Commercial Insurance Blog

29-Aug-2011 Val Feeney commercial

Performance Bonds for Contractors: Insurance

Get performance bonds for contractors and commercial business or personal insurance from andrew gordon incEvery development depends on all contractors’ ability to provide the services they agree to. If any contractor fails financially, has delays or scheduling difficulties, even the financial viability of the whole project may be threatened. With a difficult construction market, more owners are demanding proof of the financial integrity of partner contractors in a project. The best guarantee that a sub-contractor will complete a project is a “performance bond.”

Performance Bonds have long been required for municipal work, particularly time sensitive public construction, but savvy owners and general contractors are increasingly finding that performance bonds provide a measure of security in this dynamic business. If you wish to compete in the bonded projects arena, you need to understand how these bonds work.

What is a Performance Bond? A performance bond is a guarantee, issued by a “surety,” providing that the bonded contractor (the Principal) has the financial ability to complete a project for the owner or general contractor (the Obligee). A performance bond is not insurance:  if the contractor fails, the surety will demand repayment of any money used to complete the project. It is more accurately a rigorous credit check and credit guarantee.  Thus, a performance bond shouldn’t be seen as insurance, but rather proof of financial stability. If you have doubts about your ability to complete a project, the surety will, too.

What is involved in obtaining a bond? Underwriting is rigorous. Expect a financial check that is as thorough as obtaining a mortgage, and based on three C’s: Character, Capacity, and Capital. Character is the most important. A contractor who may have faced payment delays in the past but who met all his obligations will get much further today than one who’s been taken to court or who has liens on his property from previous disagreements. Capacity refers to the ability to provide the actual work, and is dependent upon other jobs in progress and a track record of handling multiple jobs at the same time or jobs in the range of the bidded project. Capital refers to the financial ability to overcome unexpected challenges and still meet suppliers’ terms, payroll, and other operation expenses. For this, on the balance sheet cash is king. Other current assets such as receivables and liquid inventory will count against current liabilities to measure an operating assets cushion during the project.

How are the three parties tied? The construction contract between the Principal (the bonded contractor) and the Obligee (the owner or general contractor) is the starting point, and the Surety (the bond issuer) will review this carefully. They’ll focus on legal and insurance requirements, payment terms, project schedule and other aspects. If the bond is offered, the Surety will require an indemnity agreement from the Principal first, which usually includes a personal guarantee.  Remember, a Performance Bond is not insurance; it is credit. Finally, the Surety guarantees to the Obligee that the Principal will complete the job.

How are claims handled? The Surety can be a valuable business partner to the Principal or the Obligee. If the Surety believes extending credit to the Principal will get the job done, that may be the best option. Alternatively, the Surety’s relationships with many financially sound contractors may help provide a replacement contractor; this can minimize delays and also reduce the amount of damages that need to be paid. If they pay the Obligee the full amount of the bond, they will then begin steps to recover their money from the Principal. 

If you are a financially strong contractor and want to step into the bonded business world as the economy rebounds, get the groundwork done today. It costs nothing to be pre-screened and gets you to the front of the line when you’re up against a bid deadline. For all your insurance and bonding needs, call the insurance professionals at Gordon Insurance today at (800)649-3252.  To pose a question, please click below.

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