Subcontractor Default Insurance (SDI): An Alternative for General Contractors

Construction & Real Estate, Property & Casualty

Large projects have many moving parts and, often, a revolving door of subcontractors. General contractors know that, without protection, the default of one or more of these subcontractors could result in the project falling through, wasting millions of dollars in the process.

For that reason, savvy contractors purchase insurance to protect their work and get it across the finish line. Over the years, insurance products for this purpose have evolved to better fit the state of the industry. Today, it is becoming common for large general contractors to consider a product known as subcontractor default insurance (SDI) in lieu of traditional performance/payment bonds from subcontractors. For example, the Arizona Cardinals stadium project utilized SDI rather than performance/payment bonds.

What is subcontractor default insurance?

SDI is a two-party agreement that shifts the burden of defaulting subcontractors to an insurance company. The policy specifies that the insurance company will compensate the general contractor for resulting losses from the subcontractor’s default.

Key things to know about an SDI Policy:

  • Generally speaking, general contractors with revenues of $50,000,000 or more can take advantage of an SDI policy
  • Covers all chosen subcontractors on a given project or on an annual basis for all projects combined. There is no individual policy for each subcontractor
  • Covers indirect losses due to subcontractor default including liquidated damages, contingencies, etc.
  • Targets private projects as opposed to publicly bid projects
  • Pricing is negotiable, but the rate is rising due to fewer players in this market and increased losses.
  • Policy term is usually 3-5 years
  • Deductibles are required and have become larger due to increased claim activity in this space.
  • Limit of liability is determined by general contractor, which can be the total dollar amount of subcontracts on a project basis or on an annual basis
  • Most common claim types can include: construction defect after a project is complete, unpaid amounts due by subcontractor, solvency issues from other jobs

Why SDI?

Contractors choose SDI for a number of reasons over traditional bonds from subcontractors. One major selling point is claims resolution. SDI makes the general contractor responsible for resolving subcontractor default issues, although costs to complete the work are covered. If the subcontractor had a bond, it could be a drawn out process controlled by the surety company of the subcontractor.

Default is also a major consideration. SDI has the general contractor take over the project and manages the defaulting contractor’s obligations under the construction contract. In the traditional bond approach, the surety company will take over the project, rebid the job, pay the general contractor the required funds or pay the obligee the penalty under both the performance and payment bonds – whichever applies. SDI proponents stress the importance of getting the general contractor to take over the default for project efficiency and successfully, in contrast to the longer process historically used by surety.

Other benefits of hiring a general contractor which uses SDI:

  • Improved project delivery in the event of a subcontractor default
  • Cost savings over bonding subs and more subs covered
  • 5-10 year warranty provisions
  • Availability of the assignment of the benefits of the SDI policy if the GC defaults

Before you begin your next project, consider whether SDI may be the right option to protect against default. Though you may have purchased the same insurance product repeatedly for past projects, it’s smart to evaluate innovative alternatives that may have better results for your business.

Reach out to your M3 Construction & Real Estate Client Executive to discuss your options and make the best decision for the project at hand.

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