Subcontractor default insurance

2013 Baker Tilly Virchow Krause, LLP

History of the market

> 1996: Created by demand of contractors with the goal of taking back
control when subcontractors default.

> 2012: 187 Accounts w/ $48.6B in enrollment

CRU 30 Accounts / $4B in enrollment

> Purchased byy most large

g g
general contractors in US
> Barriers to entry for other insurers:
No readily available loss datathe underlying source for insurance company
pricing methodologies
Surety review in house - we have this product
Program sizes require substantial reinsurance support to build capacity
limited

What is SDI?

Managing the Subs with SDI

Using Surety on all Subcontractors

Default Resolution Controlled

b General
by
G
l Contractor
C t
t

D f lt R
Default
Resolution
l ti
C t ll d b
Controlled
by S
Surety
t

Premium

GC

GC

SDI

Subcontractors

Contract
C

Contract Price
P

Contract Price
P

Incl Sub Bond $ Premium

Surety
Bonds

Contract
C

Protection

Subcontractors

Why do GCs buy SDI?

3rd Party Requirements

Lender / Owner / Surety
Profit Moti
Motive
e
The unused loss funds are returned
Altruistic Approach
Better Control / Broader Cover /
R
Recognizing
i i &P
Pricing
i i S
Sub
b Ri
Risk
k

Component

Typical Values

Comment

Per Loss Retentions

North of $500K

Deductible Retained per Sub

Contract Default

Aggregate Retentions

Expressed as Variable or
hard wired to x Per Loss

Once Aggs are reached its

fully insured

y
Co-Payment

Loss Retentions in Excess of

Deductible

10% of the next 5MM its a

sharing layer

Direct Loss

Dependent on Limits Offered

This pays to finish the

uncompleted sub work

Indirects

Hard Wired $5MM or as a %

of the direct loss 20%

Pays for financial loss

beyond completing the subs
work - OH Other Trades

Fixed Premiums

The money that goes to the

insurance carrier

X per 1000 or % .5% of

Sub trade Values

Loss Funds Premiums

Money that is paid in / set

aside to pay for losses within
the retention

X per 1000 or % of Sub

Trades - Bigger Ret Bigger
the Loss Fund %

3 Markets Overview Comparison

Zurich

Arch / Catlin

XL

Est 1996

Est 2009

Est 2012

$
$50MM

$
$25MM

$
$50MM

Jumbo GCs ENR 100

Mid Size GCs $50MM

500MM & Owners

Jumbo GCs ENR 100

10 Year Coverage Period 10 Year Coverage Period 10 Year Coverage Period

Indirects Require Proof

Indirects Paid w/o Proof

Indirects Require Proof

Minimum Premiums

No Minimums

Minimum Premiums

Deductibles & Co-Pays

Deductibles / Co-pay
Waived w/ Reporting

Deductibles & Co-Pays

Owners Added as Addl

Owners Added as Addl

Owners Added as Addl

The CRU underwriting process

Review of
Application
and Info

In Person Evaluation

SDI PROPOSAL

Senior Management Discussion:

1. Strategy
2. Operational Issues
3. Current and Future Plans
On-Site Evaluation:
1. Sub-Contractor
Prequalification
2. QA/QC
3. Project Controls

6 major criteria

SDI underwriting evaluations of potential GC

clients are based on 6 major criteria
criteria:
> Market focus
> Financial health
> Strategy for SDI
> Belief management team / business strategy
> Subcontractor pre-qualification
pre qualification
> Subcontractor management

The resulting overall risk score helps

the underwriter decide whether to
offer a quote

Illustrative

Risk Score Result

Max
Weight

Min
Weight

Chosen
Weight

Current
Score

Future
Score

Ma rketfocus

35%

15%

20%

3.5

3.5

Fi na nci a l hea l th

20%

5%

10%

2.0

3.5

Stra tegy forSDI

30%

5%

5%

3.0

3.0

Bel i efi nmgmttea m

a ndbus s tra tegy

40%

10%

15%

5.0

5.0

Subcontra ctorpre
qua l i fi ca ti on

40%

15%

25%

3.0

4.5

Subcontra ctor
ma na gement

40%

15%

25%

4.0

4.0

100%
85%
15%

3.6

4.1

Criteria

Risk
Scoring
Tool

Risk Score Translation

5.0

The resulting
res lting o
overall
erall risk score helps the
underwriter decide whether to offer
quote
3.8 5.0 a
: Quote
with

