ORLANDO, Fla. — Subcontractor defaults are likely, given the still-shaky economy, but there are steps construction risk managers can take to avoid and mitigate the effect of these defaults, said speakers during the International Risk Management Institute Inc.'s 32nd annual construction conference in Orlando, Fla., last week.

More subcontractor failures can be expected, said James LaMonica, New York-based vice president for XL Insurance America Inc. “Construction spending continues to be anemic,” with tighter margins and less work available, he said.

Mr. LaMonica said when Chicago-based Trainor Glass Co., the country's third-largest glazier, closed its doors in February 2012, 500 employees in 15 states were put out of work. “The point is, the loss with subcontractor default can be quite significant,” said Mr. LaMonica.

These losses can be direct, such as those associated with obtaining new subcontractors, and indirect, such as the additional time staff must spend on the affected project rather than focusing on future projects. The first step in minimizing the risk of subcontractor default is “selecting the right partners at the right time based on the right information to make your project successful,” Mr. LaMonica said. “You need to take the "pre' out of qualification. It's continuous qualification. It's not a one-time thing. It's a constantly recurring process.”

Mr. LaMonica said a financial review is “the hallmark of any qualification. You want to start with financial statements.” Factors such as the scope of the subcontractor's previous projects also “matter a lot.” This does not mean you cannot give a firm a larger job than it has had in the past, just that you need to be sure it is capable of handling it, he said.

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“You have to have a formal written process in place,” said Laura Laurenzi, director with Milford, Conn.-based Turner Surety & Insurance Brokerage Inc. “People throughout the organization have to know the expectations” with respect to subcontractors, including how they are evaluated.

Financial information should be kept up to date. “Any updated information you can get after you award the project is to your benefit,” said Ms. Laurenzi. Find out if there were any projects the subcontractor had planned on getting but did not, and what projects it will be bidding on in the future.

Visit the subcontractors on a regular basis, she suggested. If they are having financial issues, you may see evidence of it first in their office location, which is “probably the first place they start cutting back on people,” she said.

Investigate how the subcontractor has performed on other jobs, she added. It could be a subcontractor has not defaulted, but has encountered difficulties in other places.

“Develop your mitigation plans up front,” Ms. Laurenzi said. With exceptionally large contracts with long lead times, consider other options available to complete the project. “It's better to have a plan and not use it rather than develop a plan at the last minute,” she said.

“Keep an ear to the ground,” said Jim Richert, New York-based risk engineering leader for construction specialty products at XL Insurance America Inc. Weaknesses may have been identified at the time the subcontractor was first hired, “but along with that, have you had your eyes wide open?” he asked. In developing effective risk mitigation plans, “make sure your plan's clear, who's doing what, and when they are doing it,” he said.

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Discussing warning signs from the perspective of project management, Mr. Richert said essential factors include getting schedules submitted on time and preplanning. Mr. Richert said he has attended many meetings where the general contractor seems to know more about the scope of the subcontractor's job than the subcontractor. But the subcontractors have been hired as experts, and contractors “want to see them well-prepared,” he said.

With respect to field management, two main areas to check are scheduling and quality management. Monitor the schedule on a weekly or monthly basis. Be sure there is adequate manpower to meet goals, and that the subcontractor is meeting planned productivity, he said.

In addition, be sure the subcontractor has the right workers for the job and materials are showing up, Mr. Richert said.

Payment concerns also can provide warning signs, such as if the subcontractor is struggling around producing the proper documents to get paid, or if there are other signs of cash flow needs, such as a request for jointly issued checks.

If you see problems, “don't wait.” Start meeting with the subcontractor, Mr. Richert said.

There were about 1,025 attendees at this year's construction risk conference. Next year's conference will be held Nov. 17-21 in San Diego. More information is available at www.irmi.com/conferences/crc/default.aspx, or contact the International Risk Management Institute Inc. at 12222 Merit Drive, Suite 1450, Dallas, Texas, 75251, or 800-827-4242.