Payment Performance Bond Cost Guide

What are Performance and Payment Bonds?

Performance bonds provide a financial guarantee to project owners, ensuring that contractors complete construction projects according to the specified terms and conditions in the contract. These bonds are commonly required for large public projects but are also used in private contracts to ensure project completion, making them a crucial element in many substantial, project-based agreements.

Similarly, payment bonds also involve an obligee, contractor, and surety party but focus on ensuring that all subcontractors and suppliers involved in a project are compensated appropriately.

Due to their importance in the project completion process, many obligees require performance and payment bonds before executing contracts to prospective contractors.

What is Performance and Payment Bond Underwriting? 

Performance bond underwriting is a thorough process where surety providers assess potential contractors before issuing performance bonds. This evaluation involves a detailed review of the contractor’s financial history, credit record, past project performance, and other relevant factors to identify any risks that might affect the contractor’s ability to meet the contract terms.

Similarly, payment bond underwriting follows an equally rigorous approach. Surety providers meticulously examine the contractor’s financial and project history to assess the risk they pose and determine the likelihood of fulfilling their contractual obligations.

For more detailed information about the underwriting process for performance and payment bonds, see SuretyNow’s article here. 

How much does it cost to get a performance and/or payment bond?

Like most other surety bonds, the prices of any performance and/or payment bonds are largely determined by the amount of risk that a surety provider deems a prospective contractor and their proposed project to present. Risk is defined as the contractor’s likelihood of non-payment to subcontractors or suppliers, in the case of payment bonds, or the likelihood of not completing a project within a set timeframe or not upholding the expected standard of workmanship. 

Cost Factors

A prospective contractor and their proposed project’s degree of risk is determined by a variety of factors, which include but are not limited to the following: 

• The Proposed Bond Amount
  • Higher proposed bond totals will often come with greater surety premiums as well, as they inherently induce a greater risk to the surety provider compared to smaller bond amounts. Additionally, proposed bonds with larger amounts will also require a lengthier and more detailed, scrutinous underwriting process, which would incur a greater fee as well. 

• The Contract/Project Size and Scope:
  • Performance and payment bonds are needed for a variety of projects and contracts, ranging from large public projects commissioned by the federal or state governments that span years to smaller private construction projects that may take only a couple of months. These differences in project scope and size result in differences in risk that the surety provider must consider when determining the surety premium costs for the contractor. 

• The State and Jurisdiction in which the Bond and Project are Located
  • Rates and premiums for different contractors and projects are heavily dependent on the state and jurisdiction in which the project is being worked on and the bond is being contracted in. Different states have different legal requirements and regulations for contractors and surety providers when issuing performances and payment bonds — which can result in differing premium rates for the contractor. This component is especially important for publicly funded and contracted projects. 
  • The minimum performance/payment bond amounts — and their associated premiums and rates — can vary significantly from state to state. For instance, certain states like California, Florida, and Minnesota require bonds to be enough to fulfill the price of the entire contract amount, while others, such as Alabama and Maryland, only require that bonds are enough to cover half of the total contracted amount. Some states also operate on a tiered system, in which contracts of different price points warrant different bonding amount percentages. For instance, in Louisiana, required minimum bond amounts are categorized into four tiers based on the total monetary value of the contract. The first tier, contracts with values less than or equal to $10,000, are only required to be bonded for 100% of the total contract value. The second tier of contracts which are between $10,000 and $100,000 in value, are only need to be bonded for 50% of the total contract value but must also be greater than $10,000. For contracts valued between $10,000 and $1,000,000, which are in the third tier, bonds must be 33.33% of the original contract value but at least $50,000. Finally, for any contracts worth more than $1,000,000, the bond value must be held to be 25% of the total contract value and, at minimum, $333,333. 
  • Because of this diversity in legal and regulatory policies across state jurisdictions, it is important that you, along with your surety provider, consult the regulations and requirements specific to the state in which you wish to operate. 

