Nick Bilski
In today’s economic climate, navigating material and labor supply chain impacts on construction can be challenging. One of the most important roles of any Construction Manager (CM) involves how well they effectively manage cost and risk for their clients. BE&K Building Group’s (BE&K) tagline is, “It’s All About People.” It’s a tagline that is unique in our industry. Regardless of industry, very little can be accomplished without people. The construction industry is no exception. Identifying and securing qualified subcontractors committed to safely performing the work on our projects is one of the best ways that BE&K helps our clients effectively manage cost and risk.
Even with BE&K’s best-in-class subcontractor prequalification efforts, associated risk is never fully eliminated. In this month’s blog, I’m going to explore two, security options available to Owners — Subcontractor Default Insurance (SDI) and Payment + Performance (P+P) bonds. I’ll also explore BE&K’s related strategy to protect our clients against risk while also providing project cost savings, and why BE&K recommends utilizing SDI in lieu of P+P bonds on our projects.
Suretyship dates back to 1790 BC, with the Babylonian contract of 670 BC being the oldest surviving written surety contract. In 1894 Congress passed the Heard Act to authorize the use of surety bonds on federally funded projects. Shortly after, in 1935, Congress passed the Miller Act which applies to all federally awarded construction projects with a contract value exceeding $100,000 for the construction, alteration, or repair of any building or public work of the United States. For all such contracts, the contractor is required to provide both a payment bond and a performance bond to protect the interests of the federal government and taxpayers through third-party guarantees. A surety’s P+P bond underwriter will evaluate a contractor’s capacity, character, and capital to determine how much surety credit to extend for a specific project or group of projects. The granting of surety credit evidences the surety’s evaluation of the contractor’s ability to perform.
In comparison, SDI is a risk management alternative to traditional P+P bond programs. SDI is an insurance program utilized by CMs that protects against risk associated with a subcontractor’s failure to perform. On average, subcontracted work on projects represents more than 90 percent of a project’s final cost.
Today, CMs often go through a rigorous prequalification process with Owners to determine the best fit for a future project. An argument can be made that many private Owners often assume the responsibilities of a surety underwriter when evaluating a CM’s qualifications. Similar to a surety declining to extend a bond to a CM, a conscientious Owner will not agree to utilize a construction firm they feel has the potential to fail or underperform.
So, here’s a thought-provoking question. After completing a thorough qualification process for a highly qualified CM, why do many Owners continue to require a P+P bond to build their project? Instead, why not pay for a Subcontractor Default Insurance program? Let’s compare the two insurance products and learn about a few of the key characteristics of each coverage line.
SDI and P+P Bond Coverage Comparisons
- SDI coverage protects the Owner and CM from a catastrophic loss due to a subcontractor default.
- P+P bonds only respond to claims typically within one year of project completion, while an SDI policy will respond to a covered claim up to 10 years post-completion, depending on the jurisdiction’s construction defect statute of repose.
- A P+P bond will only provide coverage up to the penal value of the bond. In contrast, SDI will typically offer coverage up to 3 times a covered subcontractor’s contract value. History has shown that when a subcontractor defaults, it often costs 1.5 to 3 times the original subcontractor’s contract value to hire another firm to complete the defaulted subcontractor’s scope.
- The SDI product will respond immediately to a claim as the CM controls the claims process. The response to a claim from a surety representing a P+P bond is much slower, resulting in longer delays to the project’s schedule.
- SDI will compensate the named insured for indirect costs such as, but not limited to, job acceleration, extended overhead, and liquidated damages which can be difficult to recover from a surety.
- Certain subcontractors who may not qualify for a bond, but are otherwise qualified for the project, can be enrolled in SDI. Subcontractor bid lists can be expanded to include all qualified subcontractors, including minority and small business qualified firms.
The above are just a few examples of the many benefits of an SDI program. Owners requiring a P+P bond for the full value of a project from qualified CMs should be aware that additional and unnecessary costs are often incurred. Regardless of the presence of a project P+P bond, the CM may also require P+P bonds from their subcontractors, which could be as much as 2.5% of a subcontractor’s contract value with the cost often passed along to the Owner.
BE&K has utilized our alternative SDI program for over a decade in lieu of providing a traditional P+P bonds on many of our projects. Due to our rigorous prequalification process, nearly all our subcontractors qualify for BE&K’s SDI program, removing the need for traditional P+P bonds. BE&K’s SDI program provides a more cost-effective risk management solution for our Owners.
BE&K stands ready to provide our SDI program for your next project. We will effectively manage your project’s risk while also reducing your project’s cost.
For additional information, you may reach out to Nick Bilski, Director of Risk Management, at nick.bilski@bekbg.com.