Insurance, Surety & Indemnification Why do we need it anyway?

NJ Higher Education Purchasing Association Disadvantaged Business Development Fair August 17, 2005 James A. Breeding
Director, Department of Risk Management & Insurance

Agenda

Why is Insurance Required? What can and does go wrong? Additional Insured Indemnification Types of Insurance Coverage Required Why do we need Surety/Guarantee? When is a Contract Guarantee Required? Types of Guarantees Available What is a Surety Bond? Surety Bonds to Cover Supply & Construction Projects Insurance vs. Surety Bonds Letters of Credits vs. Surety Bonds
NJHEPA 2

Why is Insurance Required?

Due

Diligence Responsible Ethical Business Practices Protect University Assets Minimize Disruption to University Operations Effect a Risk Transfer

NJHEPA

Additional Insured
Defense

Costs Payments of Vendors Insurance

Indemnity

Beneficiary

Coverage

NJHEPA

Additional Insured (contd.)

Rutgers, The State University must be named as an additional insured in this policy. Such insurance shall be primary over other collectible insurance that may apply

NJHEPA

Indemnification
The vendor/contractor agrees to Hold Harmless, Indemnify and defend Rutgers, The State University, against any and all claims, demands or suits by any persons and against related damages, liabilities, costs and expenses (including attorneys fees) which may arise out of the performance of the contract.

NJHEPA

Types of Insurance Coverage Available

General

Liability

Completed Operations Products Liability Contractual Liability

NJHEPA

Types of Insurance Coverage Available (contd.)

Business

Auto Liability

Owned / Non-Owned Auto Leased / Hired Auto Underinsured / Uninsured Motorist

Workers

Compensation

Statutory Limits Part B Employers Liability

NJHEPA 8

Types of Insurance Coverage Available (contd.)

Specialty

Risk Coverage

Bus / Transportation Vendors Asbestos Removal and Monitoring Contractors Chemical Waste and Pesticide Disposal Contractors Construction and Major Renovations Contractors

NJHEPA

Why do we need Surety/Guarantee?

Time

Delay Costs to Replace Vendor/Contractor Missed Deadline (Construction) Cost to Administrate Takeover Legal Expenses Liens Placed by Subs/Suppliers Quality of Work
NJHEPA 10

When is a Contract Guarantee Required?

Vendor/Contractor supplies critical service to University Construction projects considered essential

Roof replacements New facilities with time-sensitive opening Water/wastewater management systems Large dollar stadium, library Software outsourcing Database conversion Bleacher systems Refrigeration units Energy management contractors

Projects required specialized services

Vendors with long lead time or special order units

Vendors supplying long-term guarantee of workmanships

NJHEPA

11

Types of Contract Guarantees

Vendor/Contractor Guarantee

If written into contract, provides that materials supplied & workmanship will be satisfactory to buyer This form of guarantee is only as good as company supplying goods or service. This can be satisfactory if the reputation and experience of supplier is known to University. If this form of guarantee is used, check on companys ownership. It may be necessary to obtain parent company guarantee. The acceptance of vendor/contractor guarantee puts the burden of qualifying the supplier on University
NJHEPA 12

Types of Contract Guarantees (continued)

Surety

Bonds

What is the role of Surety Bonds? Bond Types

Bid Bonds/Consent of Surety Performance Bond Payment Bond Maintenance Bond Supply Bond

NJHEPA

13

What is a Surety Bond?

Three

Party Instrument

Surety

bonds guarantee the obligation of one party to another bonds provide monetary or other recourse if the obligation is not performed

Surety

NJHEPA

14

Suretyship vs. Insurance

Subject to state laws Provides protection against financial loss Risk remains with principal Premiums charged with expectation of no loss

Subject to state laws Provides protection against financial loss Risk transferred to insurance company Premiums include an allocation to cover expected losses

NJHEPA

15

Structure of Surety Bonds

Preamble

Introduces parties
Principal Obligee Surety

Conditions and qualifications

Explains why bond is required Obligates principal and surety to a third party (obligee)

Obligatory clause

Formalizes that if principal fails to perform duties as prescribed by conditions then surety will pay or perform
NJHEPA 16