• The Surety Provider / Carriers
  • Each surety provider has their own set of internal guidelines when it comes to issuing rates and premiums for performance and payment bonds. These policies can involve things like the criteria used in the underwriting process and how they weigh individual criteria items, particularly the latter. For instance, one surety provider may analyze a prospective contractor’s previous work history and project performance more closely than others and offer better rates if the contractor has a longer history of successfully completed projects. Meanwhile, another surety provider may take credit scores and financial history to greater consideration and offer more favorable rates and premiums to contractors with higher credit scores and better financial records. 
  • Additionally, some surety firms may specialize in certain fields and types of projects and thus offer certain financial incentives and lower rates depending on the project type. For instance, one surety provider may have a proven track record of successfully contracting private construction projects, and thus will offer more favorable rates and terms to new construction-based projects, while another surety provider may have a longstanding relationship with the local municipal government and offer better rates for contractors working on government contracts. 
  • In some cases, smaller carriers may also provide better performance/payment bond rates to drive business, unlike their larger counterparts. 

• The Principal Contractor’s Credit and Financial Status
  • As a significant component of the bond underwriting process, a prospective contractor’s credit rating and financial status is crucial in determining the rates given to a potential contractor and project based on the risk that the surety deems that they may pose. Thus, a higher credit rating and better financial standing will incur lower rates and premiums from surety providers. 

• The Principal Contractor’s Job Performance and Bonding History
  • Similarly to credit scores and financial records, a contractor’s previous project performance and experience, or lack thereof, plays a significant role in determining their suitability for a performance and/or payment bond and the rates and fees that come with it. A contractor that has a proven track record of successful performance and project completion, especially in the type of work and scope that they are applying for, will be much more likely to be offered more favorable rates and premiums. 

• Change Order Fees
  • In addition to the premiums associated with the performance/payment bond itself, other miscellaneous fees also contribute to the overall cost. These consist of commissions and operating costs such as overnight shipping fees, credit report charges, underwriting fees, etc.
  • Notable costs include, but are not limited to, the following:some text
    • Maintenance rates are specific fees that surety providers charge in order to keep the performance and/or payment bond functional and accessible. In most cases, the surety company will include anywhere from 12-24 months’ worth of maintenance fees in the initial premium, with anything that exceeds it being included in an additional premium charge.
    • Time completion surcharges are additional fees tacked on contracts that are expected to take longer than a year or two to complete. 

• Type of Work
  • The type of work being performed in a given project is a major factor when calculating the potential risk posed to the contractor and the surety provider. The type of work being done in a project can often be classified into one or more of the following classes, categorized by risk:some text
    • Class B: Involves more strenuous, labor-intensive jobs and work and thus incur the greatest amount of potential risk, as the possibility for subpar performance and potential liabilities to arise are relatively high — there is more that can go wrong. These also tend to involve projects of a very large size and scope, along with a larger price tag as well. Examples of Class B work would include large construction jobs, excavation work, electrical installation, plumbing, etc
    • Class A: It consists of similar labor and work to that of Class B, but is decidedly less labor intensive and thus less risky. Projects that operate in this classification also tend to be smaller in scope and size compared to their Class B counterparts. Examples could include window installations, roofing, etc. 
    • Class A-1: Similar to Class A work but even less risky in nature. Examples include furnishing jobs, security installation, putting up signage, routine maintenance work, etc. 
    • Supply-only: This classification includes work that involves little to no labor, making it incur the least amount of potential financial risk. Much of the work in this category consists of supplying materials and equipment to external contractors/subcontractors and typically are more applicable to payment bonds than performance bonds.

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Underwriting Factors: The Three Cs

• Character: The moral character of the contractor is often assessed by examining how they conduct their business. Credit scores, project history, and records of legal or financial issues, such as bankruptcies or litigation, are typically used to evaluate this. A contractor's character reflects how much a surety provider can trust them to fulfill their obligations and maintain a productive business relationship.
• Capacity: This refers to the contractor's expected workload, work history, and skill level. It is assessed by reviewing financial statements, their work in progress/backlog, the contractor's skills and experience, and any relevant corporate management structures. A contractor's capacity indicates their ability to complete the job from a technical and functional perspective. In essence, this a measure of whether or not the contractor is capable of performing their duties for a given contract in conjunction with their previous and current projects. 
• Capital: The financial resources available to the contractor are measured by their assets, liabilities, credit history, and overall financial health. This assessment is crucial as it determines the contractor's ability to meet all contractual obligations and handle any potential financial challenges that may arise.

