Paper No. 11-0207
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TRB 2011 Annual Meeting
Performance Bond Benefit –Cost Analysis
by
Lorena Myers
(Corresponding Author)
Department of Civil and Coastal Engineering
University of Florida
345 Weil Hall
P.O. Box 116580
Gainesville, FL 32611-6580
Telephone #: (352) 392-1033
Fax #: (352) 392-9531
E-mail: [email protected]
and
Fazil T. Najafi, Ph.D.
Professor
Department of Civil and Coastal Engineering
University of Florida
345 Weil Hall
P.O. Box 116580
Gainesville, FL 32611-6580
Telephone #: (352) 392-1033
Fax #: (352) 392-9531
E-mail: [email protected]
Submission Date: November 14, 2010
Word Count:
Abstract
Text
(excluding Abstract)
Tables (8 x 250)
Figures (8 x 250)
TOTAL WORD COUNT:
181
5, 192
2, 000
0
7, 373
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ABSTRACT
A performance bond provides the assurance that an awarded construction project will be
satisfactorily completed in the event that the contractor is unable to complete the project as agreed
and the contract is terminated. Passed into law in the late 1800s, performance bonds protect against
financial losses.
The ability of contractors to provide performance bond has mistakenly been assumed as a
guarantee that contractors will perform well on the projects they are awarded. Indications are that
there is a need to evaluate the benefits and the costs of using performance bonds. This paper takes a
look at the benefit-cost of performance bonds on a national basis.
In order to perform the analysis, state construction project data was collected for contract
awards from September 2007 to September 2009. The results of the analysis suggest that states that
had a small number of defaults, or none at all, did not benefit from having performance bonds, while
those states that had numerous defaults did benefit. In conclusion, the results suggest that
performance bonds are beneficial to states that experience a large number of defaults.
INTRODUCTION
Background
Using bonds alone does not guarantee that a contractor can perform the work. Bonds protect against
financial losses but cannot predict delays and public inconveniences. Whether performance bonds
can be replaced by a performance based prequalification system is a research topic worth
investigating (1). So far, research has suggests that prequalification had not predicted delays,
eliminated public inconvenience, or guaranteed that contractors could perform work. From the
prediction standpoint, the value added by a performance based prequalification system is that State
Departments of Transportation (DOTs) would be putting to further use the contractor performance
information collected by the agencies (2).
While the current practice of states is to use performance bonds, an appropriate goal would
be to transition to a performance based qualification practice to help ensure completion of projects.
To consider transitioning from performance bonds to performance based qualification, the benefits
and costs of performance bonds need to be evaluated.
Research Objectives and Approach
The objectives are as follows:
1. Search literature on current topic of performance bond.
2. Collect contract awards data (name of contractor, type of project, cost of awarded project
and whether the contractor defaulted on the project) from September 2007 to September
2009 from all states.
3. For states with defaulted projects, obtain information about the percent complete of each
project at the time of default.
4. Obtain an estimate of surety performance bond premium cost for projects.
5. Categorize projects based on performance bond premium thresholds.
6. Apply bond premium to defaulted and all projects.
7. Analyze the type and range of projects experiencing the most defaults to see if there is
any correlation.
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8. Quantify and analyze the possible DOTs benefit-to-cost using the default information by
assuming 50 percent of total defaulted project cost is the amount the surety spent for
defaulted projects completion for selected states (presented later in Table 7).
9. Quantify and analyze the total cost of defaulted projects compared to cost of all projects
(presented later in Table 8).
10. Conclude whether the benefit/cost ratio supports the use of performance bonds.
11. Make suggestions for future research work.
The research approach is based on the relationship between performance bond and default. The
literature review section provides more insight into this relationship.
LITERATURE REVIEW
From a historical perspective, the use of performance bonding arose in the American construction
industry in the late nineteenth century in an attempt to protect public treasuries against the risk of
default on public projects. In response to the financial panic of 1893, the Heard Act was enacted (3),
by the United States (U.S.) Congress, and passed in 1894. The Heard Act granted a right of action in
the name of the U.S. against a prime contractor and its surety for unpaid labor and materials used in
the prosecution of contract work. In 1905, Congress amended the Heard Act by adding the phrase
“labor or materials used in construction of any public building or public work.” Noting deficiencies,
Congress repealed the Heard Act (4).
The Miller Act, enacted in 1935, effectively restated and recodified what had been known as
the 1894 Heard Act (5). The Miller Act provides the following: before any contract for construction,
alteration or repair of any public building or public work of the U.S. is awarded to any person, such
person shall furnish to the U.S. the following bonds (6), both performance and payment bonds for
certain contracts in excess of $2, 000, since revised to $100, 000 (5), which shall become binding
upon the award of the contract. A contractor shall furnish both performance and payment bonds, with
a surety or sureties, satisfactory to the officer awarding such contract and in such amount as he shall
deem adequate, for the protection of the U.S. (6).
