Aon Risk Solutions Construction Services Group Subcontractor Prequalification Survey 2014 Risk. Reinsurance. Human Resources.
Table of Contents Summary.... 1 Survey Results and Findings... 3 Contractor Default Insurance....3 Prequalification....6
Summary There has been a dramatic surge of interest over the past decade in subcontractor prequalification and the systems and services available to administer the flow and interpretation of documentation. Much of this focus is being driven by the use of contractor default insurance (CDI) products and in response to the severity of the recent construction market decline. As shown in Figure 1: U.S. Construction Market, the 2008 2011 construction market decline was the sharpest in recent history. Of the three occurrences where construction activity declined for more than three consecutive years since 1964, the recent downturn was three times worse than any previous cycle. As the industry continues to pull out of this recession, in many ways general contractors are finding a significantly altered landscape for safe subcontractors. Subcontractors with diminished financial strength and capacity, a limited qualified workforce, pursuing too many projects and over consuming during the economic lift, and quality issues continue to challenge general contractors. Intent Relevant insights into industry trends, benchmarking, and best practices are an important part of being effective in risk management. Each spring, the Aon Peer Conference supports an objective of providing the participants with visibility into coming trends. General contractor involvement is fundamental to making this conference a success and your ongoing contributions are sincerely appreciated in emphasis on a shared goal of continual progress within the construction industry. In conjunction with the 10th Annual Aon Peer Conference, a brief survey was put forth by Aon s Construction Services Group (CSG) which provides the general contracting community with current and future planned practices U.S. Construction Market Measured as USD mm of non-residential construction put-in-place Source: U.S. Census Bureau, Construction Spending, For more information: http://www.census.gov/const/www/c30index.html Construction Services Group 1
regarding the prominence and usage of default insurance products and prequalification tools. Reflecting the importance and relevance of this subject, a single request resulted in fiftyone participants, representing fort-five general contractors, responding to this survey. We are pleased to share these results with you and to answer any questions you may have regarding content or other Aon CSG perspectives and intelligence on these subjects. Again, thank you. Date(s) Event Director of Risk Manager / Director of Insurance 31% Chief Financial Officer / General Counsel 22% CDI/CCIP Managers, Subcontractor Risk Managers 14% Chief Executive Officer / Chief Operations Officer 10% Preconstruction / Analysts / Prequalification Managers 8% Chief Administrative Officer 2% Other 13% 2 Aon Subcontractor Prequalification Survey
Survey Results and Findings Contractor Default Insurance Contractor Default Insurance programs are designed to protect general contractors from subcontractor non-performance on a project in a way similar to subcontractor payment and performance bonds. Coverage is triggered when a subcontractor fails to fulfill the terms of their subcontract. The general contractor places the subcontractor into default and maintains the operational control to immediately replace the subcontractor and work towards keeping the project on schedule. Losses incurred as a result of the default are claimed under the insurance policy. The general contractor often retains some portion of the claimed loss risk through a deductible or insured retention being funded within the pricing charged by the general contractor on a large portfolio of projects. The subcontractor management survey includes responses from forty-five general contracting firms of wide-ranging size with locations throughout the United States and Canada. Ninety-two percent of these respondents have existing default insurance programs with one half now enrolling greater than 50% of subcontractors into a default insurance program. While the construction activities of many respondents may be limited to a specific geographic region, the implementation of default insurance is widespread with enrollment volume in the southeast and southwest United States expected to grow by double digits within the next two years. Approximate subcontractor volume your company projects to enroll into your CDI program in 2014: * Less than $200 million 28% $201 million to $500 million 37% $501 million to $750 million 9% $751 million to $1 billion 9% Over $1 billion 17% For the coming two year trend, what percent of eligible subcontracted volume is expected to be enrolled into CDI? * Greater than 75% 31% 50% - 75% 31% 20% - 50% 29% Less than 20% 9% *Note: Representative of those with existing CDI programs. Eight percent of participants reported that they do not have a CDI program. Construction Services Group 3
CDI Utilization Percent of survey responses currently using CDI by geographic region versus projected use within two years 50% Current Future 40% 30% 20% 10% 0% Northeast New York City Southeast Central / Midwest Southwest West Canada Outside the United States and Canada The majority of participants report internal project management support for CDI as strong with only 15% of survey participants reporting significant internal resistance. However, when asked for the most significant hurdles to maximizing use of CDI within the company, internal operations education /resistance and identifying the right type of work, were reported by 37% and 35% of survey participants, respectively. Contrasting these results perhaps reflects organizations with ample internal support for CDI and the need to again re-visit overall CDI strategy and training within the broader organization. Respondents went into significant detail outlining concerns regarding the future success of default insurance in the construction industry. Owner and lender acceptance was listed as a significant issue by several respondents with comments reflecting owners do not yet accept CDI as a cost of doing business and expecting a return back for no claims. Others indicated smaller less sophisticated general contractors being given CDI programs, pressures to use inferior subcontractors and a potential lack of discipline by general contractors in subcontractor selection. These viewpoints perhaps reflect a concern by more tenured CDI users over the potential for an overall increase in claims with resulting market pressures to increased insurance premiums and coverage restrictions. Finally, several respondents indicated that more education and training were needed regarding CDI programs. 4 Aon Subcontractor Prequalification Survey