Based on the surety provider’s holistic evaluation of these factors, amongst others, the contractor will be offered a rate for their respective performance/payment bond. Overall the higher the potential risk, the higher the rates. Therefore, higher-risk projects and/or contractors will incur higher premium rates (2.5 - 5%) while lower-risk projects will incur lower ones (.75% - 1%), with premium rates being calculated as a percentage of the proposed bond amount. 

How are Premiums and Rates Calculated?

When calculating premiums and rates for performance/payment bonds, there are a few key terms that are important to understand:

• Flat rate: The price of a flat rate premium does not change based on the value of the contract; it will remain at a fixed value.  
• Dollar Rate per Thousand ($/M): The price is calculated based on a fixed rate per $1,000 of the total contract value, meaning that larger contracts will have a proportionally larger premium. So, for example, a contract for a large construction project on a skyscraper valued at a $1,000,000 will have a premium 100 times greater than a smaller maintenance project with a contract worth $10,000. This often referred to as $/M, with M representing $1,000. 
• Tiered rate: For a tiered rate structure, while the premium is calculated as a percentage of the total value of the original contract, the percentage gradually decreases as the value of the contract increases. So, for instance, a large construction project worth $3,000,000 might have premiums worth 5% of their contract for the first $1,000,000, 3% of the contract for the next $1,000,000, and only 1.5% of the remaining $1,000,000.
• Change Order (CO): A change order is any change in the value of the original project contract after it has been initiated, which then affects the premium values and the overall cost of the bond. 
• Additional Premium(AP)/Overrun: A type of change order that increases the original contract amount and the associated premiums. 
• Return Premium(RP): A type of change order that decreases the original contract amount and the associated premiums. 

In general, the formula you can apply to determine the surety bond costs:

Price you pay = Contract Price * Premium Rate

However, as different pricing structures may differ drastically between different surety carriers and projects, it is important to consult with your surety carrier to determine what stipulations your respective performance/payment bond will entail and calculate the total costs from that information. 

Examples of Premiums and Rates

Here are some examples of calculations based on different scenarios and pricing structures: 

Example One: A performance bond for a construction company working on a project to construct a major expansion to the local public university campus is projected to cost $1,500,000. Their surety provider offers them a flat rate of $15 per $1,000, and thus they will be obligated to pay $22,500 in premium costs. 

Example Two: A contractor takes a payment bond for a new construction project also worth $1,500,000. The surety party offers them a tiered rate for their premiums, calculated as the sum of 5% the first $500,000, 3% of the second $500,000, and 2% of the remaining $500,000. In this way, the total cost of the contractor’s premiums will be calculated as:

($500,000 * 5% = $25,000)  

+ ($500,000 * 3%  = $15,000 )

+ ($500,000 * 2% = $10,000) = $50,000.

Conclusion

In conclusion, performance and payment bonds are critical instruments in the construction industry, providing essential financial safeguards for project owners and subcontractors. Performance bonds ensure that contractors complete projects according to the agreed terms, while payment bonds guarantee that all parties involved in the project are appropriately compensated. The underwriting process for these bonds involves a thorough evaluation of a contractor's financial history, project performance, and risk factors, which influence the cost of the bonds. Various factors, including the bond amount, project size, state regulations, and the contractor's financial and work history, play significant roles in determining bond premiums. Understanding these intricacies will help contractors and project owners navigate the complexities of bonding, ensuring successful project completion and financial security.

Sources: 

https://integritysurety.com/how-much-do-bid-performance-payment-bonds-cost/
‍‍https://www.performancesuretybonds.com/contract/typical-performance-bond-cost/
‍https://www.orsurety.com/blog/how-the-cost-of-a-contract-bond-is-determined
https://fullertonlaw.com/50-state-summary-payment-bond-law#_Toc10975516