The original act did not permit waiver of the bonding requirements, but certain decisions of
the Attorney General and the Comptroller General in the 1930s, coupled with the advent of World
War II, highlighted problems with the statute as written and led to a 1941 amendment allowing
waivers in certain circumstances. The problems leading to the amendment related to: the definition of
“public work”; defense contracts whose number and dollar value were increasing exponentially upon
the start of the war; and the surety industry struggling to keep up (5). Congress authorized the
waiving of the requirement of performance and payment bonds in connection with certain contracts
entered into by the Secretary of Commerce (7).
The waiver authority under the Miller Act was originally added to the statute, in 1941, in
order to avoid delays on defense contracts due to problems in the surety industry during World War
II. These waiver provisions were expanded, in 1955, to authorize waiver of bonding requirements on
cost-type contracts awarded by the Department of Defense agencies (5).
In 1966, Congress amended the Miller Act to further protect the government and required
that a bond issued pursuant to this legislation “specifically provide coverage for taxes imposed by the
U.S. which are collected, deducted, or withheld from wages paid by the contractor in carrying out the
contract with respect to which such bond is furnished (6). The Miller Act was amended again in 1970
to add waiver authority for the Secretary of Transportation in connection with ship construction and
repair (5).
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To understand how performance bonds work, it is important to look at how a bond is
formulated. Performance bonds are contracts that create tripartite relationships. There is the
“principal” (typically the general contractor) who has assumed a contractual undertaking. There is
the “obligee” (typically the project owner, in this case DOTs) that is due the benefits of the
principal’s performance. And there is the “surety” who provides the performance bond that
secondarily guarantees to the obligee performance of the principal’s contractual undertaking.
Performance bonds ensure that, although unfavorable circumstances may arise, the project will be
completed (3).
Performance bond coverage comes into effect when it is proven that the contractor has indeed
legally defaulted. Therefore, to analyze the benefit-cost of performance bonds, it is necessary to take
a look at the number of defaults that have occurred during the analysis period of this study. In order
to do so, it is necessary to clarify what is meant by the word default. In construction surety law, to
constitute a legal default, there must be a material breach or series of material breaches of such
magnitude that the obligee is justified in terminating the contract. Usually the principal is unable to
complete the project leaving termination of the contract as the obligee’s only option (3).
Looking at the current challenges facing DOTs with respect to contract awards to defaulting
contractors, there is a need to consider putting checks and balances in place. The United States
General Accountability Office (GAO) released a report in April 2009 that mentions contractors, who
have defaulted on previous projects, receiving bid awards for which they “qualify”. For example, a
$280 million Army munitions contract was awarded to a contractor that had previously been
terminated for default on several different contracts. Subsequently this same contractor defaulted
under that contract. The contracting officer stated that this information, if available, would have
factored into the award decision. This recent awarding of contracts to defaulted contractors highlights
the need for information on contract terminations when making contracting decisions. With the
government relying on many of the same contractors to provide goods and services across agencies,
the need to share information, on a contractor’s past performance, is critical (8).
The use of contractor project performance evaluations encompasses the three major aspects
of project success: cost, time and quality. Ensuring quality of the final product is ultimately a major
reason for implementing performance-based contractor prequalification; its impact on the DOTs
quality management program cannot be ignored. Linking a contractor’s past performance to the need
for viable and trustworthy contractor quality control programs is possible; even in an environment in
which the DOTs must give up much of the traditional control it have in project delivery (1). For
additional details not included here see Gransberg and Reimer (1).
The Ontario Ministry of Transportation’s (MTO’s) performance-based contractor
prequalification program is perhaps the most interesting example. Started in the late 1950’s, it not
only provides an incentive for contractors to perform well but also allows the agency to accrue a
tangible monetary benefit. With an annual construction program of roughly USD$1.3 billion and
average Ontario performance/payment bond costs of 5% of contract cost, the estimated savings
to the province is roughly USD$65 million per year in bond costs (1). The current trend is to
transition from performance bonds to a performance contractor prequalification based system, such
as the one MTO has been using for over 50 years. Seven states (Connecticut, Maryland, Minnesota,
Missouri, Utah, Virginia and Wisconsin) are already using an indexing system to rate or rank
contractors (9).
Table 1 below summarizes a 2001 survey that showed most states (29 out of 37 that
responded) used contractor prequalification (9). For this research being reported herein, 30 states are
evaluated (See the Methodology: Data Collection section for more details on how states are selected).
