As surety capacity tightens and retentions ratchet up, now is the time for contractors to brush up on bonding’s ins and outs in order to best ride out a turbulent environment.
Construction continues to be challenged by high costs of materials and labor as interest rates keep the pressure on and uncertainties lie ahead.
Meanwhile, the surety bond market is hardening. Countervailing economic forces are also being felt by the insurers that typically underwrite them and re-insurers that support them.
Not only are carriers seeing inflation-related losses in contract surety, but underwriting standards were somewhat relaxed when the market was soft. Loss ratios are showing the effects, and reinsurers are bearing the brunt. They are demanding higher retentions and pricing, and odds are capacity could tighten as a result.
This environment is likely to increase underwriter scrutiny and appetite, making it critical for contractors to work with a surety-specific brokerage. Further, the trends make the point that by sharpening their focus on surety bonds, construction firms will strengthen their positioning for long-term success. Here’s what you need to know.
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| ASCO Equipment |
| WPI |
Surety bonds are a guarantee that a company or individual will deliver on an obligation, required of contractors, suppliers, subcontractors, and project owners to minimize risk. They are required by law for all public construction projects in the U.S.
There is a rising need for surety bonds on private projects as owners and lenders seek added protection against growing risks posed by interest rates, costs, and labor shortages. In an analysis of the economic value of surety bonding prepared for The Surety & Fidelity Association of America:
- More rigorous prequalification and review were performed by bonded projects (96 percent of respondents) versus non-bonded ones (61 percent).
- Nearly five times as many survey respondents reported that bonded projects are prioritized during financial difficulties.
- Bonded projects tend to be finished on time or ahead of schedule, five times as many public and private owners said.
Other benefits include a reduction in risk of project default, ensuring business continuity, and providing technical and financial assistance. Surety bonds also make the transition from construction to permanent financing easier by eliminating liens, and they can even lower construction costs through improved bidding competition.
The three most common surety bonds for construction are:
- Bid bonds, typically required in order to submit a bid for government projects. They ensure certain requirements will be met, like entering into the contract in a certain time frame and providing performance and payment bonds. They also demonstrate a business’ financial standing, an important prequalifier for larger and more complex projects.
- Performance bonds are most common. They provide a guarantee that work will be completed according to a contract’s specifications and are a recourse against defaults, whether by a principal or a subcontractor (which are often required to secure them).
- Payment bonds guarantee the principal will pay all subcontractors, laborers, and suppliers under the contract.
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| Sierra Machinery |
| Romco Equipment Co |
Pricing can vary, depending on particulars like contract scope and project duration. Payment and performance bonds typically are coupled as one bond, priced between 0.75 percent to 3 percent of the contract price.
To qualify for a surety guarantee, a contractor must measure up on three fronts that underwriters use for their evaluations:
- Character — The applicant or principal must show a credit record and business history that reflect good character and integrity. A track record of meeting obligations is also key. Among the aspects examined to this end are references and reputation; quality of relationships with prime contractors, subcontractors, and vendors; credit reports and bank records; and even the owner’s personal financial statements in many cases.
- Capacity — The firm’s principal must demonstrate that everything is in place to fulfill the contract, from a staff with the necessary skill and experience to the right equipment. Also important is the surety’s understanding of the success of past projects, the backlog of new and existing ones, and contractual language. Continuity and succession planning are also examined, as are the project management systems and controls.
- Capital — The principal must show it has the financial strength to take on new projects while managing current obligations — and is able to respond to unforeseen problems. To this end, extensive current financial documentation is required, including a CPA-prepared annual report and interim financial statements. Also necessary are work-in-progress schedules, a bank line of credit, and personal financial information.
- Not allowing adequate time in submitting the bond application before the bid bond or final bond is due
- Financial presentations that don’t meet review or audit standards (especially for larger bond requests)
- Indications that the proposed project would overextend the contractor (such as being outside its primary scope of work or of greater complexity)
Securing a surety bond can be an onerous business, especially for new or smaller construction firms that may not be prepared for the deep dive underwriters take into their businesses.
Being prepared requires having finances in order over the long term, with a solid and established credit history; having documentation of everything from financial statements to project references current and at-the-ready; and a clean claims record.
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| SITECH Tejas |
| SITECH SE Texas |
Should applicants that seem to be well-qualified not be approved, it typically is due to one of three reasons:
Having a broker partner with surety experience and know-how is key, not merely as a guide through a rigorous application process but to identify and remove potential barriers on the path.
Marty Ross is the President of Surety/Bonds at global insurance brokerage HUB International. He has underwritten and managed a wide variety of companies from large, diversified programs for Fortune 500 clients to middle-market, privately held companies.
