By David Bowcott
Economic uncertainty, driven by inflation, rising interest rates, and geopolitical instability, is increasing tension between construction contractors and project owners over performance security structures. When contractors have ample resources, project owners may demand less security. However, in today’s climate—marked by limited contractor availability and rising material costs—demand for more robust performance security packages is growing.
Project owners must consider that asking for larger security packages often results in contractors raising their construction prices. This is because performance securities, such as letters of credit or larger bonds, affect contractors’ balance sheets and limit their ability to secure future work. Consequently, contractors factor these lost opportunities into their pricing. To prevent inflated costs, both owners and contractors should be familiar with the various performance security options available. This allows them to strike a balance between ensuring strong security and minimizing the financial strain on contractors.
Here’s a high-level overview of performance security options that help achieve this balance:
|
Performance Security Option |
Nature of Coverage | Impact on Contractor’s Balance Sheet |
Security Robustness Level (Liquidity and Size) |
| Parental Guarantee |
|
Low |
Low (can be higher with strong parent rating) |
| Performance Bond (North America) |
|
Low-Medium |
Medium |
| Adjudication Bond (Often used in UK) |
|
Medium |
Medium-High |
| Subcontractor Default Insurance (SDI) |
|
Low |
High |
| Letter of Credit |
|
High |
High |
| Surety-backed Letter of Credit |
|
Medium |
High |
| Demand Bond or Liquid Surety |
|
Medium |
High |
| Hybrid Demand Bond-Traditional Bond |
|
Medium |
High (on-demand portion)/Medium (conditional portion) |
This list is not exhaustive, but it highlights key options available in the market. Both project owners and contractors must collaborate to determine the best performance security structure—one that satisfies the owner’s need for security without significantly impacting the contractor’s ability to pursue future work. Understanding the available options is crucial to achieving this balance.
Questions? Contact:
David Bowcott, Executive Vice President
Construction Insurance Group
416-566-5973 |dbowcott@platforminsurance.com