Out of the 37 states listed in Table 1, 23 are included in this research: Alaska, Colorado, Connecticut,
Delaware, Georgia, Idaho, Illinois, Indiana, Iowa, Kansas, Maine, Michigan, Minnesota, Montana,
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New Jersey, New York, South Carolina, South Dakota, Texas, Washington, West Virginia,
Wisconsin and Wyoming. Delaware, Maine, Minnesota, Montana, New York and South Dakota do
not have a prequalification system (2). For additional details not included here see Minchin and
Smith (2).
The 1996 NCHRP Synthesis 190 reports that all states require a bond or the equivalent of a
bond at some stage of the qualification process (10). The Surety and Fidelity Association of America
(SFAA), a trade association of 450 companies that are licensed to provide surety and fidelity bonds,
also reports that all 50 states and the District of Columbia require surety bonds on state and local
public works projects (11).
Table 1 State Practices for Prequalification for Contract Awards for 37 States (2001)
No. State
Prequalification
No. State
No Prequalification
1 Alaska
Yes
30 Delaware
Yes
2 Colorado
Yes
31 Maryland
Yes
3 Connecticut
Yes
32 Maine
Yes
4 Florida
Yes
33 Minnesota
Yes
5 Georgia
Yes
34 Missouri
Yes
6 Idaho
Yes
35 Montana
Yes
7 Illinois
Yes
36 New York
Yes
8 Indiana
Yes
37 South Dakota
Yes
9 Iowa
Yes
10 Kansas
Yes
11 Kentucky
Yes
12 Louisiana
Yes
13 Massachusetts
Yes
14 Maine
Yes
15 New Hampshire Yes
16 New Jersey
Yes
17 North Carolina
Yes
18 North Dakota
Yes
19 Nevada
Yes
20 Pennsylvania
Yes
21 South Carolina
Yes
22 Texas
Yes
23 Utah
Yes
24 Vermont
Yes
25 Virginia
Yes
26 Washington
Yes
27 West Virginia
Yes
28 Wisconsin
Yes
29 Wyoming
Yes
Although both reports mention all states requiring bonds, it is important to take a look at the
performance bond practices of the 30 states. Table 2 below shows the performance bond threshold
for each state. Above the specified threshold, a performance bond is required. Delaware, Idaho, Ohio,
and West Virginia have no thresholds (12). Another source of the performance bond thresholds and
requirements is the standard specifications of each state. States requiring a performance bond
equivalent to 100 percent of the contract amount are noted.
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An interesting question is whether the performance bond is always 100 percent of the
contract amount. Seven states gave affirmative responses to the following NCHRP Synthesis 390
survey question (21 on pg. 78) “Has your organization ever required less than the full contract
amount to be bonded?” (1). The methodology used to evaluate the benefit-cost of performance bond
is discussed in the next section.
Table 2 State Bond Thresholds as Reported by SFAA for 30 Selected States
No. State
Threshold
No. State
Threshold
1 Alabama*
$50, 000
16 Michigan*
$50, 000
2 Alaska
$100, 000
17 Minnesota*
$75, 000
3 Arizona*
$50, 000
18 Mississippi*
$25, 000
4 Arkansas*
$20, 000
19 Montana*
$50, 000
5 California
$100, 000
20 New Jersey*
$100, 000
6 Colorado
$100, 000
21 New Mexico*
$25, 000
7 Connecticut*
$100, 000
22 New York*
$100, 000
8 Delaware*
None
23 Ohio*
None
9 Georgia*
$100, 000
24 South Carolina*
$50, 000
10 Hawaii*
$25, 000
25 South Dakota*
$50, 000
11 Idaho*
None
26 Texas*
$100, 000
12 Illinois*
$50, 000
27 Washington*
$35, 000
13 Iowa*
$25, 000
28 West Virginia*
None
14 Kansas*
$100, 000
29 Wisconsin
$10, 000
15 Maine*
$125, 000
30 Wyoming*
$7, 500
*Requires bond equivalent to 100% of contract amount (13).
METHODOLOGY
Data Collection
This section discusses how the research data was collected from the DOTs. Using a questionnaire to
get information from the DOTs seemed like a good idea. Raw data was requested instead to minimize
errors that could arise from misinterpretation of terminologies. The DOTs were contacted via email,
phone or postal mail. Data requested, from September 2007 to September 2009, for all awarded
public transportation construction contracts, included the name of the contractor, type of project, the
amount awarded for the project, and whether the contractor defaulted on the project. One state did
not respond to the request. Others responded but did not provide the data. There were some states
that responded and provided data but not in the entirety (four parts) requested.
