The subcontractor default insurance market looks set to grow as more insurers prepare to offer the coverage, industry sources said.

Existing and new subcontractor default insurers are growing more comfortable with the coverage and have adjusted policy terms to reflect claims experience in the product area, they say.

Subcontractor default insurance, which allows contractors to insure against noncompletion of work or defaults by subcontractors, was launched about 25 years ago by Zurich Insurance Ltd. and is offered by only a few insurers, but the market will likely expand, sources say.

“We have had discussions with several carriers not currently in that market which anticipate being in it on some basis within the next 12 months,” said David Hewett, Marsh LLC’s U.S. surety practice leader in Baltimore, Maryland.

There are now six insurers providing subcontractors default insurance, three of which have joined the business within the last 36 months, Mr. Hewett said.

The subcontractors default insurance business had only one insurer until about eight years ago, when a second joined, he added.

Axa XL, a division of Axa SA and then known as XL Catlin, began writing the coverage in 2010, according to Rose Hoyle, a construction risk engineer in the subcontractor’s default insurance group for Axa XL in New York.

In addition to Zurich and Axa XL, Cove Programs Insurance Services LLC in Los Angeles offers the product as does Hudson Insurance Group, a New York-based unit of Odyssey Group Holdings Inc., each according to the firms’ websites.

Arch Capital Ltd. provides subcontractors default insurance and “have been a material presence for a long time,” according to a spokesman in an email.

Berkshire Hathaway Specialty Insurance Co. “offers it on a selective basis,” according to a spokeswoman.

“In the last three years, we’ve seen a number of new markets enter the space and we expect a seventh market to enter the SDI space in 2019,” said Douglas Schrift, managing director in Aon PLC’s constructions services group’s SDI practice in Charlotte, North Carolina.

“We are always speaking with the insurance markets to help them understand SDI and how to make them successful from an insurance carrier perspective,” he said. “We are having conversations with others and will continue to do so.”

The added interest in the market is driven by insurers seeking to enter a hard market, Mr. Hewett said.

Rates are strongly related to individual policyholder specific risk controls such as quality control and prequalification procedures, loss history, and their retention levels, which can vary from $500,000 up to several million dollars per loss, said Amelia Valz, broking leader, subcontractors default insurance and professional liability, for Willis Towers Watson PLC in Dallas.

Ms. Valz added that residential work has seen double-digit rate increases over the past few years and tail coverage, for loss arising after a projects substantial completion, has started seeing restrictions or higher rates.

Rates vary by account depending upon their historical results, Mr. Hewett said.

A policyholder’s rate for subcontractor default insurance is typically fixed for a period of two to three years, Mr. Schrift said, adding “premiums are up over previous cycles with many insureds electing to increase retentions, reduce the completed operations coverage period, or even do both, in order to ease the pressure of the rate increase.”

New entrants may face challenges as they attempt to penetrate the market, sources said.

“I’m not sure how you build a successful business if you’re a startup,” due to the highly relationship-driven nature of the business, said Brandon Beane, vice president, risk management at Coastal Construction Group of South Florida Inc. in Miami, who said he has utilized the coverage. “Carriers need to maintain discipline in taking on a new contractor.”

“A lot of people have tried to dabble a little bit and then not ended up launching,” said Ms. Valz.

“Contractors have to be pretty cautious about moving their business around,” she added. “Programs are up to $50 million to $75 million and attach to projects with up to a 10-year tail, so it’s a long relationship when you move in.”

Subcontrctors default insurance policies were altered a few years ago after an uptick in claims, sources said.

“When carriers saw loss action peak three years ago, they made some changes to the policy form to tighten up what the coverage provided,” Mr. Hewett said. For example, exclusions were added for certain trades such as framing.

“Zurich did a large refresh of their form two to three years ago, which had tighter terms and conditions,” Ms. Valz said. “Each market has introduced its own form with slightly different language.”

“We were not surprised when a number of those changes started to take place on the terms and conditions,” Mr. Schrift said.

Some of the claims stemmed from labor and quality issues, which may have been exacerbated by a shortage of contractors, sources said.

Four to five years ago, after the financial crisis ended, contractors that took on huge workloads found “they didn’t have the skilled staff to build the work they’d contracted for,” Mr. Beane said.

“Historically, the leading reason subcontractors default is financial, followed very closely by quality,” Ms. Hoyle said. “If you don’t have the right labor, you’re pulling people on the job from wherever you can get them and quality tends to suffer.”

“They’re very closely related,” Ms. Hoyle added. “We’re seeing more defaults now because of labor shortage than anything else. It’s the most frequent, not the most severe.”

She said that since 2014, when the insurer first began receiving significant claims, through the second quarter of 2018, “we’ve received roughly 250 claim notices, nearly 41% of which were related to labor shortages and/or schedule delays,” she said.

Financial-related defaults comprised only 32% of the total, Ms. Hoyle said. 

“From a severity standpoint, financial-related defaults still top the charts, but are closely followed by labor-shortage/schedule-related defaults which comprise more than 30% of our entire ground-up claim costs,” Ms. Hoyle said.

“There are claims that can definitely be root-caused back to labor,” Ms. Valz said. “Not only is it just an issue of how many bodies someone can bring on the site to conclude the work, but also of the training and quality of those employees.”

Such results can vary from insurer to insurer, however.

“There are definitely carriers in that marketplace seeing different results,” Mr. Hewett said, with insurers that have been in the market longer having more significant and longer tail exposures.  

“There are claims that reflect that there’s not enough talent in the space but claims activity has really been within expectations or even better for most of the markets we’re dealing with,” Mr. Schrift said.

Even with terms and conditions tightening, however, coverage may be more broadly available now than previously.

“The product has become a lot more accommodating for smaller contractors and regional players,” such as those doing $100 million of business annually, said Mr. Beane. A leading reason for this is the availability of lower deductibles down to $500,000, he added.