WORKSHOP T2
Tuesday, November 10
10:30 a.m.–noon
2:30 p.m.–4:00 p.m.
SUBCONTRACTOR DEFAULT INSURANCE:
MARKETS, MYTHS, AND MISCONCEPTIONS
Presented by
Workshop T2
Douglas Schrift
Managing Director, Contractor Default Insurance
Aon Construction Services Group
Many construction risk or insurance professionals have an inaccurate understanding of
subcontractor default insurance. Some of the misconception is based on myths, and
some is based on out-of-date information. This workshop will provide clarity on commonly misunderstood issues such as coverage for liens, required retentions, and subcontractor prequalification. Attendees will get an overview of the expanded
marketplace for this coverage, and key differences in insurers’ underwriting philosophies for this coverage and the practical implications for contractors are also examined.
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Copyright © 2015 International Risk Management
Institute, Inc.
www.IRMI.com
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DATA
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RISK
your
Aon Construction Services Group can empower
your growth, profitability, and continuity.
As the leading provider of risk solutions to the
construction industry, Aon Construction Services
Group partners with clients to provide insightful
analysis, strategic direction and creative solutions
backed by our dedicated team of construction
experts and the strength of Aon’s global network.
For more information about Aon Construction
Services Group, visit us at the IRMI Welcome
Reception or at the Tuesday breaks sponsored
by Aon.
Risk. Reinsurance. Human Resources.
Douglas Schrift
Managing Director, Contractor Default Insurance
Aon Construction Services Group
In his role as managing director of Aon’s Construction Services Group Contractor Default Insurance (CDI) practice, Mr. Schrift leads a national team of skilled construction and insurance industry professionals in supporting general contractors with subcontractor risk avoidance techniques
and default loss mitigation solutions. Prior to joining Aon, Mr. Schrift was vice president and director of risk finance for Lend Lease Americas, legacy to Bovis Lend Lease, where his responsibilities
included implementing risk finance strategy, as well as insurance financial and management
reporting, audit compliance, analytics, and leading a consistent and sustained CDI program. He
also held positions as director of management reporting and commercial controller.
Mr. Schrift earned a bachelor of arts degree from St. Francis University and completed the Executive Education Program at Columbia University’s Graduate School of Business. He speaks frequently at construction risk management events on the topic of subcontractor default risk management. He is a Certified Public Accountant in North Carolina.
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Notes
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Subcontractor Default Insurance:
Markets, Myths, and
Misconceptions
Presented By:
Douglas Schrift
Managing Director
Aon Risk Solutions
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Peter Fewings, 2005
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Workshop T2
“A stakeholder is anyone who has an interest in
the process or outcome of a project.”
Stakeholders
•
•
•
•
•
•
•
•
•
General Contractors
Subcontractors / Suppliers
Lower Tier Subcontractors / Suppliers
Design / Architects / Others
Owners / Developers / SPV’s
Banks / Lenders
Surety
Insurance Carriers
Brokers, Consultants, Legal Counsel
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Douglas Schrift
Managing Director, CDI
Aon Risk Services
Charlotte, NC
I am a
stakeholder!
704-654-9085
[email protected]
Linkedin.com
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DEFAULT
‘Material breachobligee
or isajustified
series
of the
breaches
of such
in terminating
contract
magnitude the obligee is justified in terminating
the contract.’
Material breach or series of breaches of such magnitude the
Bond Default Manual Third Addition, 2005
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Default Insurance
Basic coverage overview:
- Coverage of loss due to prime contractor’s subcontractor or supplier default
- Subcontractor default triggers policy; insurer has no right to challenge default
- Coverage limited by per loss and aggregate loss; applicable in excess of subcontract value
- Coverage subject to retention and co-pay by prime contractor; limits apply
Enhanced coverage
Direct remedy, replacement and rip and tear costs of subcontractor default
Direct investigation, legal, consulting and engineering costs of subcontractor default
Limited indirect costs of project acceleration, overhead, liquidated damages, etc. Incurred by prime
contractor as a result of sub default – up to $5M per loss; percentage limits option;
Limited prime contractor coverage to owner for general conditions/self perform – up to $35M/project
Dedicated project limits available
Coverage for payment of professional services associated with claims preparation
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When is a claim valid?