While collecting the data, some DOTs (Arizona DOT) provided the data without a processing
charge, since the research is for academic purposes. Others (Texas and California) responded quickly
and the information they provided exceeded that which was requested. Some charged for processing
the data based on the volume of information being requested. If the requested volume was below a
threshold, there was no processing fee. For some states, simply sending an email request was not
sufficient. An official request, via a hard copy of the form, had to be made to the DOT based on the
Public Record Access. Some states saw requesting this type of information as sensitive and were a
little reluctant to release it, while others such as Alaska, California, Colorado, Georgia, Idaho,
Mississippi, New Jersey and Texas saw the information requested as public. Colorado, Georgia,
Idaho, Mississippi and New Jersey all have their contract information accessible on their website. All
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DOTs required a written request for information. The subsection, that follows, discusses data
organization for analysis.
Data Organization
In the public work sector that is specifically controlled by the DOTs, projects can be federal, state or
combined federal and state. Other categories could also include bridges, electrical, maintenance,
clearing, roadway resurfacing, roadway rehabilitation, and, from the MTO’s model: road, structures,
electrical, structural coating, and general maintenance (1). The data could be categorized in many
different ways. Each state has its own data structure of projects. This was evident from the data files
obtained. A state, having its highway road data categorized into bridge or not, questioned the data
type being requested in the email. That state did not include bridges in the data based on the response
given to exclude bridges. Subsequent states with that question were asked to include bridges. When
collecting the data, it was inevitable that the data would be categorized.
How? That is the difficult question, that led to other questions (Should a regression analysis
be done? If so, which way would be best to categorize the data?), that had to be answered. The
objective was to simplify the analysis. The research time frame and analyzing 30 states led to the
Benefit-Cost Ratio analysis; which represents economic evaluations of alternative resource use and
measure costs where outcomes can be measured in terms of their monetary values (14).
The first step in the analysis was to obtain an estimate of the surety performance bond
premium. Many surety reports indicate that surety bonds, a dependable, proven, and reliable
protection against contractor failure, cost between one and three percent of the total contract price.
On very large projects, surety bonds may cost less than one percent (15). Likewise, the SFAA reports
the cost of the performance bond one-time premium as typically ranging from half to two percent of
the contract amount. The information gathered from SFAA places the projects into four categories as
shown in Table 3 below, in terms of performance bond premium (16).
Table 3 One-time Performance Bond Premium as Reported by SFAA
Contract Amount Performance Bond Premium
Project Size Category
$100, 000
$1, 200 to $2, 500
< $1 Million
Percentage
2.50%
$1 Million
$7, 700 to $13, 500
$1 Million to
< $10 Million
1.35%
$10 Million
$56, 950 to $81, 000
$10 Million to
< $50 Million
0.81%
$50 Million
$206, 475 to $341, 000
> $50 Million
0.68%
Table 3 shows performance bond premium for various contract amounts. The upper limit of
the bond category with corresponding monetary value is use to estimate a percentage. The contract
amount and performance bond premium (column 1 and 2 respectively) were given in the surety
report. Values in the “Project Size Category” (column 3) are added in order to calculate bond
premium cost for all projects (13), and “Percentage” values (column 4) are calculated using the upper
limit performance bond premium (column 2) divided by the contract amount (column 1) and
multiplied by 100 percent.
An alternative to establish percentages, that are not too different from those in Table 3, is by
dividing the averages of premiums (column 2) by the contract amounts (column 1), yielding results
of 3.70 %, 1.06 %, 0.69 %, and 0.55 %. The cost of a performance bond premium will vary because
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it is dependent on the size, type of the project and the contractor’s bonding capacity (16). Note in this
same column (Percentage), the percentage decreases as the size of the project increases. An
explanation follows:
It is not uncommon in today’s construction environment for projects to exceed $500 million
or even $1 billion. Many sureties prefer to spread their risk by having project owners break up a large
megaproject into multiple large projects (to the extent they can be broken up), notes Mike Cusack,
senior vice president, managing director and operations board member, Aon Construction Services
Group. Bill Marino, chairman and CEO, Allied North America, says, “From the perspective of the
owner, joint ventures and the corresponding co-surety structure necessary to support the larger bond
penal sums, are beneficial. In the event that one of the joint venture’s contracting entities fails, it
becomes the responsibility of their partners to assume their contractual responsibility (17).” This
seems to indicate that sureties have analyzed how to provide the coverage necessary to provide
performance bonding in an economical way while minimizing problems that would typically arise.
