Construction work can be a tricky and dangerous business. Contractors perform a variety of trades and scopes that carry different levels of inherent risks. Failure to plan and financially protect oneself against these risks can have the potential to result in substantial financial and physical harm to both the contractor and the party for whom the contractor is working. Therefore, many projects require contractors to carry an insurance policy, a surety bond, or, in some cases, both. Contractors often misunderstand exactly what the two of these are, why they are required, and how they differ. These misunderstandings can result in financial disaster, including the complete bankruptcy of the company and personal liability for its owners.
What is insurance?
An insurance policy is an agreement between two parties — the insurance company (the insurer) and the contractor (the insured), in which the contractor pays a premium to the insurer for an insurance policy. In return, the insurer guarantees compensation to cover specific losses or damages as covered in the policy.
It is important to know which types of insurance your company will need, since there are many different insurance policies with their own specific types of coverage and limitations. For construction companies, there are generally two types of insurance needed — general liability insurance and workers' compensation insurance.
• General liability insurance — As the name implies, general liability insurance policies absolve the insured of certain liabilities up to the limits of coverage established in the policy. For example, the policy protects the contractor by guaranteeing that the insurer will cover costs if a third party suffers any damage. More specifically, general liability insurance covers bodily injury and property damage suffered only by a third party, not employees of the insured.
• Workers’ compensation insurance — No matter how diligent a contractor is when ensuring that employees are safe at work, accidents happen and people may be injured. Many regulatory entities mandate that contractors must carry workers' compensation insurance in order to become licensed. This insurance is designed to protect those employed by the contractors if they should be injured during the course of business by covering the employee's medical expenses and lost wages. These policies will also cover the insured’s legal fees should an employee file a lawsuit against the contractor for negligence or failure to provide a safe work environment.
It’s important to note that insurance carriers are taking a harder look at subcontract agreements these days. Most contractors are getting away from 100% self-performed service and subcontracting more and more, so the carriers want to see a solid, legally written subcontract where there is solid risk transfer, flow-down clauses, and minimum insurance requirements that meet or exceed those of the contractor and the specific project.
What are surety bonds?
A surety bond is used by investors in construction projects [owners and general contractors (GCs)] to protect against an adverse event that causes disruptions, failure to complete the project due to bankruptcy of the builder(s), or the job's failure to meet the contract specifications. There are three types of surety bonds:
• Bid bond — In order to work on certain projects, contractors may be required to provide a bid bond, which guarantees the owner or GC that the contractor is capable and qualified to complete the project.
• Performance bond — Also known as a contract bond, this is a guarantee of satisfactory completion of a project by a contractor.
• Payment bond — Guarantees that the contractor will pay certain workers, subcontractors, and material suppliers.
What's the difference?
The primary difference between liability insurance and bonds is which party gets financially restored from a claim or lawsuit. Surety bonds protect the interests and investments of the GC or owner, while general liability insurance protects the insured from the financial effects of lawsuits.
Many small contractors never have to bond projects, so they don’t have a bonding agent or pre-established bonding capacity. Should they wish to pursue a small project that does require a bond — and the job is under $500,000 — some agents have access to a “fast track” program that will approve the bond based solely on their personal credit score being over a certain amount (typically high 600s). This is usually a one-page application, and the rate is typically higher at around 2.5% to 3%, depending on the bonding company.
Determining insurance and bond premiums
For insurance policies, underwriters take a close look at the amount of coverage being sought, as well as statistical data such as the frequency with which accidents occur to determine the applicant's premium and coverage limits. The higher the likelihood that an accident will occur, the higher the premium. However, contractors who have not filed claims on their insurance may qualify for discounts when it is time to renew their insurance policies.
Because surety underwriters assume there will be no loss, they calculate premiums a bit differently. First, they look at the amount of the bond that is being required, as that is the maximum amount they will have to pay in the event of a claim. Then, they will typically look at the applicant's credit score to determine the likelihood that the applicant can financially handle the cost of a claim. Therefore, applicants with lower credit scores will be assessed higher premiums.
As with insurance premiums, underwriters will look to see if credit has improved and if there have been any claims or defaults when it is time for the bond term to be renewed. The contractor's premium for the next bond term may be decreased or increased depending on what the underwriters find.
This author has put together a free reference sheet with a list of coverages and explanations. Just send him an email, and he’ll send it over.
As in anything in life, unforeseen events occur and accidents can happen, so it’s crucial to be educated about your options and coverage. The goal is to minimize risks to your company and make sure you are prepared for all possible outcomes.
Author’s note: Many thanks to Jesse Couch of BB&T Insurance Services who supplied content for this article.
Cooper has more than 20 years of electrical construction and contracting experience. He has worked for several of the largest electrical contractors in the United States and holds a Class II Unrestricted Electrical Contractors license in the state of Georgia. He currently is president of Ascent Consulting and can be reached at [email protected].
