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Insurance - How much does a contract bond cost?

image Eric Lesch, Principal/Bond Producer, PCL Contract Bonding Agency, Irving, TX

AUSTIN - I frequently get asked to provide estimates for the cost of a bond as if I have a slab of meat and the buyer only needs one pound. Sure thing, I’ll just shave off a little and there you go! Of course, it isn’t nearly that simple and as my dad always says, “It depends.” The most common factors that determine rate are the type of work, time until project completion, length of warranty, where the project is located, whether design is included and the financial condition of the contractor. For this article, we will focus on performance and payment bonds for projects located in Texas.

    In Texas, like other states, each surety files rates with the Department of Insurance. Multiple rates are filed, but unlike other states, through some invisible agreement, the sureties have all settled on using a similar standard set of rates that are based on the type of work performed. This leads to many large Texas contractors receiving the exact same rate as their much smaller competitors, an environment where competition on rate is not common and very long-term surety relationships.
    Nearly all construction falls within two rate classes. The class A rate, starting at 1.5%, is used for trades such as roofing, glazing and millwork, while the class B rate, starting at 2.5%, is used for the majority of building trades like mechanical, electrical, plumbing, underground utilities, drywall, painting and concrete. As you can see from the trades and their rates, they don’t always match up with what we consider the highest risk on a project. For example, painting and drywall use a significantly higher rate than glazing and roofing. In cases where multiple types of work are present, for example a GC with multiple subcontractors, the rate used is typically the highest of the trades used.
    If you have design in your contract then you can push aside those rates because there is one special rate for things that are considered hazardous. This rate starts at 2.5%, like class B, but falls off much more gradually at each tier. You should always try to separate design and build into their own contracts and only bond the construction portion. This produces a cost savings to the owner that is typically accepted at your benefit with your surety happier too.
    As the contract amount grows, the rate decreases in tiers that are applied to portions of the contract value. As an example, the first three tiers are shown here with rates.
    As the contract amount grows, it is separated into six tiers: $0-100k, 100k-500k, 500k-2.5m, 2.5m-5m, 5m-7.5m, and over 7.5m, with each tier getting a lesser rate. For example, for class B the rate applied to each tier is 2.5%, 1.5%, 1.0%, 0.75%, 0.7% and 0.65%, respectively.
    Some surety companies have additional rates allowing them to charge above the base rate. These are most commonly used when a company’s financial condition is poor or underwriting information is incomplete.
    While you could use an elaborate spreadsheet, we supply them to clients when asked, there are many details that need to be accounted for and mistakes are easily made. It is always safer to ask your agent for an estimate, but make sure when you do, you include all the details. Many contractors forego a complicated spreadsheet and instead use a simple calculation that uses only a flat percentage or a couple tiers so that missing anything will still result in an overcalculation of premium and nothing lost.
    It is important that all change orders have bond premium added. Instead of trying to calculate a new bond premium for the project and then taking the difference, many contractors also have a default percentage to use for all change orders so that mistakes are avoided, and even though deductive change orders result in a premium refund, I advise contractors to never include that refund since it is likely to be over-estimated.
    Included in the cost of a performance bond is a payment bond and one year of warranty. An extra year of warranty starts at only 0.25% which is a bargain if you ask me. For some trades, like those concerning building envelope, it seems like an obvious choice to ask for the second year of warranty if you already paying for a bond.
    Can bond premium be marked up? It depends, but usually. You spend lots of time building a strong and dependable surety relationship and money on CPA financials and other reports that the surety requires. Another reason to markup bonds is when you want to discourage a request for bonding. By making the bonds appear very expensive, the bonding requirement may be waived.
    If a contractor bonds subcontractors then does that reduce the amount or cost of their bonds? No.
    Is the bond cost reduced if it is for a percentage of a contract? No, except for maintenance bonds which have their own complex rate calculations.
    There are many things involved in these calculations and your agent doesn’t expect you to be an expert so give them a call when you need help.

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Author Info
Lexie Velasquez lexie@constructionnews.net