Performance bonds are generally used during construction but can also be used for various large projects to guarantee that a contractor fulfil the agreed upon terms. A performance bond promotes confidence in the contractor’s abilities and provides trust between all parties.
What Is A Performance Bond?
A performance bond is a type of surety bond that is issued by an insurance provider to ensure adequate completion of a project by a contractor. If a contractor is issued with a contract and then fails to complete construction according to the contract agreement, the client is covered for any losses up to the agreed amount of the performance bond.
Performance bonds are frequently used in the construction industry or even in commodity contracts, where the buyer is reassured of financial compensation should the commodity not arrive. Either way, it offers peace of mind to your business and mitigates the risk of depending entirely on a contractor for a successful project.
How Does A Performance Bond Work?
A written guarantee from a third-party guarantor (usually a bank or an insurance company) is submitted to a principal (client or customer) by a contractor on winning the bid. A performance bond ensures payment of a sum of money (not exceeding a stated maximum) in case the contractor fails in the full performance of the contract. Learn more about surety bonds, the parties involved and the different types available.
How are performance bond costs calculated?
Performance bond costs are calculated based on three things:
- The type of bond
- The bond amount
- The risk of the applicant
Performance bonds usually cover 10 – 12.5% of the contract price and replace the bid bonds on awarding of the contract.
How long should a performance bond be active?
- Parties determine the active time period
Once the risks are sufficiently assessed, an insurer can reach an appropriate premium amount. This is normally the simple part of applying for a performance bond. Business owners often struggle reaching an appropriate and acceptable time period that the bond should be active for. - Consult your project plan
When calculating an appropriate time period for a performance bond, it is important to consult your project plan. Set milestones for certain deliverables by a certain date that your contractor must agree to. If you are issuing tenders, it would be wise to request prospective contractors to include a projected timeline for the completion of the project. When awarding the contract, use the timeline to determine performance goals. - Keep the end in mind
The duration of the performance bond should be until the end of the projected timeline.
What if the contractor runs late on the project and the bond expires?
The majority of performance bonds will have a contract period, meaning that the bond has an expiry date which leaves your business vulnerable to risk. However, before the contract period ends, the bond may be renewed or extended, failing which, it will expire. Paying premiums upfront for multiple years would guarantee that your business is covered.
Can all bonds be renewed?
Whether a bond is renewable or not is dependent on a few factors, including the type of bond and whether your project requires it to be renewed. If your bond cannot be renewed, you will need to obtain a replacement bond.
Is it complicated to renew a bond?
When renewing a bond, the insurer will re-analyse the risk to see if the premium should be adjusted. Factors considered in this process include financial status of the business, business experience and its credit history. Once a new premium has been calculated, payment is required to lengthen the bond period. It is important that this takes place before the original bond expires, otherwise the bond will have lapsed and you would need to apply for a new bond.
Taking care of your individual needs by obtaining an adequate performance bond is essential to the survival of your business. Contact our consultants today to find out how we can help you finish your next project!
Editor’s note: This post was originally published in May 2019 and has been updated for accuracy and comprehensiveness.
