors. The benefits mean an on-time and on-budget project delivery.