If you had to explore the myths about subcontractor default insurance, Douglas Schrift, AON’s managing director and practice leader for contractor default insurance, is a good person to put together—and dispel—a list of false notions.

Speaking at the International Risk Management Institute’s construction conference in Las Vegas on Nov. 10, Schrift tried to clarify everything subcontractor default insurance is and isn’t at a conference whose workshops plumbed the intricacies of law and insurance for an audience already savvy about law and insurance.

The conference’s numerous workshops drew well. People crowded into sessions with titles such as “The Additional Insured Illusion” and “Whose Design Is It Anyway?” Another session, about liability coverage for “rip-and-tear” costs—that is, the expense of replacing non-defective work to reach defective work that requires repair—opened a new line of discussion on the continuing issue of what kinds of defects and what types of claims are covered or excluded under a contractors’ general liability policy. Insurers have been denying claims as part of a legal effort to narrow the scope of what is covered, while contractors have been fighting to keep the coverage broader or, if you listen to the insurers, expand it.

Defaults Are Not Well Understood

Although subcontractor default insurance debuted 20 years ago and has been used many times as a substitute for surety bonds, some people don’t understand that, unless the prime contractor places the subcontractor in default, there is no coverage.

There is also a tendency for prime contractors to believe the policy covers more than it does. “A big misconception is that subcontractor default insurance is coverage for performance issues or out-of-specification materials or other problems that have occurred on the project,” Schrift explained. “It’s not a builders’ risk or accident insurance or workers’-comp insurance. And it is not general liability insurance. … While it does cover losses related to a default of a subcontractor, if you’re not placing the subcontractor in default within contract terms, there is no insurance.”

As with many aspects of insurance and law, even that fundamental point requires some more explaining.

For example, some subcontractor default policies require the general contractor to terminate the subcontractor as well as placing it in default.

But once the sub is placed in default, Schrift explained, “that triggers the policy, and insurance carriers will not challenge.” When there is a subrogation process for economic recovery, “if the default wasn’t valid, do you have coverage?” Schrift asked. “No, because the sub wasn’t at fault.”

There are other common misconceptions. For example, under subcontractor default coverage, is the prime contractor’s prequalification unlikely to be as thorough as the surety’s would have been? No. Is a subcontractor prequalification expensive and time-consuming for both the general contractor and the sub? No, but technology is making the process easier. Is defaulting the sub easier with subcontractor default insurance? No, because defaulting a sub has nothing to do with the choice of risk management tools and a subcontractor still has rights under its contract.

In the case of another myth—that subcontractor default insurance is simply another way for a general contractor to profit at the owner’s expense—Schrift was especially pointed: Sureties take time to research claims, during which time delays accumulate, ownership of the delays becomes unclear, and animosity on the project may multiply. The complications created by a default become a management distraction. “The wheels can come off the bus,” he said.

Said Schrift, subcontractor default insurance is a “reasonable solution for a difficult situation and provides value to the owner, to the entities financing the construction loan and to the other subs on the project.”