Since TradeTapp’s inception, we’ve studied the subcontractor default insurance (SDI) marketplace with an eye towards policy changes, loss trends, or topics that have become hot button issues. With our deep relationships with the SDI carriers — including our partnership with AXA XL — we’ve gained a unique perspective into what matters most to insurers when they are underwriting prospective clients.

Today, our users represent all the major SDI insurers and brokers in North America. Based on everything we’ve learned, here are the top five things SDI carriers are focused on when underwriting accounts today.

1. Financial assessment: if you don’t do it, it’s time to start

SDI carriers need to see a formalized approach toward financial vetting. Solvency issues are a primary contributor in many subcontractor default claims, and the vast majority of these losses might have been preventable if a basic financial assessment took place. Access to capital, or liquidity, remains the most important area to focus on in analysis, especially on projects where slow pay cycles and cash flow could become a major concern. Understanding a subcontractor’s capacity, both from a single and aggregate basis, is key.

The financial assessment will also reveal some important clues into how a company manages its assets. In cases where the subcontractor’s company is behaving largely as a pass-through entity (think LLC or S-Corp), it’s important for general contractors to recognize this as exposure and review who they are signing the agreement with. An additional guarantee from a parent company or individual may be appropriate.

2. Aggregation: understand their exposure

This is the topic we hear about the most in the SDI space, from carriers and contractors alike. Subcontractor aggregation, otherwise described as the concentration of awards made to the same contractor or vendor (usually within a particular region), is hugely important because it represents the total amount of exposure to a single company.

We have made several product enhancements to TradeTapp to help track exposure and monitor subcontractor aggregation, both internally as well as across the marketplace. Carriers view aggregation across their multiple clients as compounded risk, and it’s important to understand a subcontractor’s committed backlog, including the breakdown of projects by type and region. This may have a profound effect on work quality, manpower, or production in the field.

Measuring and managing aggregation is a function of monitoring your own awards made to a single subcontractor, as well as staying up to date on their backlog position. Like a bonding company, you should consider each subcontractor’s backlog commitments in comparison to their capital position when evaluating their ability to meet the demands of current and future projects. It may make sense to hold back on giving one contractor more work until they’ve completed some of their existing pipeline.

Aggregation is of further concern as the current economic marketplace continues to indicate increased construction spending, while the availability and supply of qualified bidders continue to decrease. Evaluating personnel, project team, and individual experience of your contractors is equally important when backlog becomes a concern.

3. Quality: find a way to monitor and measure it

Work quality is a major concern for the SDI marketplace because not all defaults occur during the project operations phase. In fact, some of the largest SDI losses on the books have resulted from defective installations which resulted in substantial “rip and tear” rework claims after the project had already been completed. This is why extended coverage — often referred to as the policy “tail” — becomes such a significant factor in premium calculations. Very often, the contractor who installed the defective work has no capacity to repair or fix the issue without being put into default, resulting in an insurance claim.

Coming up with reliable metrics to predict the quality of a subcontractor’s work is actually pretty difficult, but as a best practice, we recommend making sure project history and reference checks are part of the qualification process. Consider prior completed work, internal reviews, frequency and volume of change orders on projects they’ve performed for you in the past, and follow-ups on recently completed work references. Of course, it’s best to perform a thorough de-scope during bidding (especially on complex packages), to review personnel and assess the subcontractor’s job experience.

4. Timing: “prequal” is dead

Timing is crucial when qualifying subs, so we think it’s time to put the term “prequal” to bed. Carriers want to see that you have a continuous annual qualification process in place, and vetting subs should occur before long before the start of a new project and continue at least once per year, even if the sub is still working.

If qualifications become core to your business model, you’ll have time to implement an effective risk mitigation strategy and level bids with consideration of the risks subs pose to your projects. If done too late, all leverage is lost, and now you are forced to live with what could be significant risk. Aside from lump-sum projects where awards are strictly based on low bid, it’s key to evaluate risk prior to or in parallel with the bidding process.

In addition, “point in time” data like backlog position, financial assets/liabilities, or safety performance can vary greatly on a year to year basis. Using the most up to date information when considering several bids is key towards selecting subcontractors intelligently.

5. Accountability: being consistent

Insurance carriers underwrite prospective clients based on a combination of past performance, key personnel/internal protocols, and market conditions. One of the biggest challenges we’ve encountered for companies seeking to utilize an SDI policy for the first time is how to create internal protocol for when the award process is handled remotely by project teams.

As a GC entering the SDI space, it’s important to consider the following questions:

• What is your internal protocol for reviewing qualification applications?
• Who should review the riskiest subs, and when should these decisions get elevated?

In many cases, centralizing the review process (to a risk management group, a CFO, a controller, etc.) creates a foundation for greater consistency in risk mitigation decisions, less bias or subjectivity, and a clear audit trail of accountability for decisions.

Wrap up

It’s important to understand these trends in order to gain favorable treatment from the insurance marketplace. When leveraged into an effective program to manage and mitigate risk, a shared commitment to these five topics can result in a successful SDI program both for you and your carrier.

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