Are you familiar with subguard? If not, subguard is an insurance product also known as subcontractor default insurance. It is an insurance product obtained by the general contractor and subcontractors are enrolled by the contractor into the subguard program; the general contractor does the prequalification based on the subcontractors and suppliers it wants to utilize. The general contractor can recover its losses (direct and indirect) from defaulting subcontractors (including consequential losses, losses from defective work, losses from a defaulting subcontractor’s non-payment to others, etc.). Subguard is typically more cost effective than requiring subcontractors to obtain performance bonds and allows the general contractor to recover losses (above a deductible) much quicker than if there was a subcontractor performance bond. (Subguard is not the only subcontractor default insurance product on the market, but it is perhaps the most recognized product. For purposes of this article, subguard will refer to all subcontractor default insurance products.)
Large general contractors on large-scale projects prefer subguard versus requiring subcontractors to obtain performance bonds considering general contractors are in a position to prequalify subcontractors and remedy a potential subcontractor default (without having to jump through the required performance bond hoops that could result in further financial loss to the contractor while the claim is being investigated by the surety). Unlike a performance bond where there is the principal, the surety, and the obligee, with subguard, there is only the general contractor–the insured that obtains the subguard–and the insurance company. Subcontractors, while enrolled in the program, are not parties to the policy; the general contractor is the only party that can submit a claim on the subguard policy.
Subguard is a first party insurance policy but it works different than a typical first party insurance policy. The general contractor obtains a subguard policy with a policy limit and (large) per claim deductibles / self-insured retentions. The policy is written for a set period of time (in numerous instances the 10 year statute of repose period). When there is a claim, after the general contractor pays its deductible, there is a co-pay requirement where the general contractor and subguard insurer share in the losses until the general contractor pays a retention aggregate amount which is the capped amount the general contractor will have to pay relating to a claim. Once the cap has been paid, the subguard insurer pays the balance of the claim up to the policy limit. The sentiment is with a large deductible and co-pay requirement until an aggregate amount is paid, the general contractor has more incentive to prequalify subcontractors, manage the work, and eliminate subcontractor default since the contractor has a vested financial interest to prevent the default from occurring. For example, a subguard policy can have a large deductible of $500,000, a retention aggregate of $1,000,000, and require the contractor to pay 20% of the loss after the $500,000 deductible. So, if a subcontractor default costs the contractor $2,500,000, the contractor will pay the first $500,000 and then 20% of the remaining $2,000,000 up to its retention aggregate. In this example, the contractor would have to pay another $400,000 (20% of the $2,000,000), which would be a total of $900,000 and below its retention aggregate of $1,000,000. The subguard insurer would be responsible for the remaining portion of the claim.
Additionally, a contractor that is well equipped at managing subcontractor defaults may procure a subguard policy with a retrospective premium agreement. This is advantageous to the experienced contractor because deposit premium (sometimes referred as the experience portion of the premium) can be returned to the contractor based on no subcontractor defaults or minimal claims on the policy that the deposit portion of the premium would be applied to.
From an owner’s perspective, subguard is not a substitute for requiring the general contractor to obtain a performance and payment bond. A major reason being that the owner is not an insured under the policy. With that said, subguard is a valuable alternate to requiring subcontractors to obtain performance and payment bonds and is a product on large projects by large contractors that an owner should consider since most of the work will be performed by subcontractors (and, as mentioned above, it is typically more cost effective than requiring subcontractors to be bonded). With subguard, the general contractor is bearing the risk (with no excuses) for subcontractor default since it obtained an insurance product to specifically cover this risk (and the direct and indirect losses associated with this risk) and, thus, is incentivized to best manage the trades and eliminate default.
Check out this presentation for more information on subcontractor default insurance as an alternative to subcontractor performance bonds.
Please contact David Adelstein at dadelstein@gmail.com or (954) 361-4720 if you have questions or would like more information regarding this article. You can follow David Adelstein on Twitter @DavidAdelstein1.