Skip to main contentSkip to navigation
Back to Blog

Subcontractor Default Insurance: Is It Worth It?

January 30, 2025
13 min read
Risk Management

As a general contractor in New Jersey, you've probably lost sleep worrying about subcontractor failures. Will your electrical sub finish on time? Can your concrete contractor handle that large pour? What happens if a key sub goes bankrupt mid-project? Traditional performance bonds have been the answer for decades, but now there's an alternative: Subcontractor Default Insurance (SDI). But is it right for your business?

The $200 Million Question

Last year, subcontractor defaults cost New Jersey general contractors over $200 million. The right protection strategy can mean the difference between absorbing these losses and transferring the risk effectively.

Understanding Subcontractor Default Insurance

SDI is a relatively new risk management tool that's gaining traction among larger contractors. Unlike performance bonds, which are three-party agreements, SDI is a two-party insurance policy between you and your insurance carrier.

How SDI Works

  1. 1. You Purchase the Policy: Coverage applies to all enrolled subcontractors across multiple projects
  2. 2. Subcontractor Defaults: They abandon work, go bankrupt, or materially breach contract
  3. 3. You Complete the Work: Hire replacement subs or self-perform to finish
  4. 4. File SDI Claim: Recover costs above your deductible and co-insurance

Key SDI Features

Coverage Includes:

  • • Cost to complete work
  • • Correction of defective work
  • • Delay costs
  • • Legal fees
  • • Extended overhead

Policy Structure:

  • • Annual aggregate limit
  • • Per-loss limit
  • • Deductible per loss
  • • Co-insurance (you share losses)
  • • Direct claim relationship

SDI vs. Performance Bonds: The Complete Comparison

Understanding the differences between SDI and traditional bonds is crucial for making the right choice:

FactorSDIPerformance Bonds
ControlGC controls processSurety controls
SpeedFast (days)Slow (weeks/months)
Cost StructurePremium + DeductibleBond premium only
Coverage ScopeMultiple projectsSingle project
Sub PrequalificationGC responsibleSurety vets
Owner AcceptanceLimitedUniversal
Risk RetentionHigh (deductible)None

The Real Numbers: Cost Analysis

Let's break down the actual costs for a typical New Jersey general contractor:

Scenario: GC with $100M Annual Subcontract Value

SDI Option

  • • Premium (0.5%): $500,000
  • • Deductible: $250,000
  • • Co-insurance: 10%
  • • Admin costs: $50,000
  • First Loss Cost: $800,000

Bond Option

  • • Avg premium (1.5%): $1,500,000
  • • No deductible: $0
  • • No co-insurance: $0
  • • Minimal admin: $10,000
  • Annual Cost: $1,510,000

SDI saves $710,000 annually IF no major defaults occur

One $3M default would eliminate 4 years of savings

When SDI Makes Sense (And When It Doesn't)

SDI Works Well When:

  • ✓ Annual revenue exceeds $75M
  • ✓ Strong sub prequalification process
  • ✓ Sophisticated risk management
  • ✓ Can absorb large deductibles
  • ✓ Stable, repeat subcontractors
  • ✓ Mostly private projects
  • ✓ In-house legal/admin resources

Stick with Bonds When:

  • ✗ Annual revenue under $50M
  • ✗ Limited cash reserves
  • ✗ Government/public projects
  • ✗ High-risk subcontractors
  • ✗ New/unknown subs frequently
  • ✗ Limited admin capacity
  • ✗ Risk-averse ownership

Real SDI Cases from Bergen County

Success Story: Hackensack High-Rise GC

Situation: $150M annual revenue, implemented SDI in 2021

Results: Saved $1.2M over 3 years, handled 2 defaults smoothly

Key: Strong prequalification eliminated high-risk subs

Cautionary Tale: Mid-Size Fort Lee GC

Situation: $40M revenue, switched to SDI to save money

Results: $2.5M default in year one, couldn't absorb deductible

Lesson: SDI requires financial strength to weather storms

Mixed Results: Paramus Infrastructure Contractor

Situation: Uses hybrid approach - SDI for private, bonds for public

Results: 30% cost savings while maintaining flexibility

Innovation: Best of both worlds approach gaining traction

How to Implement SDI Successfully

If SDI makes sense for your company, proper implementation is critical:

1. Strengthen Prequalification

Essential Prequalification Elements:

  • • Financial statements (3 years, CPA-prepared)
  • • Banking relationships and credit lines
  • • Work in progress schedules
  • • Claims history and litigation
  • • Key personnel stability
  • • Equipment ownership vs. rental
  • • Supplier payment history

2. Set Enrollment Criteria

Not every sub should be enrolled in SDI. Consider these thresholds:

  • Minimum Contract Size: $1M+ (smaller contracts aren't worth the risk)
  • Financial Strength: Working capital > 10% of annual revenue
  • Experience: 5+ years in business, 3+ years with your company
  • Performance History: No defaults, minimal claims/disputes

3. Create Default Procedures

Critical: Have Plans Before You Need Them

  1. 1. Early warning system for sub distress
  2. 2. Pre-negotiated replacement sub agreements
  3. 3. Legal counsel on standby
  4. 4. Documentation procedures
  5. 5. Communication plans for owners/stakeholders

Financial Requirements for SDI

SDI isn't just about saving premium dollars—it requires significant financial capacity:

Minimum Financial Benchmarks

Balance Sheet

  • • Working capital: $5M+
  • • Current ratio: 1.5+
  • • Debt/equity: <2.0
  • • Cash reserves: 2x deductible

Operations

  • • Gross margin: 12%+
  • • Net margin: 3%+
  • • Backlog/working capital: <15
  • • DSO: <60 days

Warning: One major default can consume 2-3 years of SDI premium savings

The Hybrid Approach: Best of Both Worlds?

Many successful contractors use both SDI and bonds strategically:

Smart Hybrid Strategy

Use SDI For:

  • • Trusted, repeat subs
  • • Private projects
  • • Smaller contracts ($1-5M)
  • • Low-risk trades

Use Bonds For:

  • • New subcontractors
  • • Public projects
  • • Large contracts ($5M+)
  • • High-risk trades

Your SDI Decision Framework

Use this checklist to determine if SDI is right for your company:

SDI Readiness Checklist

Score: 6-8 checks = Strong SDI candidate
3-5 checks = Consider hybrid approach
0-2 checks = Stick with bonds

The Bottom Line on SDI

Subcontractor Default Insurance isn't a magic bullet—it's a sophisticated risk management tool that requires financial strength, operational excellence, and strategic thinking. For the right contractor, SDI can provide significant cost savings and greater control over the default process.

However, SDI isn't for everyone. Smaller contractors, those with limited cash reserves, or companies working primarily on public projects should stick with traditional performance bonds. The key is understanding your risk tolerance, financial capacity, and operational capabilities.

As the construction market in New Jersey continues to evolve, we're seeing more contractors adopt hybrid approaches—using SDI where it makes sense while maintaining bonding capacity for situations that demand it. This flexible strategy often provides the best risk/reward balance.

Get Expert SDI Analysis for Your Company

Our team will analyze your subcontractor portfolio, financial position, and project mix to determine if SDI makes sense for your business. Get a custom cost/benefit analysis with real numbers.

Free analysis • No obligation • Confidential review

About the Author

Midland Associates Insurance Team

President, Midland Associates

Our team has guided dozens of New Jersey general contractors through SDI implementation and optimization. We're recognized as leading experts in construction risk transfer strategies and speak regularly at AGC events on subcontractor default management.

Subcontractor DefaultPerformance BondsRisk TransferGeneral Contractors