Can combined general contractor-subcontractor default insurance fill a need?

XL Insurance is seeking its first customer for a new product, introduced in March, that combines contractor and subcontractor default insurance for private construction projects.

Called CapAssure, the subcontractor default insurance part will work the same way as Subguard, the product launched 16 years ago by insurer Zurich North America that currently has virtually all of the subcontractor default insurance market.

Subguard is used to cover about $35 billion worth of subcontracting work each year, according to Nils Sorenson, Zurich's Subguard product manager.

CapAssure, in contrast, will provide coverage for both subcontractor and general contractor defaults.

According to XL Vice President Jason LaMonica, combined subcontractor-general contractor default insurance will provide an opportunity to eliminate any overlap that could occur when subcontractor default insurance is used by the general contractor but when the general contractor must also provides a surety bond to the owner.

In a a hypothetical example of a $100-million contract, $90 million of the work would be performed by subcontractors with about $10 million for the general contractor’s fee for general conditions and other responsibilities.

The surety is likely to “charge you against the full value of the job even if you want $10 million” as the maximum amount of the guarantee, LaMonica says.

Depending on credit profile, the fee that sureties charge to the contractor range from about .5% to 2%.

Another advantage of eliminating surety guarantee on a project is the speed and control for the owner in replacing a defaulted contractor. With surety guarantees, the surety often takes time to investigate a default and to arrange to have the work completed.

“The job can sit idle while [the surety] investigates,” adds LaMonica.

To be fair, a surety has a fiduciary responsibility to make certain that the default of a contractor is justified and that the owner did not terminate the firm for convenience. The investigation is necessary to prevent an unscrupulous owner who decides it needs more money and defaults a contractor and tells the surety to pay.

“Many contractors have experienced the frustration of having to terminate a subcontractor, followed by a lengthy investigation by the bonding company,” according to 2005 summary of subcontractor default insurance by the law firm Peckar & Abramson. “In a complex, time-sensitive project, any delays by a bonding company’s investigation can be extremely expensive.”

Developed by LaMonica with Senior Vice Presidents Bill Mills and Martha Gaines, CapAssure could provide an advantage similar to other default insurance in giving the owner control of the completion of work once a general contractor has defaulted.

As with simple subcontractor default insurance, CapAssure would involve significant deductibles and retention. And as with Subguard, bigger companies are the target market. CapAssure is being directed toward contractors that perform $75 million or more worth of work in a year.

Sorenson, Zurich’s Subguard product manager, says the Subguard product has never been used as a replacement for anything other than subcontractor pay and performance bonds, and will not be in the future. “That’s not our intent,” he says. They are "very different kinds of risks.”