Structure of Surety Bonds (In comparison to a Letter of Credit)

Bond Preamble Conditions Qualifications Obligatory clause

Letter of Credit Preamble Conditions Qualifications Obligatory clause

Pay on demand Fund principal Replace principal

Pay on demand

NJHEPA

17

Bond Forms
Bid

Bond

Evidence of the good faith & ability of the contractor; The purpose of the bid bond is to:
Eliminate unqualified or irresponsible contractors from competitive bidding To save University the expense of another bid letting should the successful bidder not qualify To assure the completion of the lowest possible cost
NJHEPA 18

Bond Forms
Default

under a Bid Bond

When does a default occur? Courts position Invoking a bid bond

NJHEPA

19

Bond Forms
Performance

and Payment Bonds

Used to guarantee the completion of construction projects Provide for the benefit of laborers, subcontractors & material suppliers Require separate performance & payment bonds to equal 100% of the contract price New Jersey, Senate Bill 305 Can be provided for a single construction project with one or more sureties
NJHEPA 20

Bond Forms
Performance

and Payment Bonds (contd)

Provides indemnity for costs & damages by reason of the contractors failure to deliver under the terms of the contract Assures that persons supplying direct labor or material will be promptly paid under the terms of the contract

NJHEPA

21

Bond Forms

Default under Performance Bond

Upon a contractor default, the surety can complete the contract under these methods:
Offer financial support or other guidance to see the firm to the completion Obtain bids from other contractors to arrange to take over the project Forfeit the bond penalty (limit)

Under Payment Bonds:

The surety has the obligation to pay all verified bills which it is legally liable to pay up to the bond amount

NJHEPA

22

Legal Obligations of University as a Bond Obligee

To

ensure a mutual meeting of the minds Notice to the Surety Responsibilities of bond obligee Duties of bond obligee

NJHEPA

23

Letters of Credit and Bonds

Letters of credit (LOC) are often viewed as substitutes for performance & payment bonds. However, LOCs are not suited to guarantee performance of contractor which require more than a single delivery of goods and payment of a certain sum. At the time of default a LOC simply generates a sum of money to the owner. Administering the completion of the contract is left to the owner. A LOC does not assure payments to subcontractors, laborers & suppliers. The surety bond company has duties & responsibilities to both the contractor & owner to be equitable to all parties. Before making payments, the surety assures that claims by subcontractors are for correct amount & are for the bonded contract. The duration of performance & payment remain in force subject to the terms & conditions of the bond & contract document. Since a LOC is not bound by the contract, an owner must decide when to release the LOC since there is no recourse available after the release.

NJHEPA

24

Surety Bonds vs. Letters of Credit

Surety Bonds offer construction project owners greater protection than LOCs. Surety Bond guarantee the owner of the project that if the contractor defaults, the surety will complete the contract. A LOC is issued by a bank, usually for 10% of the total contract amount & callable by the owner upon demand. A LOC does not guarantee; sufficient funds to complete the project; administer contract completion; or assurance that rightful claims by subcontractors, suppliers & laborers will be paid. A surety bond assures all these things & more for less than 1-3 % of the contract amount.

NJHEPA

25

Surety Bonds vs. Letters of Credit

Construction Assurance Surety Bond Letter of Credit

Prequalification of Contractor
Continuous Independent Project Monitoring
Extraordinary Protection/Indemnity to Avoid Loss

Yes
Yes Yes Yes

No
No No No

Full Financial Protection

Unqualified Forfeiture
Required to Investigate Complaints Financing Contractor

No
Yes Yes

Yes
No No

Ability to Respond to Contract Problems by

Assuming Construction Responsibility

Tendering Offer to a Competing Contractor Assisting Existing Contractor to complete Project (Assuming Responsibility)

Yes
Yes Yes

No
No No

Forfeiting Financial Limit

NJHEPA

Yes

Yes
26

References
Forms

for Bonds

http://www.aia.org/docs_family_adminmanagforms
Dept.

of Treasurys Listing of Approved Sureties http://www.fms.treas.gov/c570/c570.html# certified

NJHEPA

27