Performance-Based Contractor Prequalification As An Alternative to Performance Bonds

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This document is a technical summary on a Federal Highway Administration (FHWA) project that will be fully documented in a separate report under the same title (FHWA-HRT-14-034) and will be published in early 2014.

INTRODUCTION

State departments of transportation must rely on private industry construction contractors to build, rehabilitate, and replace their infrastructure assets. FHWA is interested in ensuring that State transportation departments select contractors that can complete projects cost-effectively. One potential method to help select qualified contractors is to use a performance-based contractor prequalification process. FHWA commissioned this study to evaluate the wisdom of expanding the use of this process. This report presents the results of this study, which examined relevant literature, evaluated the benefits and costs of performance bonds and performance-based contractor prequalification, and recommended a model performance-based prequalification approach.

In the highway industry, one of the main methods of prequalifying a contractor is determining whether or not a performance bond can be secured. The current performance bonding system does not differentiate between a high-performing and marginally-performing contractor, as long as the two companies have the same level of financial assets. This gives both companies the same opportunity to bid on a project, regardless of performance. In a low-bid environment, a transportation department concedes marginal performance, which in turn reduces the incentive for top performers to continue superior performance. This research project—which consisted of a detailed literature review; surveys of contractors, State transportation departments, and sureties; and State transportation department case studies—analyzes the benefits and costs of performance bonds and performance-based contractor prequalification and creates a performance-based contractor prequalification model. The research suggests that the minimum contract value that requires a performance bond should be raised to somewhere between $1 million and $10 million and that the cost of performance-based prequalification is low compared to the cost of the premiums for performance bonds. Last, a three-tiered, performance-based contractor prequalification model was developed to prequalify a contractor based on performance and financials, which rewards good performance and encourages improvement of marginal performance. The model is general enough so that an individual transportation department will be able to adapt the model to its own specific conditions.

This TechBrief presents a performance-based prequalification model for the transportation industry that includes incentive for good performers and encourages marginal performers to improve. This model is intended to guide State transportation departments in making their existing systems more robust and to take into account the performance of the contractor in the awarding of projects. A brief description of the model and its three tiers is included in this technical brief, as well as some guidance on implementation through the identification of the business decisions for each tier.