Each year, the U.S. Government spends $250 Billion on construction projects and risks losing $10 Billion due to contractor failure — but they wind up losing nothing. Meanwhile, millions of private homeowners spend $150 Billion to remodel their homes and risk losing $5.4 Billion due to contractor failure — and they wind up losing all $5.4 Billion!
Why is this happening?
The Government has a secret weapon at their disposal to eliminate the financial risk on their construction projects. This secret weapon is called a surety: a type of insurance company that guarantees construction projects are delivered as promised. They are an integral part of the construction process and since 1893 their involvement is a legal requirement on any public construction project larger than $100,000. Here is how the Government uses them in two easy steps:
1. Professional pre-qualification process - Firstly, the Government requires that a contractor’s ability to complete projects on time, on budget and to specification be professionally assessed by a surety. Sureties have been assessing contractors for over a century and know exactly what to look for and their rigorous pre-qualification process ensures that only the strongest contractors are eligible to bid on the Government’s projects. This process lowers the Government’s annual exposure alone by nearly 70% from $10 Billion to around $3.16 Billion.
2. Performance & payment bonds - Finally, the $3.16 Billion cost associated with the elite group of surety approved contractors failing to perform (yep, even the best of the best fail in construction), is absorbed in full by the surety via performance and payment bonds. These financial instruments see the surety company taking financial responsibility for the contractor’s performance and payment of all subcontractors and suppliers (hence why they are so good at assessing them). In the event a contractor does not perform according to the terms of the building contract, the surety company steps in with the funds and a replacement contractor and delivers the Government’s project exactly as promised. Unfortunately the situation for homeowners is far bleaker. Unlike with Government projects, there is no professional pre-qualification process to weed out irresponsible contractors (Angie’s list doesn’t cut it) and no surety company absorbing the cost of their contractor’s failures. Instead, there is just $5.4 Billion of personal finance vanishing into thin air.
How Michelle Obama lowers her risk in two easy steps
The $5.4 Billion of loss homeowners suffer every year remodeling their homes actually translates into an average loss of $3,570 for every $100,000 spent remodeling. So lets assume Michelle Obama is remodeling the Executive Residence of The White House and you are remodeling your New York City apartment and both projects are expected to cost $100,000. Here is how the process of lowering the $3,570 of financial risk on each of these projects plays out:
1. Professional pre-qualification process - Michelle will begin lowering her risk by nearly 70% to $1,128 by asking a surety company to assess her contractor’s ability to perform on her project. You could try to lower your exposure by vetting contractors yourself but this is a highly complex and technical due diligence process for which you lack the necessary know-how, resources, and time. Even if you could somehow convince a surety company to get involved it would be prohibitively expensive. Surety companies only assess contractors for public and commercial projects or very large residential projects ($500,000 and above). And so, at the point of choosing a winning contractor, Michelle only has $1,128 of risk remaining on her project while you are still stuck at $3,570.
2. Performance & payment bonds - The remaining $1,128 of risk associated with the winning surety approved contractor failing to perform on Michelle’s White House remodel is then absorbed in full by the surety via the contractor purchasing performance and payment bonds. This option is simply not available to you and so your risk remains stubbornly at $3,570. In sum, from the moment she signs her building contract with her contractor, until 12 months after her project is complete, Michelle Obama enjoys complete peace of mind that her project will be completed exactly as promised with absolutely no financial risk. You on the other hand have no way of ensuring your project will even get off the ground let alone be completed properly and, throughout the entire ordeal, you are exposed to an average loss of $3,570, which you ultimately pay for alone.