Surety bond business weathers construction industry woes
Experts see opportunities for agents
By Dave Willis
To become more aware of some core issues facing the surety bond
business, retail agents and brokers would do well to observe and understand
what is happening in the construction business. These days, it takes very
little effort to do this. Daily, it seems, newscasts share each little up and
down—for the last few years, there have been more downs than ups—in
the construction arena.
"As the economy went
into recession in 2008, there was a lag before state and local governments
started to experience reduced tax receipts, which led to increasing deficits,"
explains Roland Richter, vice president of marketing at Liberty Mutual Surety.
"This ultimately resulted in governments slowing or cancelling a number of
construction projects, particularly at the state and local level. At one point,
government census data reflected a drop of some $50 billion in annual state and
local construction spending."
Spending is off in the private sector, too, says David Byrne III,
principal and president of Byrne Bonding & Insurance, a surety agency
recently acquired by Starkweather & Shepley, a Rhode Island-based Assurex
Global partner. Because fewer jobs are open for bid—public or
private—many contractors have had to tighten profit margins just to get
work in an increasingly crowded field of competitors.
"This profit squeeze leaves little room for construction error,"
Byrne notes, "which adds an extra risk factor to each project. In addition,
lower profits mean that fewer funds are available for investment in new
equipment and personnel. Overcoming these challenges is the primary focus for
today's surety bond clients."
An exception to this slowdown exists, and that is in the large
construction marketplace. Large construction projects are more complex and,
because of the complexity and amount of financing involved, they often carry
longer lead times.
"Because of the lead times, once these projects—for
example, hospitals and universities and road projects—are put in motion,
rarely are they stopped," Richter explains. This bodes well for the largest
national and multinational contractors. They have work because they are among
the few firms that can actually bid these big jobs.
Another factor benefits these larger contractors. "Federal and
state governments have changed how they do road projects," Richter notes. "If
they were rebuilding, say, a 25-mile stretch of interstate highway, they used
to break it down into five-mile segments. At $10 million a mile, that would be
$50 million for each project. But by making it one $250 million project, they
have fewer bidders, but save money and make better use of staff because they
only need one project manager, not five."
These factors generally lead to healthy profit margins among the
larger construction firms. "As a result," Richter comments, "the jumbo
contractors are doing rather well, and they have sizable backlogs, good
profitability and flexibility in their work."
Lack of construction work has started to have a modest effect on
the surety arena. For instance, reduced margins have caused smaller contractors
to struggle to cover their overhead. "The surety industry is starting to see
more losses reported by smaller contractors," notes Richter. "This, in turn,
suggests more surety defaults and claims on surety bonds, as contractors run
out of money and can no longer finance existing projects." This is likely to
lead to an increase in frequency in small contractor losses.
"The good news is that the surety bond business does not go up
and down as frequently as the broader P&C industry—it may have one
down year after a long run of profitable ones—and the surety capital base
is sufficient to cover losses," he adds. "Where sureties usually run into
trouble is when they have large severity losses."
Byrne concurs. "In general, the surety industry will have another
profitable year in 2011, with only a slight profit fade from the previous
year," he says. "Of increasing importance is the continuation of the economic
recession. The slowdown in business has reduced the number of bonded
construction projects. In addition, miscellaneous surety business, which comes
from sources other than construction, is also experiencing a reduction in the
number of bonds issued."
Surety companies are trying to balance these marketplace
realities with underwriting discipline and the need to maintain premium levels
to support their operations. "In addition," Byrne explains, "several sureties
have just entered the surety bond business or are ramping up existing
facilities to increase market penetration. As a result, we don't expect there
to be any significant price increases or shifts in underwriting attitude."
Adds Richter, "As an industry, we have done a good job
communicating with our customers and agents, and creating more transparency in
the underwriting process. Our customers and agents understand where the
business is going, where the underwriting process is going, and what the
pricing rationale is."
Opportunity for agents
Retail agents and brokers would do well to consider how surety
might fit into their overall portfolio of products. "Agents need to keep in
mind that most surety provided is mandated by state and federal law," Byrne
explains. In many instances, it is not a discretionary purchase.
"As concerns about the economy continue," he adds, "more owners
are requiring bonds to mitigate their risk on everything from new building
construction to the purchase of an expensive piece of machinery, and even
insistence that a specific delivery schedule be met. This means there are more
opportunities for agents and brokers to serve existing clients and prospect for
According to Richter, agents need to recognize the importance of
transparency both ways—from the surety to the client, and then back
again. "Agents and brokers can serve their clients well by helping ensure
transparency among all parties," he says. "Communicating the underwriting
posture of the surety helps clients to better plan and then adapt their
operations and business model to help drive stable surety capacity."
By the same token, he notes, customers need to be open and candid
with the surety about all of their issues. "If the surety is presented with a
financial or operational surprise, that may cause it to rethink the surety
capacity being offered to the customer," Richter says. "For example, if a
contractor is having difficulty on a project—for instance, the owner is
refusing to pay or there's some large dispute going on—the surety should
Byrne offers similar counsel for agents and brokers based on his
years of front-line experience in the market. "First, make sure client files
are up to date with current financial information," he explains. "This allows
for better communication and increased transparency.
"Second, make sure you understand all of the information
provided," he says. "If there are any losses or problems revealed, be certain
to get an explanation that you understand and can share with the appropriate
"Finally," he says, "make sure that clients provide ample lead
time for requests and avoid last-minute surprises. Bonding companies can
certainly do a better job for your customer when they are given an appropriate
time frame in which to work."