The Case for Reducing Performance Bond Requirements

In the Philippines, government and LGUs require performance bonds and payment bonds for large projects to protect the tax payer’s investment. If the contractor does not complete the project specified in the contract, the surety bonding company will either pay for the completion of the project or hire a contracting firm to complete the project. A performance bond protects the owner against possible losses in case a contractor fails to perform or is unable to deliver the project following the agreed contract provisions.

Reasons for Reduced Performance Bond Requirements

While many large scale infrastructure and local government projects have traditionally required surety bonds to cover 100% of the contract value for large infrastructure projects, there is a growing trend in procurement to allow flexibility in reducing performance bonds primarily to encourage competition during the bidding process. Higher performance bond requirements may lead to fewer bidders because only a few contractors will be large enough and have sufficient bonding capacity to obtain a surety bond in the amount necessary to cover 100% of a project’s value.

Reducing the bonding requirement means that more contractors may be capable of bidding on a project with a high contract value because:

1. a greater number of contractors have the bonding capacity to bid;

2. the amount bonded does not tie up a contractor's bonding ability, incentivizing contractors to bid in the first instance,

3. a lower bond requirement allows a greater number of sureties to write the bond and leaves additional capacity in the surety market for other projects.

Best Practice Alternatives

Among the best practices that a project owner may consider in determining whether to allow a partial bond in place of 100% performance bonding requirement is to structure the evaluation criteria during procurement to account for the reduced screening by the surety industry. For example, the project owner may rely more heavily on factors that address the contractor’s current financial capacity, litigation history, potential solvency issues and information gained from past project references. This underlines the role of the underwriting process for performance bonds as an indicator of financial health, not a comprehensive analysis of previous project experience.

The decision to require a reduced performance bond involves a trade-off between the liability risks of contractor defaulting and the increased competition from reducing the bonding amount. If the gains of diversifying the number of contractors for the project outweigh the former, there is a pioneering technology-driven financial condition analysis solution that can be utilized to reduce contractor risk while allowing diversification of contractors and reducing the bond amount required. It automatically performs an adequate assessment of a contractor’s financial health to identify only those contractors who have the financial capacity to take on a project.

Source: Performance Bond Strategies for Project Owners (WSP)

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