The urgency for timely and high-quality construction in disaster recovery has never been greater. NOAA declared 2023 as the most disaster-stricken year in U.S. history, and 2024 is already following suit, with seven weather events causing losses exceeding $1 billion each.

However, amid the pressing need for rebuilding and repairs, contractor fraud poses a significant threat. While most contractors are reputable, some exploit their clients. According to the National Insurance Crime Bureau, 10% of disaster expenses are lost to contractor fraud, amounting to $9.3 billion in 2023 alone.

Read on to learn about prevalent forms of contractor fraud, warning signs and strategies to mitigate your company’s risks.

Common Forms of Contractor Fraud After Natural Disasters

After a natural disaster, vulnerability to contractor fraud is heightened. This deception can take many forms, such as bid rigging where colluding contractors manipulate bids to ensure securing the contract at an inflated price. Be cautious of bait-and-switch tactics where contractors initially offer low-cost materials or services but deliver inferior or more expensive options. Also, watch out for phantom materials where contractors bill for supplies never purchased or used and inflated invoices that overcharge for labor and materials.

Poor-quality workmanship, with substandard work failing to meet required standards, is another scam. Some contractors may push for unnecessary repairs to inflate project costs or withhold necessary permits and licenses while charging for them. Deceitful practices also include altering damage reports to justify higher costs or demanding full payment or large deposits upfront only to disappear without completing the work.

Insurance fraud is another major concern, involving inflated damage estimates or false damage reports for higher payouts. Additionally, kickbacks, illegal payments from subcontractors and change order manipulation to increase project costs are also common.

Red Flags of Contractor Fraud

Conducting thorough due diligence on contractors and being vigilant for common red flags can protect your business from becoming another victim. Watch out for typical indicators you might be another target, such as:

• Unusually low bids
• Demands for large upfront payments
• Lack of proper documentation (e.g., licenses, permits, insurance certificates)
• High-pressure tactics to rush decisions
• Reluctance to provide a written estimate
• Requesting cash-only payment
• Resistance to provide references

Legal & Financial Impacts of Contractor Fraud

Hiring a disreputable contractor for disaster-related repairs can have serious legal and financial repercussions for your business. Legally, you may face breach of contract issues if the contractor fails to meet the agreed terms, leading to potential litigation costs and additional legal fees. Fraudulent contractors might also violate state and federal regulations, exposing you to legal consequences and penalties. Additionally, if their actions result in property damage or personal injury, your business could be held liable for resulting damages or injuries.

Financially, contractor fraud can lead to immediate financial losses, including the cost of the initial contract and additional expenses to rectify substandard work or complete unfinished projects. You may incur significant recovery costs by hiring another contractor or legal counsel to pursue restitution. Substandard workmanship or materials can also decrease your property value, leading to financial losses if you decide to sell. Furthermore, insurance claims related to contractor fraud can result in increased premiums or policy cancellations. Lastly, falling victim to contractor fraud can damage your reputation within the community or industry, affecting your ability to secure future contracts or business opportunities.

Staying vigilant and conducting thorough due diligence when hiring contractors is essential to protect your business from these severe implications.

Preventive Measures to Prevent Contractor Fraud Risks

To safeguard your business against contractor fraud, it is crucial to establish preventive measures, including:

• Conduct thorough background checks.
• Review credentials, licenses and references.
• Obtain multiple bids to compare pricing and scope of work.
• Ensure contractors have valid insurance coverage.
• Hire through reputable sources or referrals.
• Clearly outline all agreed-upon work, materials, terms, specifications, payment schedules, project timelines and dispute resolution procedures in a written contract.
• Verify permits have been obtained.
• Implement a staged payment plan linked to specific project milestones and avoid large upfront payments.
• Consult legal counsel before signing contracts.
• Regularly inspect work to ensure it meets the specified standards.

Partner With Your Insurance Advisor

Your insurance advisor is a pivotal asset to protect against contractor fraud and can  offer:

• Contract review services
• Risk management assistance to help identify and mitigate potential risks associated with contractor agreements
• Assistance in filing a claim, including dispatching a claims adjuster to assess the damage and scrutinizing any contracts you receive
• Curated list of reliable, competent and highly recommended contractors

It's important to carefully review your insurance policies with your advisor to understand the extent of coverage provided for contractor fraud and other related risks. Additionally, partner with your insurance professional to implement proactive risk management strategies and due diligence measures to minimize the likelihood of contractor fraud and mitigate its potential impact.

By utilizing their services for contract reviews, risk management guidance, claims assistance and contractor recommendations, you can fortify your business against fraud, navigate challenges with confidence, expedite your recovery process efficiently and ensure a resilient future

Protect your business from costly contract mistakes. Download our Contractual Risk Guide for expert tips and resources against contract risks. 

We’re Here to Help Protect Your Business from Fraud

As the country continues to face unprecedented natural disasters, the role of contractors in recovery has never been greater. The continued threat of contractor fraud demands vigilance and proactive measures to prevent risks to your business. Conducting due diligence and working closely with your risk advisor can ensure a more secure and effective recovery process.Connect with a member of our team for additional insights into disaster prevention and recovery.