Does your internal project management staff support use of CDI (whether willingly or through fiat)? Generally, we have strong support for use of CDI 61% We have a few who still do not support / understand CDI 25% We continue to have significant resistance to using CDI 14% What are the most significant hurdles to maximizing the use of CDI within your company (multiple): Owner & Lender education / resistance 41% Executive team (e.g. CEO, COO, CFO) education / resistance 8% Internal operations education / resistance 37% Identifying the right type of work 35% Participants currently using CDI were very supportive of our request for suggestions to other general contractors just now implementing CDI. The vast majority of comments reflected a focus on the importance of establishing the right foundation and management strategy around the product prior to program implementation. Suggestions included, have operational and executive buy-in and controls before implementation, stick to your requirements, subs want the work, insist on a strong prequalification process that is applied consistently, pre-qualify subs as if you had no protection; don t use CDI as a way to bring on board troubled subs and low bidders, recognize and have management buy in to the fact that we are underwriting these subs and that we are taking the risk of nonperformance. Cannot pick bad subs and then say no worries because we have CDI and create a robust prequalification process immediately. Do not wait until you start to have defaults and be reactive. Other suggestions emphasized the importance of understanding the intent of these products and the right approach when educating owners. One participant noted, get owner approval early. While others stated, don t discount the cost of the product, put the effort into internal education, and emphasize the benefits other than financial to owners. Using real examples of how CDI was instrumental in pulling a project out of a default without the typical surety problems. Finally, one person summed up their opinion as follows, You re far from an early adopter, getting info from subs & getting owners on board isn t as difficult as you think it will be. When asked what specific data or information is important to you for managing CDI within your firm, almost every response underscored the importance of claim and loss trends. In the 2013 policy year, Aon clients enrolled projects valued at more than $13 billion into the combined Zurich, XL, and Arch/Catlin CDI programs and now retains a database totaling in excess of $60 billion of enrolled volume. Based on this enrollment, and the associated claim and loss activity, Aon actuaries offer CDI specific reserving analysis as an option for our clients. In addition, both Zurich and XL provided loss trending analysis during the Aon Peer Conference and, at our request, Zurich presented for the first time a formal case study on the curtain wall industry, the numerous curtain wall defaults over the past few years, as well as best practices in loss avoidance and mitigation. Aon will continue to concentrate on ways to present meaningful claim trend analysis for our clients. Construction Services Group 5
Prequalification A Peer Conference breakout session involving general contractor and insurance carrier participants reviewed the below survey results which generated robust conversation and varying levels of opinion. Most agreed a more central approach to prequalification allows for better enforcement of controls and helps to mitigate situations of seeking to qualify a subcontractor who has already been engaged. Survey participants reinforced this approach as eighty-six percent currently perform financial prequalification as primarily a corporate function. Overall, survey results represent the general trend of subcontractor prequalification with a majority prequalifying subcontractors at least annually, with clearly defined roles and written processes, using formal risk mitigation plans, when applicable, and with a general feeling that general contractor prequalification programs are running well and require no or only minor changes. However, fifty-three percent of those with prequalification trend experience agree the approval process has grown increasingly more difficult due to borderline subcontractors. How is the subcontractor financial prequalification process performed in your company (multiple): Primarily a centralized / corporate function 86% Primarily a regional / local office function 16% Other 4% None 6% Which of the below most accurately describes your current prequalification process: Formal / written process, with robust compliance 47% Formal / written process 41% An informal process 12% When does your company typically prequalify subcontractors for approval to work on a specific project? Annually 29% Approved on a project by project basis 20% Both 37% We don t have a formal/written prequalification process 8% At the bid stage and then every 18 months thereafter 2% Biannually with a project specific update for finance and safety 2% New subs to bid list 2% 6 Aon Subcontractor Prequalification Survey
