Contractor Default Insurance was designed to be a substitute for the traditional surety performance guarantee but recent analysis has shown that this option certainly has its inadequacies. Default insurance is also known as subcontractor default insurance. The reason why contractors purchase this type of insurance is to make sure that the performance of all the subcontractors is high and that they make due on their prime contracts. In addition to the contractor, this type of insurance can be purchased by the owner to cover the contractor and all his subcontractors on a particular project.
The benefit to purchasing this type of insurance is less premiums because you don’t have to purchase two separate insurance coverage’s for both the contractor and the subcontractors. You also have the added advantage of greater control in managing the performance of both parties. While this sounds good on paper, there are four aspects in which Contractor Default Insurance falls short. They are as follows:
Default insurance reimburses general contractor or owner in fulfilling a defaulting contractor’s contractual obligations. Basically, the insured has to first use up its own resources before it can submit a request for reimbursement. This causes an issue with cash flow as well as putting the insured in the unenviable role of managing a default situation. The problem with this is that the defaulting contractor might actually have a dispute with the other contractor. This conflict of interest causes complications.
Default Insurance includes an aggregate limit of insurance, a qualifying loss limit, a qualifying loss indirect cost sublimit, a non-qualifying loss limit, a deductible for each qualifying loss, a co-payment percentage for each qualifying loss, and an advanced claims payment percentage. These limitations make it difficult for contractors. None of these limitations apply when you get payment bonds.
Subcontractors Not Covered
‘Nuff said. If claims from a supplier are filed incorrectly a lien on the project could be implemented.
No Prequalification Service
This is one of the biggest if not the biggest shortcoming of default insurance. There is no prequalification service provided by the insurer. The burden to prequalify and manage the subcontractors falls entirely on the named insured.
To put it more simply, default insurance is too focused and other insurance options cover much more. In comparison to traditional performance and payment bonds, it seems that default insurance is not worth the price. In the end you get what you pay for.