Another organization of members, founded in 1985, dedicated to providing the most
productive and cost-effective public service is National Council for Public-Private Partnerships
(NCPPP). These contractual arrangements, between government entities and private companies for
the delivery of services or facilities, are used for water/wasterwater, transportation, urban
development, and delivery of social services, to name a few areas of application. The average
American city works with private partners to perform 23 out of 65 municipal services. Governments
traditionally realize cost savings of 20 to 50 percent when the private sector is involved in providing
services (18).” Some DOTs have PPPs incorporated in their transportation program. For example,
Washington Department of Transportation (WSDOT) has a Transportation Innovative Partnership
(TIP) program, which was authorized by the legislature in 2005 (19). Another DOT with a similar
program is the Texas Department of Transportation. The number of DOTs having PPPs programs
needs to be research. The upcoming section provides and discusses the results of the methodology
use to analyze the benefit-cost of performance bonding.
ANALYSIS, RESULTS AND DISCUSSION
Analysis
In order to determine the value to the agency of using performance bonds during the period
September 2007 to September 2009, an analysis is done of the benefit-cost of having performance
bonds in four states with defaulted projects (identified in more detail later). Added information, also
presented later, includes the percentage complete of projects when defaulted as well as the
percentage of defaulted contractors to the total number of contractors. To begin the analysis, the
percentage cost of the performance premium (Table 3, column 4) is applied to all 30 states (Table 4),
during the two-year analysis period (13).
Table 4 below shows the original cost of all projects, the estimated cost of bond premium to
the surety, the total number of projects and defaulted projects for each of the 30 states. The total cost
of all projects, for the last two years, is $52, 031, 657, 600 and total estimated performance bond
premium is $595, 000, 000 or an equivalent of 1.14 percent of the total project costs. MTO’s
percentage is 5 (1). Note, in the last two columns of Table 4, a total of 37 projects were defaulted out
of the 19, 206 projects awarded.
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Table 4 Project Data Collected for 30 States during 2007 – 2009
Bond Premium
No. State
Original Cost
(estimated using
Table 3 percentage
1 Alabama
$1, 442, 902, 272.23
$17, 692, 293. 41
2 Alaska
$809, 449, 179.23
$8, 573, 850.53
3 Arizona
$1, 600, 656, 820.58
$14, 350, 967.89
4 Arkansas
$817, 217, 457.10
$10, 312, 799.89
5
California
$4, 511, 000, 828.23
$46, 107, 973.83
6 Colorado
$798, 099, 709.03
$10, 270, 813.75
7 Connecticut
$1, 463, 076, 429.07
$12, 356, 052.58
8 Delaware
$354, 338, 346.14
$4, 829, 758.68
9 Georgia
$1, 536, 868, 015.91
$18, 034, 485.62
10 Hawaii
$430, 535, 237.92
$4, 653, 012.66
11 Idaho
$748, 941, 611.51
$8, 240, 033.04
12 Illinois
$3, 670, 007, 329.67
$53, 195, 750.67
13 Iowa
$1, 711, 395, 839.83
$24, 617, 299.54
14 Kansas
$1, 144, 606, 054.61
$13, 622, 288.39
15 Maine
$1, 152, 569, 066.57
$15, 359, 930.09
16 Michigan
$2, 160, 533, 881.73
$29, 027, 635.42
17 Minnesota
$1, 666, 376, 259.62
$17, 370, 360.55
18 Mississippi
$1, 356, 422, 262.75
$15, 484, 356.48
19 Montana
$579, 074, 020.80
$7,449, 512.95
20 New Jersey
$1, 928, 373, 439.99
$18, 668, 802.95
21 New Mexico
$775, 577 646.78
$7, 759, 073.65
22 New York
$2, 834, 889, 153.48
$28, 678, 216.00
23 Ohio
$2, 856, 017, 473.98
$34, 688, 219.00
24 South Carolina $1, 138, 306, 766.89
$15, 519, 605.09
25 South Dakota
$582, 638, 520.64
$7, 476, 267.89
26 Texas
$5, 453, 915, 663.07
$59, 887, 883.77
27 Washington
$4, 357, 111, 404.32
$39, 615, 276.95
28 West Virginia
$1, 162, 017, 166.16
$14, 968, 176.68
29 Wisconsin
$2, 310, 381, 065.44
$27, 875, 716.65
30 Wyoming
$678, 358, 676.51
$7, 670, 376.36
Total
$52, 031, 657, 599.79
$594, 536, 792. 83
Total
Projects
631
187
205
408
1237
326
134
170
513
129
225
2682
1424
643
545
1303
447
392
231
256
126
559
1393
715
292
1333
650
945
901
204
19, 206
Total Defaulted
Projects
7
0
0
0
0
0
0
0
19
0
2
0
0
0
0
0
0
2
0
0
0
0
0
6
0
1
0
0
0
0
37
Table 5 below provides information on defaulted contracts (contracts include the state’s
criteria for defaults). The contractor (for privacy, the name is replaced with an alphabetic character),
the type of project defaulted, the contract award amount and the approximate complete of the project
at the time of default expressed as a percentage, are listed. The type of project, experiencing the
highest number of defaults, is construction for roadway widening. Also, the highest number of
defaults that occurred from any one contractor, Contractor D, is 17. The source of the contract
amount (column 3) was either directly from the DOT or the state’s website.
