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August 17, 2015
John Claeys, Surety Manager
Subcontractor Default Insurance (SDI) has become a much more visible feature on major construction projects in the Northwest. Our region was arguably the last to embrace SDI. But, with the huge spike in commercial construction, the influx of national contractors, and the now proven track record of the product, owners, and contractors in the Northwest have embraced the product.
SDI is an insurance policy used as an alternative to surety bonds in transferring the default risk of subcontractors and suppliers to an insurer. Originally known as “SubGuard” (a Zurich trademark), SDI is now a product marketed by several insurers and, in some cases, used as part of a captive insurance program.
By using the structure of an insurance policy rather than a surety bond, SDI is able to provide a general contractor with more control over both the claims process and the schedule of the job. While surety bonds have an impressive and proven record of performance, the surety’s role and responsibility can be seen as time-consuming and complex in resolving default claims. The Insurance policy format of the SDI product makes the claim process more efficient and predictable.
SDI gives the general contractor more control, enabling them to address a subcontractor failure more quickly. SDI also provides some soft cost coverage related to expenses not strictly available from a bond. However, the very nature of the process of enrolling subcontractors in an SDI program yields a less obvious, but no less tangible benefit: a focus on the general contractor’s chosen subcontractor’s viability, capability, and compatibility with the rest of the project team.
In order to qualify to for an SDI policy, a general contractor needs to establish sophisticated subcontractor prequalification and management systems. These systems are designed to collect, analyze, and monitor meaningful financial and operational information to assist the general contractor in selecting and managing qualified subcontractors. We have observed measurably improved relationships between general contractors and subcontractors when they share more information and develop a regular dialogue on the inner workings of each other’s businesses.
There is also evidence that as SDI becomes more prevalent in our market, it is playing a role in changing dialogue at the owner/general contractor level. General contractors are focusing more on the prequalification element of their role and the long-term value of assembling the best team for the project in their conversations with owners. Whether the tool is a bondor SDI, the construction market wins when projects are awarded on this basis.
Surety bonds continue to offer value to the construction industry, and it is clear that SDI has also created value in the construction marketplace. Determining whether you could benefit from SDI requires a detailed review of your situation, which we have done numerous times and could readily do for you. Your questions around SDI will be very different depending on your role in the construction marketplace: General contractors will want to carefully analyze the product to see if it is a fit for their business model. Subcontractors should understand the product and prequalification process in order to enhance their opportunities for new work. Owners should understand the costs and the benefits as they relate to the success of their projects.
There are meaningful differences among providers of SDI, and should it be determined that SDI could benefit you, we can explain the strengths and weaknesses of each. Bonds and SDI are outstanding tools when used as part of a thoughtful risk management strategy. As a full-service broker, Parker, Smith & Feek can assist you in determining the best combination for you and your business.
The views and opinions expressed within are those of the author(s) and do not necessarily reflect the official policy or position of Parker, Smith & Feek. While every effort has been taken in compiling this information to ensure that its contents are totally accurate, neither the publisher nor the author can accept liability for any inaccuracies or changed circumstances of any information herein or for the consequences of any reliance placed upon it.