CHAPTER 3 —OVERVIEW OF INDUSTRY OUTREACH EFFORT

Four outreach efforts were conducted to obtain feedback from the major parties that are involved in the use of construction contract performance bonds. Representative State transportation departments, their contractors, and sureties all participated in this outreach effort. The representative State transportation departments completed surveys on their use of performance bonds, contractor evaluation methods, and views on performance-based prequalification. Contractors also completed surveys to provide input on the use of performance bonds and performance-based prequalification methods. The SFAA provided overall surety industry data, summarized industry practices, and participated in interviews. The final step of the outreach effort was the completion of case studies for five State transportation departments. This chapter presents each of these efforts and the corresponding results.

STATE TRANSPORTATION DEPARTMENT, CONSTRUCTION CONTRACTOR AND SURETY SURVEY/INTERVIEW RESPONSES

Survey/Interview Participants

Six State transportation departments participated in the transportation agency survey: the Alabama Department of Transportation (ALDOT), FDOT, Georgia Department of Transportation (limited responses were provided), MoDOT, SCDOT, VTrans, and the California Department of Transportation (Caltrans). These participants represented small, medium, and large transportation agencies and reflected a reasonable geographical cross-section for data collection.

At each State transportation department, one person took primary responsibility for completion of the survey, although he or she may have consulted other members of the agency. The individuals who participated held a range of positions within their organization, including director of construction, State construction engineer, State engineer, assistant State construction engineer, and principal transportation engineer.

Eleven construction contractors responded to a separate contractor survey. Their responses reflected a wide range of organization sizes, types, and degrees of focus on State transportation department-specific work. At the time of the survey, national firms employed six of the participants, while regional firms employed two of them. Of the remaining participants, one was employed by a firm that does international work, one was employed by a single State, and one was employed by a single locality.

Five contractors described their typical role on a State transportation department project as that of a general contractor and one identified its role as solely that of a subcontractor. The remaining five reported that their organization takes on the role of either a general contractor or a subcontractor, depending on the project. Nine of the organizations focus primarily on roadway work, while two focus on bridge work.

The majority of the construction contractors stated that their average annual volume of State transportation department work exceeds $100 million. Two participants noted a lower annual volume-between $6 million and $10 million-while one participant noted an annual volume of $1 million to $5 million.

Before the surety survey was distributed to a sample of surety companies, the SFAA reviewed it and concluded that better industry-wide data and opinions could be obtained from the SFAA than from individual companies. The SFAA collects all of the data that State insurance regulators in the industry require and is the designated statistical reporting agent for the surety and fidelity industries in all U.S. States, except Texas. The information provided by the SFAA and data collected by these regulators was used in this research effort. The SFAA summarized industry practices and provided quantitative data, where possible, in response to specific written questions. SFAA officials and representatives from five surety companies also participated in the interviews.

Survey/Interview Results

The input from representative State transportation departments, contractors, the SFAA, and surety company representatives was assessed as part of an effort to evaluate the benefits and costs of performance bonds and performance-based prequalification methods. In order to understand all perspective on these tools, a better understanding of State transportation department and contractor attitudes was needed. Contractors noted their misgivings about the value of performance bonds, given their cost. However, State transportation departments expressed hesitation at the idea of abandoning the use of performance bonds. The surety industry outlined the benefits of performance bonds during prequalification and construction and presented data on the costs of performance bonds.

A significant number of State transportation departments believed that a performance-based prequalification process would improve the quality and timeliness of project delivery and enhance State transportation department-contractor relationships. Contractors appeared uniformly open to an equitable performance-based prequalification process as a means to improve project delivery. Survey responses suggest that performance-based prequalification methods can be implemented and/or refined to better emphasize the performance and financial factors that are most relevant to effective project delivery.