For the purposes of this research, projects that qualify as defaulted projects refer to roadway
construction project that also qualify under the state's definition of default. Based on this, four states
out of the six qualified as candidates for the benefit-cost analysis.
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Table 5 Defaulted Project Data Identified by Contractor from 6 States during 2007 – 2009
Approximate
Complete at
No Contractor
Type of Project
Contract Amount
Default (%)
1
A
Grade, Drainage,
$6, 189, 906.60
100
Pavement, Bridge and Signals
2
A
Bridge Replacement (bridge
$714, 000.00
100
culvert) and Approaches
3
A
Removal of Structures at the
$480, 000.00
100
Salvage Yard
4
B
Widening (W1)
$2, 950, 000.00
66
5
B
Bridge Replacement and
$4, 000, 000.00
68
Approaches
6
B
Relocation
$3, 475, 000.00
65
7
C
Bridge Approaches
100
8
D
State Route Surfacing
$738, 130.00
0
9
D
State Route Surfacing
$1, 409, 580.00
0
10 D
Widening (W2)
$9, 376, 306.00
80
11 D
Widening (W3)
$77, 789, 276.00
90
12 D
Widening (W4)
$55, 281, 144.00
70
13 D
Widening (W5)
$40, 749, 261.00
40
14 D
Widening (W6)
$12, 469, 439.00
65
15 D
Widening (W7)
$17, 819, 608.00
45
16 D
Widening (W8)
$18, 862, 592.00
40
17 D
Widening (W9)
$18, 811, 311.00
0
18 D
Widening (W10)
$4, 624, 063.00
70
19 D
State Route Surfacing
$2, 129, 159.00
30
20 D
State Route Surfacing
$1, 777, 346.00
25
21 D
Bridge Replacement
$3, 728, 832.00
60
22 D
Bridge Replacement
$2, 558, 669.00
50
23 D
New Construction
$16, 601, 857.00
99
24 D
Interchange Reconstruction
$9, 761, 799.00
99
25 E
Widening (W11)
$26, 292, 771.00
85
26 E
Widening (W12)
$12, 469, 439.00
99
27 F
Concrete Sidewalks and Signage
$496, 316.00
0
28 F
Minor Excavation and Paving
$208, 542.00
0
Pathway
29 Building
10
30
Bridge Painting
75
31 G
Traffic Signals
$1, 496, 890.00
32 H
Widening (W13)
$14, 520, 727.00
33 I
Sidewalk
$177, 213.98
34 J
Widening (W14)
$1, 794, 116.89
35 J
Intersection Improvements
$1, 203, 259.03
36 J
Intersection Improvements
$2, 159, 894.85
37 K
Wastewater Treatment
$748, 780.00
0
Indicates incomplete research
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Table 6 shows default project data for four states. The total number of defaulted contractors;
contractors; and projects; as well as percentage of defaulted contractors; are listed. The percentage
values (column 5) are derived using the total number of defaulted contractors (column 3) divided by
the total number of contractors (column 4) and multiplied by 100 percent.
For Alabama, three contractors (two contractors defaulted 3 projects each and one contractor
1 project) defaulted on 7 projects (refer to Table 4 above). Looking at Georgia, two contractors (one
contractor defaulted 17 projects and the other 2 projects) defaulted on 19 projects. For Idaho, one
contractor defaulted on 2 projects. Finally, South Carolina had four contractors (three contractors
defaulted 1 project each and one contractor 3 projects) defaulted on 6 projects. It is not uncommon
for one contractor to have many projects. Alabama’s highest number of contract awards to one
contractor is 48 projects; while Georgia, Idaho and South Carolina’s are 102, 18 and 69 respectively.
