Surety and Performance Bond Cost
In the construction industry, the difference between winning and losing a contract can come down to a fraction of a percent. Sometimes that difference can be the cost of your contract surety bonds.
Generally, your surety company will outline your rates for a contract bond in a Terms and Conditions Agreement. This is normally provided to you when you sign up for your bond facility and outlines your bond limits, financial covenants and the rates you are expected to pay for bonding.
When considering the cost of bonding, it is important to understand that pricing is different at the bid stage versus project award. Bid bonds and agreements to bond are generally required at the tender stage and the cost associated with these bonds are covered by an annual administration fee.
This fee is charged once a year and covers the cost of all of your bid bonds, agreements to bond and pre-qualification letters. Whether you bid once a year or 50 times a year, the administration fee will typically range between $1,500 to $2,500. In the case of new contractors or contractors establishing their first bond facility you could see this annual fee start higher than $2,500. Have a plan with your surety broker to reduce this over time as you establish a relationship with the surety company.
The other bond cost you will incur will be for bonds issued at the award stage. Performance bonds and labour and material bonds, also known as “final bonds” are the bonds issued to guarantee the projects that you have been awarded. These costs vary depending on the type of bond and percentage required.
Final bond premiums are relatively straight forward to calculate. In Canada, the premium is calculated as the contract price including all applicable taxes, divided by $1000 and then multiplied by the base rate. A surcharge will be applied to the base rate for certain items, including but not limited to, an extended maintenance period, design build, or contracts that exceed one year. The following outlines standard rates that are applied by most bond companies
RATES AND FEES
Facility Administration Range: $1,500-$2,500
Performance Bond Rate
50% Bond Amount – $7/$1000
100% Bond Amount – $10/$1000
Labour & Material Bond Rate
50% Bond Amount – $3.00/$1000
100% Bond Amount – $5.00/$1000
24 Month Maintenance Surcharge
If the contract calls for a 24 month maintenance period, a surcharge will apply based on the percentage of the performance bond issued.
Under a 50% performance bond amount – $1.50/$1000 surcharge
Under a 100% performance bond amount – $2.00/$1000 surcharge
The annual rates are for a one year period, beginning at the contract date. For contracts that exceed one year, a renewal premium is payable at each anniversary date of the contract based on the amount of uncompleted work at that time.
Your firm is issued a contract of $1,000,000 plus tax (13%). You are required to provide a 50% performance bond and a 50% Labour and Material Payment Bond and there is a 12 month maintenance period specified.
- Total contract amount with tax is ($1,000,000 *1.13) = $1,130,000
- Divide this by $1000
- ($1,130,000/$1,000) = $1,130
- Multiply this number by the rate. Referring to the table above, 50% performance rate is $7.00 and 50% L&M rate is $3.00 for a total rate of $10.
- Therefore the total premium is ($1,130 * $10) = $11,300.
Your firm is issued a contract in the amount of $2,500,000 with a duration of 1.5 years. The project owner is asking for a 100% performance bond with a 12 month maintenance period. After the first year, we are expecting the remaining contract value to be 30%.
- Year 1 premium – Contract price plus tax is $2,825,000. Divide that by $1000 and we get $2,825
- The rate for 100% performance is $10. The premium for year 1 is $28,250.
- Year 2 premium – Since we are expecting 30% remaining at the end of year 1, we take 30% of our year 1 premium to get $12,712.50 as our year 2 premium.
- The total premium is ($28,250 + $12,712.50) = $40,962.50
Contract price with taxes is $565,000 and the contract has a 24 month maintenance period. The owner is asking for 100% performance and 100% Labour and Material Bond.
- The rate for 100% performance is $10 and the rate for 100% Labour and Material is $5.00. Because there is a 24 month maintenance period, a $2 surcharge applies.
- The total rate for this bond is $17/$1000.
- The premium is ($565,000/$1000) * $17 = $9,605
Change orders throughout the life of a contract can also have an impact on bond premium. Imagine that you start a contract for $1,000,000 and because of various change orders, the final contract price becomes $1,500,000. The surety company will charge you an additional premium for the extra $500,000 at the end of the contract.
The surety will request progress reports from the owner and will charge you an additional premium for their additional risk in the event of a contract increase. Keep in mind that if the contract is reduced, you will also be able to recover any premium that you overpaid. Make sure you are aware of the effects to bond premium when you are calculating your change order costs.
There are several other potential caveats to calculating bond premium, but they are beyond the scope of this article. We would always recommend discuss your rates with a qualified surety bond broker to make sure you are carrying the appropriate bond costs in your bid. Estimating is a game of inches, so make sure you know your costs and thus increase your chances of being the successful bidder.