The data was collected using two different methods. A small number of State transportation departments and contractors were surveyed in detail, the SFAA provided surety information from the aggregated data of filings made to State regulators, and several surety companies provided additional anecdotal input. This resulted in two very different data sets: a set of microeconomic data from a sample of State transportation departments and contractors, which may or may not be representative of their populations, as well as a set of macroeconomic data from the entire population of sureties. The premiums sureties charge contractors for performance bonds are found where the two data sets intersect (i.e., both data sets report upon the same statistics). These results are found consistent and do not differ significantly from each other. Sureties report premium rates with a mean of 0.64 percent and a standard deviation of 0.26 percent, while contractors report an average premium rate of 0.70 percent (as shown in table 9) with a standard deviation of 0.80 percent. Given that the difference between the two means is only 0.06 percent, the hypothesis that both are estimates of the same true mean of the population cannot be rejected (all of the sources of the premium rates).

Table 9. Respondent contractor-reported bond rates.

The data also indicates the following:

• The State transportation department-reported average default rate is 0.69 percent. Applied to the combined 2010 reported-letting budget of $6.2 billion for the surveyed State transportation departments, this reported default rate would result in $42.8 million worth of defaulted contracts across the surveyed State transportation departments.
  
  
• Under the current administrative system (illustrated in table 10), State transportation departments reject a much higher rate of new applicants (7.6 percent) than renewal applicants (0.4 percent).
  
  

Table 10. Respondent State transportation department prequalification rejection rates.

Also, numerous conclusions about the potential benefits and structure of performance-based contractor prequalification can be made. In summary, the conclusions are as follows:

• Table 11 shows that both contractors and State transportation departments feel that a performance-based contractor prequalification process has the potential to improve overall project performance.
  
  

Table 11. Impact of performance-based contractor prequalification.

• Table 12 indicates that both contractors and State transportation departments rate the evaluation of “corporate qualifications” (i.e., qualifications that relate to the experiences and qualifications of the contractor organizations) more highly than they rate the evaluation of contractors’ programs.
  
  

Table 12. Respondent State transportation department and
contractor performance factor rankings.

• Table 12 also indicates that both contractors and State transportation departments believe past performance, relevant experience, illegal behavior, personnel qualifications, and claims history are likely the most critical factors for determining a contractor’s effectiveness.
  
  
• Table 12 also indicates that the State transportation departments rate past projects’ performance evaluations of contractor, past relevant experience of the contractor, past illegal behavior, and qualifications of key personnel as the most critical factors, equally.
  
  
• Table 13 shows that contractors believe that a marginal contractor has an unfair advantage over a well-qualified contractor under the current system, which is reinforced by their belief that implementing performance-based contractor prequalification would disqualify the marginal contractors from bidding.
  
  

Table 13. Respondent contractor views on methods of determining project qualification.

Numerous State transportation department respondents and all contractor respondents expressed the belief that project performance can be quite valuable as an indicator of a contractor’s ability to deliver projects in an effective and timely manner. This suggests that improvements in the area of performance-based prequalification could benefit the project delivery process.

While all respondents considered financial factors important to ensuring effective project delivery, contractor respondents did not appear as confident as State transportation departments in the role that surety companies play. These differing opinions may be due, in part, to misconceptions about the nature of performance bonds and the roles that sureties play in the evaluation of contractors and the completion of a contract. These possible misconceptions are described below.

First, performance bonds are not insurance. They do not guarantee against non-completion of a contract under all conditions, as insurance would (if insurance companies made such a product available). Instead, performance bonds come into play only when the contractor has defaulted on completion of the contract and is in financial default (i.e., is unable to provide the funds to remedy the situation). Performance bonds are more a form of credit than insurance, in that they are priced like credit. Sureties go through the same steps to evaluate contractors as banks go through to evaluate corporate borrowers, and sureties have the same rights to monitor and intervene in the affairs of their contractors as do other creditors.

Second, sureties’ role as creditors gives sureties a superior ability to assess the financial and managerial capacities of contractors over long periods of time and to intervene in the affairs of contractors to prevent and avoid defaults. However, the advanced evaluation and intervention capabilities are limited by the nature of performance bonds themselves; these bonds do not guarantee the quality of work, nor do they guarantee that the full costs to complete a project in default will be covered by the performance bond.