Do you expect to revise your prequalification process over the next twelve months: Yes, minor changes to our focus on prequalification 55% Yes, major changes to our focus on prequalification 20% No, our program is running well 16% No, we need to make changes, but just too busy or internal resistance 9% Based on the trend in prequalification over the past three years, would you agree or disagree that the approval process: Has grown increasing more difficult due to borderline subcontractors* 40% Is easier now that the economy is starting to improve 10% We don t have enough formal prequalification trends experience to measure 22% We have not seen a significant change 28% *Note: Of those with enough prequalification trends experience to establish an opinion, 53% agreed with this statement. Which of the following is part of your formal/written controls for prequalification and risk management (multiple): Role(s) identified for the prequalification process 78% More than one person is involved in reviewing and approving certain sections of the questionnaire or process 78% Limit of Authority (LOA) when approving subcontractors 55% Company bonding (or CDI) requirements for subcontractors based on contract value 78% Risk Mitigation Plans (RMP), when applicable 73% Typically require lien releases from first tier subcontractors 75% Typically require lien releases from lower tier subcontractors 75% Scoring in the prequalification process (numerical or letter grade) 53% Subcontractor performance evaluations performed and retained from past projects 63% Limit payment to a subcontractor without an executed contract 78% Limit payment to a subcontractor without prequalification approval 47% Different prequalification requirements for smaller valued contracts 55% Construction Services Group 7
Which of the following best describes your approach to prequalification questionnaire type questions: We don t currently collect this information in a structured way 4% We manually provide forms to our subcontractors for manual completion and submission 35% We use a third party system / process to collect the subcontractor data 18% We use an internally created / proprietary internet accessible system for the subcontractor to directly input data into our database We use an internet accessible system for the subcontractor to obtain our internally prepared prequalification forms for manual completion and submission (e.g. pdf, MS Word documents) 35% 8% Does your firm perform a significantly different prequalification process (e.g. financial statement requirement) for subcontractors covered by CDI versus those not covered by CDI? No 73% Yes 15% We don t currently use CDI 12% Which of the following is part of your typical prequalification process (check all that apply): Financial statement review 98% Performance history 90% Safety performance 98% Surety capacity 90% Available line of credit 73% Other 37% None of these 2% 8 Aon Subcontractor Prequalification Survey
Please select the documents typically requested in your subcontractor prequalification process (check all that apply): CPA prepared Balance Sheet 88% CPA prepared Income Statement 84% CPA prepared Statement of Cash Flows 69% CPA financial statements cover letter 63% CPA financial footnotes 59% Bank letter 45% Surety beauty letter 63% Bid bond 12% EMR (safety experience modification rate) 88% References 92% Geographic area 67% Dun and Bradstreet information 43% List of largest completed projects 88% Year company was founded 76% Where CPA prepared financial statements are required, which of the following is most accurate: We require CPA prepared financial statements in most situations and are successful more than 50% of the time We require CPA prepared financial statements in most situations, but are successful less than 50% of the time We require CPA prepared financial statements in most situations and are successful most (> 90%) of the time 37% 22% 16% We don t require CPA prepared financial statements 14% We occasionally require CPA prepared financial statements 11% Construction Services Group 9
Third parties increasing offer services to collect and even evaluate subcontractor financial information. The participants in the Peer Conference breakout session viewed a schedule listing the majority of these firms and reflected on the costs, capability, necessity, timing, and limitations of these services as well as whether the general contractor will ultimately have to make a subjective decision based on many other inputs. These inputs were identified as duration of scope, historical performance, safety review, bid spread, capacity to take on the work, and the ability to understand identified risks in a meaningful way so the potential to mitigate and move forward is effective. Does your company currently utilize a third party company in the financial prequalification process? If yes, which company? Textura 11% Contractor Score 8% CMiC 6% isqft 6% SureTec 4% No 65% To what extent do you currently utilize a third party in the overall prequalification process (multiple): Data / documentation collection only 25% Partial underwriting (3rd Party analysis / scoring of the data) 11% Full underwriting (actual 3rd Party approval / non-approval of the subcontractor) 2% Other 5% We don t currently use a third party for prequalification 57% 10 Aon Subcontractor Prequalification Survey
Do you expect your company to utilize a third party provider in the next two years for prequalification? Yes, using our current provider 37% Yes, we currently don t use a third party provider 12% Yes, likely changing our current provider 2% No 49% What accounting software are you using? CMiC 27% ViewPoint 20% J.D.Edwards 14% Timberline 12% SAP 10% Oracle 4% Other 6% Unsure / No Response 7% Construction Services Group 11
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Contacts Douglas Schrift 704.343.4113 douglas.schrift@aon.com Scott Trethewey 305.961.5929 scott.trethewey@aon.com About the Business Unit Aon is the largest manager of CDI volume. By applying our advanced knowledge of industry best practices, an Aon CDI program places you in the best position to achieve your goals. Whether you are targeting best practice in loss avoidance and mitigation, innovative technology solutions, competitive analysis, claim support, increased sales, or overall strategy development and process improvement, Aon provides executive planning support and program service. When it comes to putting the pieces of business and building together, we create the perfect fit. With Aon Construction Services Group, you get much more than an insurance broker; we create a dynamic partnership with unparalleled depth of talent, leading edge innovations, global reach and local expertise all backed by Aon s world class resources. At Aon Construction Services Group, we protect your business and help drive economic opportunity.
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