President's Message

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Be Grateful for Subcontractor Default Insurance: SDI has not killed surety, and it has made us stronger

Now that I have your undivided attention, please allow me to elaborate before petitioning NASBP’s Board of Directors to tar and feather me and then drive me out of the industry on a rail. Most, if not all, NASBP Members would assert that they support free enterprise and market competition. However, in our heart of hearts, we may secretly long for the dominant position of surety bonds prior to the mid-1990s. We do compete for clients based on elements such as expertise, service, or underwriting terms and limits. However, we did not face product competition on public projects in the decades after passage of the Miller Act in 1935. As an aside, if you missed the Boca Raton dramatic presentation of the Congressional Hearing that led to the Miller Act, you missed the reenacting of history in the making. Several of the panelists may be in the running for nominations for Oscars or Golden Globe Awards.

The reality is that the Miller Act and the subsequent Little Miller Acts in the states mandated the use of the contract surety product on public work. In addition, performance and payment bonds became the “go to” products used by prime contractors managing subcontractor risk and by private owners who wanted a guarantee of a completed and lien free project. Both bond producers and underwriting companies benefited by our unique product over the half century following the passage of the Miller Act.

Our comfortable and complacent world was shaken to the core in the mid-1990s with the introduction of subcontractor default insurance (SDI). Reactions from surety participants ranged from disbelief to denial to anger. With the passage of time, we came to realize that our product was not meeting some key issues for large, sophisticated, and well-capitalized prime contractors. Those contractors came to believe that they could self-perform or outsource the pre-qualification process. As projects grew larger, more complex, and more time sensitive, they believed SDI could respond quicker than a surety product could. Finally, those contractors saw SDI as a potential profit center if they successfully managed their subcontractor risk.

After more than two decades SDI can now be considered a mature risk management tool. The product is now offered by multiple companies. I believe SDI in some form will be with us for the foreseeable future.

Recent experience by some SDI providers has illustrated that the terms and conditions offered by the carriers were overly broad. They have painfully learned the danger of offering long-term guarantees. There have been reports of SDI serving as a construction defects policy. The carriers and contractors are reportedly becoming more mindful of aggregation risk. I predict that the carriers will modify their terms and conditions to mitigate these risks. Contractors may be exposed to a denial of coverage if they do not fully comply with those stricter terms. However, I repeat that surety professionals should not expect the SDI product to disappear.

In conclusion, I return to the title of this article. Why should we be grateful for the pain and anguish of competing with SDI? I firmly believe that competition sharpens our skills and drives us to analyze and improve the surety product. We now know that we operate in a dynamic, not a static, environment. We are already seeing innovation in surety bond forms that allow for construction to continue when problems arise. Other forms require the utilization of dispute resolution prior to triggering a default. On large, complex projects we may see bonds that have a liquidity feature.

NASBP Members have benefited from detailed presentations of the critical differences between bonds and SDI. As a result our members can effectively illustrate how bonds can benefit owners, subcontractors, and lenders in ways that SDI cannot.

Competition is not always enjoyable, but it demands increased professionalism and persuasive advocacy by each of us. There is an adage that states “That which does not kill us makes us stronger.” SDI has not killed surety, and it has made us stronger. I rest my case. Please cease heating up the tar and plucking feathers off that poor chicken.

Howard Cowan is Principal of Acrisure, LLC dba Cowan-Hill Bond Agency in Lubbock, TX. He can be reached at howardcowan@sbcglobal.net.