When
When
When
When
a subcontractor
placed
into
default
Material breach oris
series
of breaches
of such
magnitude the
obligee
is
justified
in
terminating
the
contract
the subcontractor is at fault
a default results in an a loss to the general contractor
a claim is documented
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Markets
Name(s):
Contractor Default Insurance (CDI), Subguard®, ConstructAssure®, Subcontractor Default Insurance (SDI)
Use in Market:
Widely utilized in N. America; Programs in place for 50% of the top 100 ENR contractors; Available in UK,
Germany and Australia
Typical Amount:
Varies (per loss limit and aggregate limit to suit contractor’s risk appetite and third party risk appetite – equity and
debt)
Contractor Size:
At least $50 million in per annum subcontract volume enrollment
Contractor
Experience:
Strong operational best practices
Project Size:
Any
Project Type:
Usually Buildings (challenges: plants, civil, and residential, although currently using these products)
Contract Structure:
At risk contracts
Trigger:
Notice of default issued by insured to subcontractor
Remedy:
Replace subcontractor, finance subcontractor, or pay loss amount (general contractor or others with financial
interest control final remedy)
Response Time:
30 days from proof of loss filing
Considerations:
• Covers only subcontractor default risk (deemed by S&P to be a top 5 construction risk)
• Carriers include Zurich, XL Catlin, and Arch
• Capacity has grown to $75 million per loss limit and $225 million aggregate limit with project specific policies
also available
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Source: Aon Risk Solutions
Trends:
• Complex claims situations where the subcontractor is not yet out of business
• Concerns over larger subcontractor packages and a challenged labor market
• Residential claims more costly than non-residential
A Hardening Market?
Aversion to non-union general contractors in the Northeast United States; focus on growth strategy;
Reduced appetite to carry “for sale” residential risk within the overall insurance carrier portfolio;
Increased emphases on QA/QC and other operational controls;
Ongoing trend towards limiting single-loss coverage to a factor of subcontract price (e.g. loss limits of 3X
subcontract price);
Challenging environment for non-SDI general contractors without a proven prequalification process to
obtain coverage;
Pressure towards increased premiums and general contractor retentions;
“Training Wheels”
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MYTHS ABOUT SUBCONTRACTOR DEFAULT
INSURANCE:
AND the Reality of the Construction Progress
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MYTH:
Zurich Dominates the Market
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REALITY:
Zurich launched Subguard® in 1995 through it’s subsidiary Steadfast Insurance. They secured
this niche with a moat that included cultivating in house knowledge on SDI claims, risk
engineering services, and partnering with larger subcontractor volume general contractors.
Zurich held an effective monopoly on SDI for 15 years. Overtime, departing Zurich employees
went into competition with their employer and used their knowledge, skills, and experience to
compete. First Arch/Catlin, now just Arch, and then XL, now XL/Catlin.
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MYTH:
“With SDI, the prime contractor must
perform its own prequalification,
which is unlikely to be as thorough as
the surety’s.”
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REALITY:
A general contractor is typically the best party to understand the operational capabilities of a
subcontractor. Given the large deductible and co-pay requirements that put the contractor’s
own funds at risk under an SDI program, an insured is more incentivized and engaged in the
process than they might be under other forms of security. Engaging in prequalification provides
the general contractor with visibility into subcontractor strengths and weaknesses which may
be vetted against the specific proposed scope of work. In addition, working by triage, the
general contractor is able to specifically target identified weaknesses through the process of
risk mitigation.
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MYTH:
Subcontractor prequalification is
expensive and time consuming for
both the general contractor and
subcontractor.
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REALITY:
Since the 1990s, the number of general contractors taking advantage of available technology to
prequalify subcontractors has increasingly become the norm. Email, the Web, shared drives,
CPA’s and third party services offering data collection and prequalification software and
services have greatly reduced the inefficiencies of the paper process and now provide general
contractors with more visibility into their subcontractor relationships before making a final
determination on award. A small investment in fostering a company-wide commitment to an
agreed prequalification process eliminates redundancy and reduces significant financial risk in
the firm. In addition, the actual costs of this investment are typically covered within the pricing
model of successful SDI programs.