Total
CurrentScore

100%

85%

FutureScore

15%

0%

confidence

2.3 3.8 : Consider quote,

but also consider more
restrictive terms

1.0 2.3: Decline to quote

Total Score 3.63

1.0
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Sample quote of SDI

Section4 Rating
CoverageScenarios
andRatings

Option

PerLoss
Per
Loss
Deductible
(Thousands)

$500

$750

$1,000

$1,500

Aggregate
Deductible
(Thousands)

$1,500
$
,

$2,250
$
,

$3,000
$
,

$4,500
$
,

FixedPremium
Rate

$5.64

$4.50

$3.74

$2.79

LosFundRate

$6.36

$7.50

$8.26

$9.21

SDITransfer
R t
Rate

$12.00

$12.00

$12.00

$12.00

Premiumsinclude10%brokercommission
Premiumsdonotincludetaxesandsurcharges

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After general contractor buys SDI

Co e age is
Coverage
sa
available
a ab e
any project that the
GC enrolls in its
program

GCs may elect not to

enroll one or more
projects

Premiums are paid

when the program in
enrolled
No minimum
premiums

Once a program is
enrolled all subs are
enrolled,
in the program unless
the general contractor
bonds them

After enrolled program

p
, final sub
is complete,
values are reported
and premium is
adjusted

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Benefits to the owner of hiring a

GC which uses SDI

Improved
project delivery
in the event of a
subcontractor
default

Cost savings
over bonding
subs and more
subs covered

Up to 10 year
warranty
provisions

Availability of
the assignment
of the benefits
of the SDI
policy if the GC
defaults

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Examples of common claim types

Defective
W k
Work

Project
Controls

Subcontractor
Issues

Replacement of poor work by replacement sub

Construction defect after project complete (15%)

Overbillings by subcontractor with other problems

Unpaid amounts due by subcontractor to others
(15%)

Improper estimation of costs or quantities

Solvency issues from other jobs (60%)

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How loss is calculated

$5,000,000

Original Contract Value

$2 000 000 + Change Orders

$2,000,000
$1,000,000 - Amount Paid on Original Contract
$8,000,000 - Amount to Finish Remaining
$2,000,000 = Loss Amount Before Indirect
$500,000

25% Indirect

$2,500,000 Claim Before Deductible

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Other questions

> Surplus lines state tax varies by state

> Final audits
As projects complete NOT PROGRAM
Voluntary

> No collateral required 1st party relationship

> Loss funds are returned
When there are loss payments
Or upon request of insured for adjustment

> If loss fund is empty, loss is paid minus deductible

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Questions?

Tim Cleary, CRIS, CLCS

Account Executive & Practice Group Leader
M3 Insurance
I
tim.cleary@m3ins.com
608 288 2839

Tim Anderson
Senior Vice President
Construction
Underwriters
C
t ti Risk
Ri k U
d
it
tim.anderson@crunderwriters.com
970 879 7870

Reminder: To qualify for the CPE credit, you must complete the
evaluation form at the end of the webinar.

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Disclosure

Pursuant to the rules of professional conduct set forth in Circular 230, as

promulgated by the United States Department of the Treasury, nothing
contained in this comm
communication
nication was
as intended or written
ritten to be used
sed b
by an
any
taxpayer for the purpose of avoiding penalties that may be imposed on the
taxpayer by the Internal Revenue Service, and it cannot be used by any
taxpayer for such purpose. No one, without our express prior written
permission,
i i
may use or refer
f tto any tax
t advice
d i iin thi
this communication
i ti iin
promoting, marketing, or recommending a partnership or other entity,
investment plan, or arrangement to any other party.
Baker Tilly refers to Baker Tilly Virchow Krause, LLP, an independently
owned and managed member of Baker Tilly International. The information
provided here is of a general nature and is not intended to address specific
circumstances of any individual or entity
entity. In specific circumstances
circumstances, the
services of a professional should be sought. 2012 Baker Tilly Virchow
Krause, LLP

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