- November 30, 2016
- Posted by: Surety Bond Experts
- Categories: Subcontractor Default Insurance, Surety Bonds
The popularity of SDIs has risen since 1996. They have been used as a way for contractors to protect themselves from certain risks when working with subcontractors. Through SDIs, the contractor is willing to accept and manage risks that can be attributed to subcontractor defaults. The negative aspect is, that they do not carry the benefits of a performance or payment bond.
One of the biggest differences between the two are that surety bonds are regulated by state insurance departments. Therefore, more regulations are involved with surety bonds as opposed to SDIs (which are sold). A surety bond also protects the obligee and not the principal, whereas an SDI is a two party contract between the insurer and principal. The calculation of the premium is also different. For surety bonds, the potential for any sort of loss is considered. In an SDI, the premium is calculated by a pooled risk. How claims are handled also differs in both cases. In a surety bond, the surety determines if there has been a violation of the surety bond, whereas in an SDI, the insurer pays the insured. In an SDI, there is no right to the insured’s assets. Finally, a surety bond’s coverage is project-specific whereas an SDI is term specific.
The specific types of surety bonds also differ from SDIs, for example performance and payment bonds. The difference between the two entities begins with the prequalification process. With performance and payment bonds (PPB), this process is evaluated by the surety. The subcontractor submits requested financial documents to show and prove competency. Whereas with an SDI, the prequalification process is not as thorough as in a PPB since they do not require all the financial documents needed for a PPB. Payment protection for the subcontractor and suppliers are fully covered in a PPB, but not in a SDI. In an SDI, the subcontractor or supplier cannot file a direct claim with the insurer. In the case where a claim is filed, the SDI allows the contractor to declare and manage the default whereas in a PPB, the surety (acting as an independent party) decides the legitimacy of the claim. If it is decided that the subcontractor has violated the bond, the surety completes and arranges for (or pays) for the contract to be completed, based upon the agreed upon bonded amount. As far as legality is concerned, a PPB is more legally established than an SDI, because it is required by federal and state law on public projects and has a long history of case laws and legal precedents.
The differences between a surety bond and a subcontractor default insurance are that the surety bond requires more financial information than an insurance agent. The surety acts as an independent party in the contract, therefore being an unbiased party. Surety bonds have a longer legal history, which helps to resolve claims because of precedents and case laws. Surety bonds are regulated, therefore providing more protection.
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