Subcontractor Default Insurance: A Necessary Investment?

Subcontractor default insurance (SDI) is a risk management tool that protects general contractors from losses if a subcontractor defaults on a contract. This could be because they are unable to finish their work, are no longer in business, or have performed poorly. SDI is an alternative to surety bonds, giving contractors more autonomy and control over managing the risk. The insurance covers the costs of finding a replacement subcontractor, paying penalties for finishing a project late, or redoing poorly done work. It is available to large general contractors, typically with annual subcontract volumes of $75 million or more.

Subcontractor default insurance (SDI) is a risk mitigation tool

Under an SDI policy, a general contractor enrolls all prequalified subcontractors for a specific project or policy term. The general contractor is then indemnified by the insurance company for any covered direct or indirect costs incurred if one of the subcontractors defaults on performance. This includes both direct and indirect costs, such as liquidated damages, acceleration of other subcontracts, and extended overhead. SDI policies generally cover losses related to first-tier subcontractors and second-tier contractors.

SDI is a valuable tool for general contractors as it provides financial protection and control. In the event of a default, the general contractor can make a claim and select a replacement subcontractor to complete the work. The claims process for SDI is also faster and more reliable than that of surety bonds, which can create frustrating delays on time-sensitive projects.

SDI gives general contractors the confidence that they can deliver their projects to owners and helps them stay in control of the project in the event of a default. It encourages better subcontractor management and provides the security of knowing that subcontractor defaults will be covered. SDI also allows the general contractor to control when to declare a default, enabling them to respond more effectively to issues.

SDI is an alternative to surety bonds

Subcontractor default insurance (SDI) is an alternative to surety bonds. It is a risk mitigation tool for general contractors to control subcontractor default risk. It protects GCs and upstream parties from subcontractors who default on contracts because they are unable to finish their work, are no longer in business, or perform work so poorly that it must be redone.

SDI is a type of coverage that helps pay for losses when a subcontractor defaults on their work. It can provide savings to the GC and more control in case of a default. This coverage doesn’t mean a subcontractor can get out of their contract. They are still liable for the work they promised to do. When a subcontractor defaults, the contractor is the one who deals with the financial repercussions. Because of this liability, SDI helps pay for common risks like:

• Finding a new subcontractor to finish the job
• Payments for finishing late
• Redoing work that does not meet requirements

SDI is a two-party agreement between the insurer and the insured (the at-risk party holding direct contracts with subcontractors, e.g. the GC or CM at Risk). In contrast, a surety bond is a three-party agreement between the general contractor, subcontractor, and surety bond company.

With SDI, the GC determines when a subcontractor is in default and can start a claim. For example, if a subcontractor has financial difficulties and can’t pay their workers, the GC can start a claim and select a replacement subcontractor to complete the work. The GC controls when to declare a default and can more effectively respond to an issue. The SDI policy gives funds directly to the GC, allowing them to deliver the whole project contract to the owner.

SDI is typically not required by project owners, while performance and payment bonds are often required on public construction projects. Some private owners may also require bonds instead of or in addition to SDI.

SDI is a type of catastrophic insurance policy

Subcontractor default insurance (SDI) is a type of catastrophic insurance policy that safeguards general contractors from financial losses if a subcontractor fails to fulfil their contractual obligations. It is a risk mitigation tool that empowers general contractors to manage subcontractor default risk effectively. SDI offers comprehensive coverage for economic losses incurred due to a subcontractor's default, including both direct and indirect costs.

SDI is designed to protect general contractors when subcontractors default on their contracts by failing to complete their work, going out of business, or performing unsatisfactory work that necessitates redoing. It serves as an alternative to surety bonds, providing general contractors with greater autonomy in managing risks associated with subcontractor performance. The insurance policy covers losses related to first-tier subcontractors (those directly contracted with the general contractor) and second-tier subcontractors (those contracted with first-tier subcontractors, including suppliers).