Table 6 Defaulted Project Data with Percent of Defaulted Contractors during 2007 – 2009
Total Number of
% of
Total Number
Total number
State
Defaulting
Total Contractors
of Projects
of Contractors
Contractors
Who Defaulted
Alabama
631
3
105
2.86
Georgia
513
2
91
2.20
Idaho
225
1
75
1.33
South Carolina
681
4
111
3.60
In developing Table 7 below, the total cost of defaulted projects for each of the four states
(column 2) is divided by half to get an estimated amount (column 3), representing a benefit to the
DOT; assuming the surety pays this amount to complete projects to simplify the analysis. SFAA
reports that sureties have paid more than $11 billion on contractor defaults since 1994. Half of that
was paid between 2002 and 2005 (20). The total performance bond premium cost for the defaulted
projects (13) and the Benefit/Cost (B/C) ratio of performance bonds are also listed in Table 7.
The B/C ratio (column 5) is obtained by dividing the values in the “50% of Total Cost of
Defaulted Projects” (column 3), which is a benefit to the state, by the values in the “Total Cost of
Defaulted Projects Bond Premiums” (column 4), which is a cost to the state.
Table 7 Defaulted Project Data Benefit-Cost Analysis for Selected States during 2007 – 2009
Total Cost of
50% of Total Cost
Total Cost of
Defaulted Projects Benefit/Cost (B/C)
State
of Defaulted
Defaulted Projects
Bond Premiums
Ratio for State
Projects (B)
(C)
Alabama
$17, 598, 906. 60
$8, 799, 453.30
$17, 692, 293.41
0.50
Georgia
$332, 347, 230.00
$166, 173, 615.00
$18, 034, 485.62
9.21
Idaho
$704, 858.00
$352, 429.00
$8, 240, 033. 04
0.04
South Carolina $7, 974, 633.78
$3, 987,316.89
$14, 666, 964.23
0.27
Table 8 below shows the total number of projects (refer to Table 4), total cost of projects,
total cost of defaulted projects, and the percentage defaulting cost. The value of “Percentage
Defaulting Cost” (column 6) is obtained by dividing the value of “Total Cost of Defaulted Projects”
(column 5) by the value of “Total Cost of Projects” (column 3) and multiplying by a 100 percent.
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Table 8 Defaulted Project Data with Percentage Defaulting Cost during 2007 – 2009
Total
Total
Total Cost
Percentage
Number
Total
Number of
of
Defaulting
State
of
Cost of
Defaulted
Defaulted
Cost (%)
Projects
Projects
Projects
Projects
Alabama
631
$1, 442, 902, 272.23
7
$17, 598, 906. 60
1.22
Georgia
513
$1, 536, 868, 015.91
19
$332, 347, 230.00
21.62
Idaho
225
$748, 941, 611.51
2
$704, 858.00
0.09
South Carolina
681
$1, 061, 600, 282.34
6
$7, 974, 633.78
0.75
Results and Discussion
From the Table 7 results, Georgia is the only state where the benefits outweigh the costs. In the other
three states, the sureties made a profit. Sureties are in business for the money and deserve to make
some profit in view of the risk they are taking and the service they provide. But the amount of profit
they are making, especially at the expense of the DOTs that have few or no defaults, is simply
staggering. It shows that there is a need to seriously think about replacing performance bonds with
another system, such as the Ontario Model in Synthesis 390 (1).
To summarize Tables 7 and 8, Alabama’s B/C ratio is 0.50 and percentage defaulting cost is
1.22. Georgia’s B/C ratio is 9.21 and percentage defaulting cost is 21.62. Idaho’s B/C ratio is 0.04
and percentage defaulting cost is 0.09. South Carolina’s B/C ratio is 0.27 and percentage defaulting
cost is 0.75. When benefits exceed the costs, the ratio is greater than 1, and the use of performance
bonds can be viewed as being beneficial.
While Table 7 gives B/C ratios for the states; it is a simple matter to calculate B/C ratios from
the sureties' viewpoint as they are the inverse of the states' B/C ratios. A state’s B/C of 0.50 translates
to a surety B/C of 2.0. In other words, if benefits to the state are 1/2 of costs, then costs to the state
(which are benefits to the surety) are twice the expenses to the surety. The B/C ratios from the
viewpoint of the surety are 2 (AL), 0.11 (GA), 25 (ID), and 3.70 (SC). Of course, additional
administrative management costs to the surety for finishing defaults projects decrease the surety B/C
somewhat.
The results, therefore, indicate that during the 2-year analysis period, Alabama, Idaho and
South Carolina’s requirements, for performance bonding (which includes the state’s criteria for
defaulting), are not beneficial. For Georgia, the use of performance bonds is beneficial primarily
because that state had a relatively large number of defaults for some unidentified reason.
