THE STORM has died down, the seas have calmed and the clouds are parting. The surety industry has weathered the turbulent times of the late 1990s and the first years of the 21st century, and has come through intact and on course for a potential recovery.
The large losses faced by the industry in the past few years served as a clarion call to return to the solid traditions on which surety is founded. By returning to the fundamentals, namely solid underwriting practices, the industry is heading toward recovery.
The surety bond producer will continue to play an essential part in advising contractors how best to adapt to market conditions. The producer can emphasize the need for contractors to invest in quality financial statements and the importance of having a solid balance sheet. Since sureties are requiring more accurate and current information, the producer's role as the nexus of communication between the surety and contractor is more important than ever.
While there have been a number of high-profile mergers in the surety market, capacity remains sufficient to support the nation's construction needs. However, contractors at different market sizes may see changes in the near future.
?Capacity for small and emerging contractors remains available, though they will be subject to the same underwriting standards as their larger peers. Small and start-up contractors who have difficulty meeting today's underwriting standards may opt to explore the U.S. Small Business Administration's Surety Bond Guarantee Program.
?The mid-market contractor is least likely to be affected by capacity issues. This segment is the primary target of the industry, and qualified contractors will continue to receive strong support. The same back-to-basics underwriting standards apply: Quality financials, capital retention and personal/corporate indemnity are all required.
?Contractors in the $250 million-and-over market may need to address changes in the industry. Surety companies are less likely to assume the risks of massive, multiyear projects on their own. Co-sureties, segmented bonding and joint ventures may be more common. The tightened reinsurance market is a factor in the need for more creative surety solutions on mega-projects.
While some in the industry have seen a lull in contractor claims activity, others are not so sure. The claims that are being seen are in large part a result of the more relaxed underwriting standards of years past that are still working their way through the market.
"Cautious optimism" is the phrase most commonly used to describe the near future. While the industry incurred nearly $1.3 billion in contract surety claims in 2003, according to The Surety Association of America, many in the industry foresee the possibility of moderate profitability within the next few years.
The "cautious" in "cautious optimism" stems in large part from uncertainties about the nation's economy. While the construction market has grown strongly in recent months, the effects of rising prices for gasoline, steel and other construction-related commodities remain a concern. If economic conditions decline for contractors, the domino effect on claims may negatively affect the surety industry's bottom line. For the near term, however, construction looks strong. According to the U.S. Census Bureau, construction values stood at $970 billion in April 2004, 11.3% higher than a year earlier.
Surety is often touted as the most inexpensive financial guarantee around. And while it remains a bargain-offering 100% payment and 100% performance protection for pennies on the dollar-premiums may be on the rise. The highly competitive market of the 1990s led to an underpriced contract surety product. Now that the market has tightened, sureties are not only assessing their exposures but also returning pricing to more realistic levels. After several years of large losses and unprofitability, the industry is poised for a comeback. Although the unpredictable nature of the economy may obscure the horizon, the surety industry, by adhering to sound underwriting, is prepared to support the nation's construction needs in the face of whatever may come.
Advice to contractors
Because of the close relationships they have with contractors, surety companies and surety bond producers are well positioned to analyze and manage construction risks. Sureties have seen it all and can offer a unique perspective to contractors on how to avoid potential pitfalls. The following surety executives offer their insights and advice to contractors in today's market.
"Contractors should involve their surety bond producer and surety at the first signs of problems on a project. Involving them at the onset may enable producers to suggest ways to mitigate problems earlier and avoid claims altogether. Communication is essential."
–Craig E. Hansen, senior vice president, Holmes Murphy & Associates, Inc., and president, National Association of Surety Bond Producers.
"Contractors should avoid working in geographical areas that are unfamiliar or far from the home office. They should also avoid taking on unfamiliar work or projects for which they are unqualified. Document disputes and claims, and respond promptly to notices from project owners, citing facts and contract provisions. Other ways to avoid default include maintaining bidding discipline, being familiar with and adhering to contract requirements (including scheduling), and following through on commitments."
–John Welch, president, CNA Surety.
"Contractors should be sure their subcontractors are bonded, ensure that project owners have sufficient finances and investigate whether owners have a track record of litigation on prior projects. Contractors should select candidates who will be successful customers."
–Henry W. Nozko, Jr., president, ACSTAR Insurance Co.
"To avoid default, contractors should notify the surety early of problems. There have been instances in which all three parties to a bond-obligee, principal and surety-agreed via a memorandum of understanding to have the surety act as an intermediary between the obligee and contractor. This approach is helpful when the difficulty on a project is caused by a deteriorating relationship among the parties. Contractors should not attempt to hide their problems from either the owner or their surety."
–Mike Peters, president, Safeco Surety.
"Contractors need to prequalify owners and adjust their work procedures and pricing for the risk of individual owners. There also needs to be effective and equitable contract language, which spells out the responsibilities of the owner, contractor and design professionals."
–Terrence W. Cavanaugh, COO, Chubb Surety.
"Contractors should maintain accurate and current financial and project records, especially regarding change orders, disputes, claims and back charges. They should know their subs-their availability, capacity and ability. Bond major subcontractors and consider issuing joint checks if there is any question about their financial strength. Require a professional, business-like demeanor in all correspondence and oral communications. Do not permit disputes to become personal, as the idea is not to make friends but to avoid making enemies. Permit no handshake agreements. Read, understand and follow the contract to the letter and comply with notice requirements. If your surety is ever contacted, cooperate with them fully and give them the tools to respond."
–Dennis Perler, president, Liberty Mutual Surety.
"A major cause of problems on projects is insufficient time spent reviewing and understanding the underlying contract. The vast majority of problems that arise between contractors and subcontractors are caused by a lack of clarity and understanding of scope and responsibility. Strong, clear definitions of each party's scope of work and duties can help avoid problems."
–William A. Marino, chairman and CEO, Allied North America.
"Contractors should not be afraid to say no to a project. It is imperative to spend time up-front to develop an understanding of the risk and to review the contract thoroughly, taking into consideration all risk variables, including the financing, schedule and scope."
-Geoffrey Heekin, managing director, Aon Surety.
Marla McIntyre is executive director of the Surety Information Office, a source of information on contract surety bonds for all parties involved in the construction process. The organization's Web site is www.sio.org.
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