Surety Outlook 2012
OUR PERSPECTIVE ON THE SURETY CLIMATE
Surety losses are expected to increase in 2012 and 2013, since the downturn in construction activity means more bidders fighting for fewer jobs yielding lower profit margins. There has been no quarterly growth in construction spending since early 2006, and a prolonged period of anemic spending is expected for the construction industry; in the first four months of 2011 it was 8.4% lower than during the same period of 2010. While reassurance from Federal Chairman Ben Bernanke lifted investor confidence, a slower “recovery over time” is still anticipated.
At mid-year, construction unemployment stood at a high average annual rate of 18.2%. Private investments in construction projects have been few and far between because of difficult access and compliance to capital requirements. The government stimulus spending on supposed “shovel ready” projects is often strung out by lack of financing. Public fiscal restraints will continue due to the overwhelming need for a balanced budget.
The U.S. surety market is primarily concentrated on 25 top writers who handle 65% of the industry premiums. The continuing industry consolidation is a concern for underwriting flexibility and conflicts in claims handling. Still, the industry remains healthy. As most sureties have evolved to excess-of-loss reinsurance with large deductibles, the underwriting shifts will be driven by the direct market results more than reinsurance restrictions.
Capacity is increasing for single bonds and maximum aggregate programs. Surety rates continue to follow an inverted pricing curve, where the largest capacity users pay higher rates than the middle market – because many surety companies are willing to write the middle market, but only about six will write the jumbo contractors ($500 million-plus work programs). Despite the down economy, small contractors’ access to bonding may be at an all-time high. Several programs have been introduced specifically to assist in obtaining surety bonds. The U.S. Small Business Administration (SBA) Surety Bond Guarantee Program continues to expand. The Bonding Education Program (BEP) – a joint effort between the U.S. Department of Transportation and The Surety & Fidelity Assn. of America (SFAA) – aims to educate small businesses and assist them with obtaining transportation-related contracts. SFAA’s Model Contractor Development Program (MCDP) continues to help small, minority and women contractors become bondable and increase their bonding capacity across the country.
Sureties are competing for the best contractors on capacity and service. However, struggling contractors will face more scrutiny; loss ratios are creeping up for sureties that specialize in writing smaller contractors. These contractors have shorter backlog durations and are starting to more quickly feel the balance sheet erosion from unprofitable work. Surety underwriters will want to meet with contractors to evaluate financials more frequently, look harder at the details, and confirm acceptable contract, bond form, and financing terms. More often, sureties will require subcontractors to bond back to primes and generals. Overall, sureties will be expecting a higher standard of conduct from contractors in the years to come.
Contractors need to look at operating profitability and maintain a history of completing contracts profitably. Complete, accurate, and timely job costing and financial reporting is mandatory in today’s environment. Communicating both good and bad news in real time to their surety business partners is the most important thing a contractor can do, enabling everyone involved to work through problems pro-actively.
Construction is cyclical, and contractors should prepare for the pent-up demand that will build during as we exit the recession. Contractors need to protect their core resources and be ready to bid work when the economy rebounds. Conserving capital, aggressively billing and collecting fees, procuring materials, and locking in prices are areas in which it’s important to stay vigilant. It’s also necessary to have the right-size bank line of credit and a back-up bank in case of need. Bidding the job, not the competition, is key; it’s better to adjust overhead than to “buy” a job to keep employees busy. Subcontractors should also supply bonds to better manage risk. Subs should be bonded when they represent a key trade to the project, provide a significant portion of the work, are the sole source for anything, or are simply an unfamiliar resource. Their sureties should be qualified, and bonds forms reviewed.
In times of economic uncertainty, a well-developed surety relationship is essential. A professional surety bond producer and surety company underwriter are key players on a contractor’s team. Sureties want a sound business partner who is rational, committed, honest, and knows how to run a successful construction company – one that will continue to grow and be profitable.