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MYTH:
SDI makes it easier to default the
subcontractor.
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REALITY:
Defaulting a subcontractor has nothing to do with a general contractor’s choice of risk
management tools. Whether the general contractor employs SDI, surety bonds, letters of credit,
owner indemnity or practices no risk transfer, the ability to default a subcontractor is governed
by the underlying subcontract. A subcontractor still has rights under the subcontract and
should a court later determine the subcontractor was improperly defaulted, not only could the
general contractor be subject to paying damages, the firm could be faced with the prospect of
repaying the insurance company for claimed SDI funds.
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MYTH:
SDI doesn’t provide payment
protection for lower tier
subcontractors and suppliers.
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REALITY:
SDI does not provide assurance of payment protection for lower tiered
subcontractors. However, the simple omission of a payment bond doesn’t
necessarily mean there is no protection available for subcontractors. In addition,
while a subcontractor cannot make claim against a SDI policy, the general
contractor does have the ability to claim losses to satisfy downstream payments
to tiered subcontractors, provided the direct subcontractor is in default of their
contractual obligations. When combined with lien rights and the general
contractor’s need to vacate liens, use of SDI provides a reasonable level of
payment assurance.
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MYTH:
SDI provides coverage to an owner in
the event of a subcontractors default.
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REALITY:
SDI protects owners by placing the general contractor in a position to individually manage a
subcontractor default situation and to provide financial relief to the general contractor for losses
incurred as a result of the default. As such, risk of the general contractor not completing the
project within the planned budget and schedule are greatly diminished. Similar to subcontractor
payment and performance bonds, the intent of SDI is to cover the general contractor for these
risks. An available endorsement to the SDI policy provides the owner access to the policy only in
the event of general contractor insolvency. Otherwise, the owner must seek recourse direct with
the general contractor through the general contractor contract (e.g. LD’s, the courts) or through a
general contractor surety.
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MYTH:
SDI is simply another way for a
general contractor to profit at the
expense of the owner.
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REALITY:
The single most impactful risk to project success is the default of a
subcontractor. Under the typical “at risk” contract, the general contractor
assumes the risk of budget and schedule. In lieu of bonds, the general
contractor uses SDI to transfer a portion of the risk to an insurance carrier. SDI
is typically priced competitive with subcontractor surety bonds, offers coverage
enhancements, and allows for the general contractor to retain control of the
default situation. Use of SDI is a reasonable solution for a difficult situation and
provides value to the owner, to the entities financing the construction loan, and
to other subcontractors working on the project.
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MYTH:
SDI provides protection for the
general contractor’s work.
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REALITY:
Similar to a subcontractor surety bonds, SDI does not provide loss coverage for the
work of a general contractor. Both products are intended to provide loss coverage
to the general contractor in the event of a subcontractor default, not for general
contractor failure. XL Catlin does offer a hybrid solution called CapAssure®.
CapAssure® combines the XL Catlin SDI coverage option with limited prime
contractor coverage to the owner for general conditions/self perform.
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MYTH:
SDI coverage ends at the expiration of
the policy period.
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REALITY:
SDI coverage does not end at the date of expiration noted on the policy. The
policy period represents the time period available to the insured to enroll
projects or subcontractors into the policy. The actual coverage period is
determined by the policy and often permits claims for a period of up to 10 years
after project completion.
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MYTH:
Failure to prequalify a subcontractor
results in no coverage to the insured.
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REALITY:
Historically, 100% accurate. However, at least one insurance carrier has
issued endorsements on select accounts with requirements for the insured to
collect and analyze subcontractor financial statements “in order to be covered”
by SDI. This endorsement is intended to drive process and does not specify
the manner of what documents are to be collected, when, or the required
financial analysis output.
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Workshop T2
For more information on how Aon Construction Services Group can help you
understand common misconceptions of Subcontractor Default Insurance,
please feel free to contact me.
Douglas Schrift
Managing Director, CDI
Aon Risk Services
Charlotte, NC
704-654-9085
[email protected]
Linkedin.com
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Notes
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T2. Subcontractor Default Insurance: Markets, Myths, and Misconceptions
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Douglas Schrift
Preparation and quality of information
Energy and enthusiasm of delivery
Educational focus (not a sales pitch)
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