CONCLUSIONS
The Benefit-Cost (B/C) analysis, because of the simplicity it provides in getting a ball park figure in
a short time frame, is useful to compare the alternatives of having performance bonds to not having
any at all. The September 2007 to September 2009 analysis period illustrates that the use of
performance bonding, in Alabama, Idaho, and South Carolina, is not beneficial. Also, for the
remaining 26 states, the use, of performance bonds, is not beneficial. For Georgia, the only state
where this is true, the B/C analysis indicates having performance bonds as beneficial. However, the
conclusion should not be made that Georgia is a “winner.” Certainly, having a relatively large
number of defaulted projects is not the state's goal. In addition, sureties might well raise the cost of
premiums on Georgia’s projects based on that state’s recent history.
A B/C ratio greater than 1 can be viewed as the use of performance bonds having been
beneficial. Although no specific B/C ratio is established, states that have very low or high B/C ratios
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are encouraged to evaluate their performance bond criteria and take a look at the practices of those
states with B/Cs that are a little over 1. A very high B/C indicates that many defaults are occurring. A
very low B/C indicates little or no defaults are occurring therefore the use of performance bonding
should be evaluated. The decision of whether to use performance bonds involves risk. States,
therefore, should evaluate the risks involved with projects and make a decision based on that as to
whether performance bonds would be required or not.
Although no analysis is done on some other aspects, it is interesting to note from the data
collected that the project type experiencing the highest number of defaults is roadway widening (14
out of 37), and the most projects defaulted by one contactor is 17. There is reason to believe that the
contractor probably had a good past performance record and probably went bankrupt all at once
resulting in numerous defaulted projects.
States that experience defaults benefit from having performance bonding. If little or no
defaults occur in a state, no benefit is seen. In light of this, this research is not suggesting eliminating
performance bonding. DOTs are encouraged to evaluate the risks involved with using or not using
performance bonds for projects and make a decision based on that.
FUTURE WORK
For the benefit-cost of performance bonds to be more fully and better analyzed, more detailed
information of the benefits and costs to the DOT, contractor and surety need to be collected.
Categorizing projects into, for example, duration of projects, types of projects (e.g. roadway
surfacing roadway preventative maintenance, and so on), types of funding (federal, state or
combined), would help to give a clearer picture of which projects are problematic and would require
performance bonding. Future data collection and analysis efforts could also: 1) identify contractors
who go bankrupt under one name, later resurface under a new name for business, and are
subsequently awarded projects after having a history of poor performance; and 2) evaluate defaults
between the years 2002 and 2005, since the surety industry lost half of the total money spent on
defaults since 1994 during that time period (20); 3) determine the actual cost of dealing with surety,
delays, and so on over and beyond what the contract may have cost and in comparison to the bond
cost; 4) determine the cost-effectiveness of these bonds – which are required by state law; 5)
investigate the applicability to Public-Private Partnerships and the number of DOTs having PPPs
programs; 6) how prequalification should be sufficient and is a lot cheaper than performance
bonding.
In addition, suggestions for future research for performance bond cost-effectiveness analysis
found in Synthesis 390 include: 1) quantifying the cost of performance bonding on a national basis
and compare it with a rigorous performance-based contractor prequalification process based on the
Ontario Model; 2) analyzing contractor default rates on a state-by-state basis and seek to identify
those types of public transportation projects that were at the most and least risk of default; and 3)
developing an algorithm to adjust a good contractor’s performance bonding requirements in the event
the DOT choose to implement the algorithm (1).
ACKNOWLEDGMENTS
The technical support of the DOTs is recognized for providing the necessary data to make the work
possible. Also acknowledged is the support of Mr. Peter Kopac, former Federal Highway
Administration official, for providing insight, direction and an alternative analytical approach to data
interpretation; Dr. Mang Tia, University of Florida Professor, for guiding and encouraging me to
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keep focus on what is important; and Dr. William Myers and those who provided help in small, but
significant ways.
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1. Gransberg, D. and Reimer, C. NCHRP Synthesis 390: Performance-Base Contractor
Prequalification, http://onlinepubs.trb.org/onlinepubs/nchrp/nchrp_syn_390.pdf.
Transportation Research Board. Accessed date July, 2009.
REFERENCES
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2. Minchin Jr., R. E. and Smith, G. R. Quality-Based Performance Rating of Contractors
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3. American Bar Association. The Law of Performance Bonds. Chicago, Illinois. 2009, 2nd Edition,
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4. Luckey, J. and Allman, A. Overview of the Miller Act Subcontractor Protection in Federal
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7. United States Congress House Committee on the Judiciary. Amending the Act of April 29, 1941,
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11. The Surety and Fidelity Association of America. Ohio HB 1 – The State Budget Hurts Small and
Emerging Contractors and Puts State Taxpayers and Laborers at Risk,
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