With uncertain times making business survival more challenging for contractors, a nearly decade-old insurance product covering subcontractor default on projects may be getting a second wind.

Subguard, an insurance policy developed in 1995 by Zurich U.S. Construction, Schaumburg, Ill., and soon to be emulated by others, gives prime contractors more control in cases of subcontractor default than the usual performance bonds that cover such events, say some industry sources. Instead of having the surety calling the shots in completing the covered work, the default causes a payment to be made to the prime, which then selects a replacement sub.

SUCCESS Turner Corp. used Subguard default insurance on just-completed college arena. (Photo courtesy of Turner Corp.)

Users are mostly large building contractors that employ a multitude of subs. They say Subguard is a faster and more reliable alternative to surety bonds in covering the impact of a "catastrophic" default. But sources say that it is geared for only the most sophisticated customers. And some construction executives are not willing to totally dismiss surety coverage.

"Subguard can be fantastic for some, but it's not for everyone," says John Miller, senior vice president in the construction practice of insurer broker Willis, New York City. "Our approach to sales is deliberate, based on business practices." Miller says the program works best for contractors that subcontract more than $75 million of work annually.

Subguard also generally requires a substantial deductible that can range from $500,000 to $700,000, making it cost-effective only on the largest projects and for contractors that already have effective subcontractor prequalification and monitoring programs in place, says J. William Ernstrom, a construction attorney with Rochester, N.Y.-based Ernstrom & Dreste, who weighed using the product on a major airport expansion for a client. "With Subguard, you have to lose half a million dollars before the policy kicks in," he says. "With a surety bond, you get paid for each dollar."

Despite such caveats, some contractors find Subguard a successful alternative. Industry sources say as many as 75 policies have been sold.

Turner Corp., New York City, used the policy on the recently completed $40-million University of Miami Convocation Center in Coral Gables, Fla., says Mark Boyle, general manager of the contractor's risk department in Woodcliff Lake, N.J. He says one advantage is broader subcontractor coverage, even for very small firms that might not qualify for a surety bond, but whose default could cause major project headaches. "I have seen an increase in sub defaults in the last year and a half, and it's not trade specific," says Boyle. "This product covers it all."

Other contractors find similar benefits. "One of the selling points is that Subguard gives more flexibility and control to the contractor and owner to craft the remedy themselves, as opposed to turning to the surety and having it investigate it," says John Hughes, risk manager for Perini Corp., Framingham, Mass. "It's a relatively new product, but it's definitely catching on."

The ability to retain control seems worth the cost to some primes. "The contractor can move in immediately if a sub falls out," says Steve W. Warnick, vice president of Austin Industries, Dallas. "With a bond, there is a third party involved, which has to investigate the claim to determine its merit. If you have to wait 30 to 60 days to fix something, then you're dead." He says the cost can be balanced by effective subcontractor management on the project. "If you manage the risks properly, [Subguard] is less than a bond would cost," claims Warnick. "Without losses or administration fees, it can save up to 50% over the price of a bond." Other executives say the default insurance takes some pressure off bonding by offering an alternative to contractors on higher- risk projects.

In some cases, owners are purchasing Subguard coverage. Perini had Subguard as part of an owner-controlled insurance program on a $1-billion, 4.9-million-sq-ft expansion of the Mohegan Sun hotel-casino in Uncasville, Conn., which opened in 2002. The project finished ahead of schedule and on budget. But some sources say owners do not generally make the most successful users. "While some owners are naturals at it, the general contractor is geared to be the more effective manager on a day-to-day basis," says one. Adds a contractor: "It's really not set up for an owner to buy, but brokers sell it to them anyway."

Cost increases and poor response by sureties in some sub defaults have caused more customers to shop around. "Sureties still have their place, but the market is tightening up," says Warnick. "Sureties have lost a lot of money in recent years, so the underwriting is becoming stricter. Before, if you had a pulse, you could get a bond."

CONTROL Casino addition in Connecticut had owner-bought program. (Photo courtesy of Woodruff & Brown Photography)

But sureties are hardly ready to cede their market. Executives point to what they say are significant drawbacks in Subguard. "The general has to do his own subcontractor background checks [and] Subguard doesn't handle claims," says Steven D. Nelson, information systems president of SureTec Financial Corp., Austin, Texas. "We sell [contractors] pre-qualification services, and in many cases, help to procure those services that Subguard does not provide." He says contractors may have to add staff to handle such tasks.

Nelson also claims that many subs want their own bonds "because it sets them apart from their competition and indicates that they have a certain amount of financial security." He says an undercapitalized sub that is part of a larger firm "could still get a bond, but if it worked in a Subguard program and defaulted, the parent company may have no legal obligation."

The American Subcontractors Association opposes use of Subguard-type insurance. "It's very questionable as to how well the purchaser of Subguard is going to qualify subs, unlike a surety," says spokesman David Mendes.

The Surety Association of America and the National Association of Surety Bond Producers also defend bonds. "No one likes the claims process, but we have paid a significant number of claims in the last two years," says Lynn M. Schubert, SAA president. "We're standing behind our obligations."

The jury is still out on Subguard. "It's still an evolving product," says a spokesman for Gilbane Building Co., Providence. "We're still analyzing the pros and cons."

Other insurers may move into the market. "We are doing some due diligence on the possibility of coming out with a similar product, but we are still in the formative stage," says Robert Kelly, assistant marketing vice president for Chubb Group of Insurance Cos., Warren, N. J.