5 Operational Practices of Contractors that Contribute to Claims Loss Severity

The surety industry tracks not only the frequency of claims, but the severity of claims. To proactively mitigate risk, it's important to have an understanding of contractors' operational practices that can contribute to loss severity. 

Common Contributors to Loss Severity

Underbidding in relation to actual expenses is a reflection of contractors failing to control or properly account for – be it contractually, financially, or otherwise – price increases in overhead, labor, and materials over the course of a project. From a loss perspective, it places the surety at a disadvantage because the contract amount is low relative to the cost to complete remaining work.

Overbilling can be the result of underbidding a project in the first place, because billings are too low to generate sufficient cash flow to cover job costs. Overbilling in relation to actual work in place – for example, billing 75 percent of the contract amount when 50 percent of the work is complete – serves to increase the loss further because the contract balance is not enough to cover the cost of the remaining scope of work (even at original contract pricing).

Defective work increases the loss in a number of ways:

1) defective work can necessitate investigation and testing

2) repair work increases the completion scope of work

3) the scope of repair can be difficult to ascertain with certainty, which results in contingencies and higher pricing

4) repair work extends the time necessary to complete the remaining work, which increases general conditions and the likelihood of delay damages.

While past-due payables often result in payment bond claims that can serve as an early indicator of a contractor’s financial strain, that is not always the case. Sureties are encountering high 90+ day old balances, often without any prior notice or claim, which leads to strained or ruined vendor relationships, charges and penalties, and additional losses.

Delays in projects. This can result in supplementation costs and delay damages, including liquated damages, which reduce the contract balance and ultimately increases the loss.

Partnering With a Proactive Surety

Contractors should be mindful of these issues in assessing their own operations as well as those of subcontractors and suppliers. They should also partner with a surety that demonstrates a proactive approach to claims. The right surety partner will seek to bring value to the relationship by working with contractors to avoid claims, and if the situation is unavoidable, to mitigate the severity of it.

How do I get a Surety Bond?

Surety bonds are issued by Merchants Bonding Company (Mutual) through insurance agents. Contact your local insurance agent or use our Find an Agent tool. They will guide you through the process, informing you of what documents and information are needed by the surety (Merchants Bonding Company (Mutual)) to underwrite your bond.

What is a Surety Bond?

A surety bond is a three-party agreement that ensures the fulfillment of a commitment or contract. For instance, the surety (Merchants Bonding Company (Mutual)) may provide a surety bond to a construction company (the principal) which is required by the state (the obligee), ensuring the construction company will perform the duties as outlined in the contract. In bonding the construction company, Merchants assumes the risk should the company default or not fulfill their contract. A surety bond is different from traditional insurance in that the principal is obligated to pay back the surety company on any claims paid out.

All information provided is subject to change.