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What is Subcontractor Default Insurance and When Might it be Needed?

Default Insurance

 

You love the feeling when you complete a project and can step back to admire all your hard work. That’s one of the wonderful things about being a construction contractor. But being a construction contractor is also difficult job. You need to satisfy your clients, manage your suppliers, and handle your subcontractors. That’s why you get construction contractor insurance, just in case something goes wrong.

A construction site can be a dangerous place. A small mistake can cause a lot of damage. There can be a lot of people involved in the project, which means there’s more risk that someone could make an error. This means that general liability insurance for contractors is a must.

The challenges of being a contractor or subcontractor

The construction business can be complicated. With subcontractors and contractors working on the same project, it can be unclear who has liability if things go wrong. For example, if someone trips and falls over uneven flooring, who is liable to pay their medical costs? Is it the contractor, or the subcontractor who installed the flooring? The subcontractor and the contractor both need valid construction contractor insurance, as well as a contract that makes it clear who is liable.

What is subcontractor default insurance?

There’s another issue at stake for the contractor. What happens if the subcontractor defaults on their contract? The subcontractor is liable to complete their work, but if they can’t finish it, you’re the one who’ll have to deal with the consequences. That could mean finding and hiring a replacement subcontractor, paying penalties for finishing the project over time, or having to redo poorly-done work.

That’s where contractor default insurance comes in. Contractor default insurance covers you  in case your subcontractor defaults on the project for any reason. It is totally different than general liability insurance, which covers you for property damage, personal injury, and physical injury that happens on your site or because of your work.

What is the difference between subcontractor default insurance and surety bonds?

You’ve probably heard about subcontractor surety bonds. You might even have used one yourself. A surety bond is a deal that you make with the subcontractor and a surety bond company to make sure that you won’t lose out if your subcontractor defaults.

There are two types of subcontractor surety bonds:

  • Subcontractor performance bonds protect the contractor and the owner of the project in case the subcontractor defaults. If that happens, the surety bond company promises to make sure that the work is completed.
  • Subcontractor payment bonds protect the sub-subcontractors, laborers, and suppliers in case the subcontractor defaults. If that happens, the surety bond promises to pay whatever the subcontractor owes them.

Many people get confused about the differences between subcontractor surety bonds and a subcontractor default insurance program. Both of them help the contractor in case the subcontractor can’t finish his work. But there are a lot of differences between them.

Here’s a quick overview:

  • Subcontractor default insurance is an agreement between you and the insurance company. Subcontractor surety bonds are a three-way agreement, between you, the surety bond company, and the subcontractor.
  • With subcontractor default insurance, you decide if the subcontractor breached their contract. If so, you can make a claim straight away. With a subcontractor performance bond, you have to wait for the surety company to investigate the situation, and they decide if it counts as a breach of contract.
  • With contractor default insurance, you are responsible for finishing the project. The insurance company simply pays out the agreed amount of money. With a subcontractor performance bond, the surety company takes over responsibility for finishing the project.
  • Contractor default insurance only protects contractors. Subcontractor payment bonds also protect the subcontractor, sub-subcontractors, suppliers, and laborers by promising to pay whatever they are owed.

 

Construction Business Insurance

 

Do I need subcontractor default insurance, or a subcontractor performance bond?

Choosing between contractor default insurance and a subcontractor performance bond  isn’t always easy. Here are the pros and cons to both options.

Subcontractor default insurance

Pros:

  • Premiums are less expensive
  • You’re in control of deciding if there’s been a breach of contract
  • You choose which subcontractor is qualified for the work
  • Pays out faster if there’s a breach of contract

Cons:

  • The deductible is very high, usually at least $500,000
  • You have all the responsibility for finding a new subcontractor and completing the project
  • You have to screen subcontractors yourself to decide if they are reliable
  • The policy limit is often less than the total cost of the subcontractor’s contract

Subcontractor performance bond

Pros:

  • The surety bond company has the responsibility to complete the project, so you don’t have to worry
  • The surety company screens subcontractors for you to decide if they are reliable
  • A surety bond covers the entire cost of the project
  • There’s no high deductible

Cons:

  • Surety bonds can be more expensive, usually 1% – 1.25% of the value of the contract
  • If there’s a breach of contract, you have to wait while the surety company investigates, which can delay the project even more
  • The surety company might not agree that there’s been a breach of contract, and refuse to pay out

Everything you need to know about subcontracting

Ideally, you won’t need to use your subcontractor performance bond or contractor default insurance, because everything will go smoothly. If you’re about to subcontract part of your next project, or to start working as a subcontractor, here are the main issues to keep in mind.

  • Read the contract carefully. The contract should include:
    • The subcontractor’s scope of work, describing exactly what they have to deliver
    • Who is responsible if the supplier doesn’t send materials on time and causes a delay in the work
    • When the subcontractor gets paid
    • How to settle disputes between the subcontractor and the contractor (e.g. through arbitration or through the courts)
  • Make it clear who is responsible for insurance. The contractor might add the subcontractor as an additional insured (this is free with Next Insurance), or they might require the subcontractor to provide their own certificate of insurance.
  • Agree on the types of insurance. You might want your subcontractors to have professional liability insurance, workers’ compensation, or other types of insurance for construction contractors.
  • Arrange a lien waiver. A lien waiver is an agreement between the contractor and the subcontractor. In the lien waiver, the subcontractor agrees not to file a lien on the property once they have been paid. There are 4 different types of lien waiver, so you need to decide on the one that’s best for you.

Whether you work as a subcontractor or hire subcontractors, you need to make sure that you’re protected in case of breach of contract. Understanding subcontractor default insurance and when you might need it helps you to decide if and when to buy a contractor default insurance policy.

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