One of the key advantages of SDI is the enhanced control it gives to general contractors. They have the authority to decide if a subcontractor has breached their contract and can immediately file a claim. Additionally, SDI allows general contractors to select qualified subcontractors for specific projects, ensuring they choose competent and reliable partners. This proactive approach to risk management incentivises general contractors to closely oversee subcontractors, fostering a more efficient construction process and better outcomes.

SDI also offers broader coverage compared to other options, including indirect expenses such as liquidated damages, acceleration of other subcontracts, and extended overhead. The coverage limits are not tied to the value of the subcontract but extend to the policy limits, which can be as high as $50 million. This higher coverage limit provides greater financial protection for general contractors in the event of a subcontractor default.

SDI is particularly attractive to large general contractors with substantial subcontracted values, as it helps protect their profitability and manage their risks effectively. It is a valuable tool in the construction industry, where labour shortages, material delays, price escalations, and other factors can increase the risk of subcontractor default. By choosing SDI, general contractors gain financial flexibility, streamlined claims resolution, and improved control over project outcomes.

SDI provides coverage for direct and indirect costs

Subcontractor default insurance (SDI) is a risk management tool that protects general contractors (GCs) from losses if a subcontractor defaults on a contract. It covers both direct and indirect costs resulting from a subcontractor's default. This includes the costs of completing any unfulfilled obligations, such as subcontractor replacement, job acceleration, extended overhead, and liquidated damages.

SDI provides coverage for direct costs such as the expense of hiring a new subcontractor to finish the work. For example, if a concrete subcontractor defaults on a $500,000 contract, the general contractor may need to hire a new subcontractor at a higher cost to avoid delays in other areas of the project. The increase in the subcontract value would be covered by SDI.

Additionally, SDI covers indirect costs, such as liquidated damages due to schedule delays caused by the default. In the previous example, the $400,000 in liquidated damages resulting from the schedule delay would also be covered by SDI.

SDI also covers other indirect costs, including contingencies and claim preparation expenses. It is important to note that the exact terms of coverage may vary, and it is always advisable to consult the specific policy to understand the included costs.

By providing coverage for both direct and indirect costs, SDI helps general contractors mitigate the financial risks associated with subcontractor defaults and ensures they have the necessary resources to complete their projects successfully.

SDI is a two-party agreement

Subcontractor default insurance (SDI) is a two-party agreement between the insurer and the insured (the at-risk party holding direct contracts with subcontractors, usually the general contractor or construction manager). It is a risk-mitigation tool that protects general contractors and upstream parties from losses incurred due to a subcontractor's default on their contract. This includes defaults due to a subcontractor's inability to finish their work, ceasing to be in business, or performing work so poorly that it must be redone.

In the event of a subcontractor defaulting, the insurer directly indemnifies the contractor for costs related to the default, including both direct and indirect costs. This can include costs such as liquidated damages, acceleration of other subcontracts, and extended overhead. The SDI policy gives funds directly to the general contractor, allowing them to maintain control of the project and deliver the whole project contract to the owner.

The general contractor typically has to absorb some of the costs associated with resolving the default, up to the deductible amount. This is known as the self-insured retention (SIR) or copay. The deductible for SDI policies can be high, usually at least $500,000.

SDI is different from surety bonds, which are three-way agreements between the contractor, the surety bond company, and the subcontractor. With SDI, the general contractor has more autonomy and control over managing the risk. They are responsible for pre-qualifying the subcontractors and determining when a subcontractor is in default. This gives the general contractor the flexibility to choose the most qualified subcontractors for the job and decide when to trigger a claim to overcome the obstacle most effectively.

SDI is particularly useful in situations where there is a risk of subcontractor default, such as during labour shortages, material delays, price escalations, or when subcontractors carry expanding backlogs. It is available to large general contractors with annual subcontract volumes of at least $100 million.

Frequently asked questions