Finally, and most relevant to the objective of improving the quality of contracted construction work through the prequalification of contractors, performance bonds give no protection against mediocre work. Sureties do not evaluate contractors in terms of the completion of timely, high-quality work that satisfies State transportation departments’ expectations. Sureties are unable to obtain data from State transportation departments about contractor performance, and even if the sureties could and did obtain such data, the low rates of default and the sureties’ limited obligations give the sureties little incentive to raise the costs of performance bonds in order to incorporate the contractor performance data.

The surety industry’s responses portray the significant benefits surety companies provide to State transportation departments throughout the construction process, which their unique status as the contractors’ creditors enables the sureties to provide. State transportation departments seem more attuned to the specific advantages of this service than contractors are and consequently appear unwilling to abandon the perceived security that performance bonds provide. Contractors have greater reservations about this conclusion and feel more strongly that performance-based prequalification methods can lead to improved project delivery, possibly even in place of performance bonds.

Analysis of the responses obtained from State transportation departments, contractors, the SFAA, and select surety companies suggests that opportunities to standardize and integrate performance-based prequalification methods as part of a more comprehensive prequalification process should be addressed to improve project delivery. The results provide an initial indication of State transportation departments’ and contractors’ appetites for improvements to the prequalification process, as well as an indication of potential areas for improvement, supplementation, and consolidation of the contractor evaluation process. Additionally, they reinforce the conclusion of NCHRP Synthesis 390 that barriers to performance-based prequalification implementation are low among members of the construction industry and that, while State transportation departments show little willingness to completely abandon performance bonds, they acknowledge the potential benefits of evaluating contractor project performance and using the information in the prequalification process.⁽¹⁷⁾

The bond benefit-cost analysis, in part based on the quantitative data detailed above, will be presented below. That analysis will integrate the data with indirect costs and additional economic factors, where applicable. The benefit-cost analysis and the information provided in this report, along with information collected in the literature review, will drive the elements of the prequalification model, also provided below.

OVERVIEW OF THE CASE STUDIES

Case studies were conducted with five State transportation departments: Iowa, Oklahoma, Utah, Virginia, and Washington State to evaluate the performance-based prequalification model in relation to the current prequalification practices of the State transportation departments; to get the State transportation department perspective on performance bonds; and gather project data for the benefit-cost analysis of both performance bonds and performance-based contractor prequalification.

All of the participants have some form of a performance-based prequalification system in place. The level of sophistication varies from reference checks to contractor project performance evaluations, and the level of integration of performance-based prequalification into the prequalification process also varies. All of the State transportation departments thought that the performance-based prequalification model was a good model. However, most indicated that they would not drop their current system for the new model because of the costs to replace their existing systems. Also, the States with more sophisticated systems already included most aspects of the performance-based prequalification model. The case studies indicated that a reduction in the value of a performance bond is not an advantage for good performers because the resulting change in performance bond premium price is minimal.

None of the participants could remember a time when a surety got involved in a project before the State transportation department requested the surety’s involvement. The studies also showed that the State transportation department would not necessarily know if the surety was involved with the contractor before the State transportation department’s request. Only two States reported any defaults between 2007 and 2011, and each of those States reported one default. Respondents from several States mentioned that the benefit of having performance bonds, even though the default rate is so low, is the State transportation department’s ability to threaten to contact the surety if a contractor is not performing well. This is an effective threat because if the surety is informed that a contractor is not performing well, it can impact the contractor’s premium rate on the next contract and make the contractor less competitive. None of the participants was comfortable eliminating performance bonds.

During the case studies, several different types of data were collected for the benefit-cost analysis. Each State was asked to identify how many full time employees were required to administer the performance bond system and the performance-based prequalification system. Also, each State was asked to provide contract values for each of the projects that occurred between 2007 and 2011, as well as the number of defaults that occurred over the investigated time period. A summary of this data is shown in table 14, and appendix B includes a summary of each case study.

Table 14. Summary of case study data.

¹Based on a 0.8 percent performance bond premium rate.
N/A = Not Applicable.
FTE = Full Time Equivalent.