When do construction firms need subcontractor bonds?
Surety bonds are vital to the construction industry and can be a profit center for insurance agencies.
For many property and casualty agents, the contract surety business is an enigma. Maybe it’s because surety isn’t written like a commercial lines policy. Or it’s the arcane language we use, like referring to project owners as “obligees.”
One thing is clear, though: Surety bonds are vital to the construction industry, and they can be a profit center for your agency.
Surety is a powerful risk-mitigation tool that ensures a contractor will perform according to the terms of the construction contract. This is especially true with subcontractor bonds, which protect the general contractor if a subcontractor defaults on a job.
It’s not too difficult to see why a general contractor (GC) might need to be bonded since it’s the GC who will be held responsible for anything that goes wrong on a project. Yet, staying on schedule and completing a job hinge on having good subcontractors. Subs can make or break a construction project.
If you have contractors as clients, you should be aware of the additional need for subcontractor bonding. These bonds can also open a new avenue of income for your agency.
Subs may do great work, but they still need to be bonded
In my 30 years of surety experience, most surety claims are on the payment bond. While subcontractors may be excellent at their craft, an entirely different skill set is required for paying bills and managing cash flow. If only there were a way a third party could analyze the financial statements of that subcontractor and make a guarantee to the GC that there is recourse and recovery in the event of a subcontractor default.
Well, that’s exactly what a subcontractor bond does. One of the most important functions a surety performs for a GC is prequalifying their bonded subcontractors. Sureties thoroughly analyze a subcontractor’s financial health, assess their experience and weigh their backlog of projects. They review what lines of credit are available to the subcontractor and any recent ownership changes. These are things that can be invisible to the GC, even if the GC has worked with the subcontractor before and knows their reputation.
Let’s look at some situations where subcontractor bonds are a good idea from a surety underwriter’s perspective. In these five instances, the surety may require or strongly urge that the GC have the subcontractor bonded.
1. A critical-path sub
Most large construction projects have what are known as critical-path subcontractors. They are essential to the project and can significantly delay its completion if they don’t finish their part of the job on time. The most commonly bonded critical-path subs are the mechanical, plumbing and electrical subcontractors.
2. A specialist that cannot be easily replaced
GCs should always bond back specialized subcontractors that are key to the project and difficult to replace. If a project has a unique installation — such as a custom-designed retractable roof — the GC would be hard-pressed to replace that sub if a problem arose.
3. Liability exposure that magnifies the GC’s risks
A subcontractor may be responsible for a key aspect of the project, such as the electrical, HVAC and fire suppression systems. The design liability from these complex systems may flow upward to the GC, magnifying the risk and cost of default. In these cases, the subcontractor should be bonded.
4. A subcontractor that is an unknown
It’s not always possible for a GC to hire subs they’ve worked with before. Perhaps their go-to drywall installer is on another job. For new subs that are unknown, GCs should consider requiring a bond, or at least securing a bondability letter from their surety.
A bondability or “good-guy” letter from a surety provides some comfort that an objective third party has evaluated the sub’s financials and has expressed a willingness to bond the sub within certain parameters. However, it doesn’t guarantee the performance of the sub or that the sub will pay their bills. For that peace of mind and transfer of risk, performance and payment bonds are needed.
5. A GC that wants to expand
If a GC is taking on a bigger project than normal, the GC’s surety may ask that the subs be bonded. A surety is more likely to increase a GC’s bonding capacity if the GC demonstrates they are willing to manage their own risks through subcontractor bonding.
Once you understand the unique way surety protects your contractor clients, you’ll be one step closer to helping them mitigate their project risks. Subcontractor bonds are an important risk-transfer tool, and they typically cost between 1% to 3% of the subcontract price. It’s a small investment for the assurance that your clients will be made whole if their subcontractors default on their obligations.
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