What are your top recommendations for construction firms to mitigate risk in the current economic environment?

Gina Lockwood
Senior Claims Attorney
Merchants Bonding Company

Preparing your company to adapt to an uncertain environment will leave you in a position to find success. Three measures are:

1. Focus on cash flow. Cash is crucial for weathering any post-pandemic economic impact. Accordingly, it's essential to take steps to protect your company's cash flow, and from a surety perspective, cash flow always helps bonding capacity.
2. Stay on top of jobsite pandemic issues. Developing and implementing appropriate procedures and following recommended jobsite safety protocols is critical.
3. Retain key talent. Even construction has had administrative activities being done remotely. A more flexible work environment and an analysis of offsite project production will be important for retaining key personnel and maintaining efficiency.

If any sector is going to feel the post-pandemic financial strain, it’s likely the smaller contractors. You can take these three steps if a subcontractor runs into issues:

1. Keep the dialogue open. This is the most critical step. From a surety perspective, when a claim arises, it's often caused by a lack of communication. Cooperatively addressing problems as they arise is the most cost-effective solution.
2. Communicate in writing. Problems or impacts should be documented. A failure to communicate in writing in accordance with the subcontract time frame could leave a subcontractor without recourse.
3. Engage the surety early. The surety can help find a resolution prior to the parties’ incurring significant costs, expenses and delay.

It’s prudent for companies to be proactive in mitigating risk in order to succeed over the next few years.

Eric W. Stickle
Senior Vice President, Director Contract Surety
Chubb

Since the financial crisis in 2008, contractors have seen substantial risk transfer in the construction community. Construction contracts with onerous terms and conditions imposed by project owners and developers have become more and more prevalent, and have been pushed downward from owners to construction managers, general contractors and, ultimately, trade contractors. Unfortunately, it became routine for contractors to accept these unprecedented and unreasonable contractual terms in order to compete and earn new work. At the same time, I’ve had the pleasure of working with exceptionally talented contractors in my career and, while there are many ways to mitigate risk (such as bonding back subcontractors and implementing sophisticated cost control systems, among other things), the difference between a good job and bad job often points back to the contract.

I don’t think any contractor ever concludes “why did I agree to build that project?” Rather, the more accurate reflection is “why did I sign that contract?” Put differently, it’s easy to become unconscious to construction contracts with excessive liquidated damages, delayed payment terms, tighter deliverables, broader default triggers and other problematic terms after successfully navigating the same or similar terms across several jobs over many years. It can and will catch up unless the industry begins to look at the risks and opportunities differently. With that in mind, every contractor has a differing tolerance for risk, but it should be emphasized that even project owners benefit from mutually agreeable terms and conditions through more competitive bids. In summary, the best risk mitigants for surety exposures can often be addressed through diligence in your contractual negotiations. Your surety provider can help you identify onerous contract terms as well.

Now that the GSA has officially accepted e-signatures, what is the future of e-bonding?

Joseph Sforzo
CEO
Surety2000

Over the past decade, the surety industry has been trending toward electronic surety bonding at an ordinary pace. COIVD-19 is the “Black Swan” event that has accelerated this trend permanently.

The paper-laden surety bond process had been an institution since 1837. Despite advances in technology that made the process swifter, more secure and entirely paperless, there remained a complacency that slowed widespread adoption of e-bonding.

COVID-19 exposed a major weakness in this paper process that caused many to rethink how surety bonds are executed.

The GSA now accepts electronic signatures on surety bonds; however, this is not a controversial decision that will serve as a rule or guide for other public agencies to follow. Electronic signatures have been acceptable forms of validation since 2000, when state and federal legislation was passed to make e-signatures legally binding.

As government agencies explore the adoption of e-bonding, it will be important for them to choose solutions that meet a high standard of security and reliability. The software must be entirely tamper-proof, and the e-signing process must be conducted under one platform rather than via email or other medians that are prone to cyber-attack. The electronic signatures on each bond must be unalterable and contain a full audit trail with certificate of completion.

The impact of COVID-19 on the traditional paper surety bond process has resulted in many government agencies to arrive at the same, independent conclusion—the right electronic surety bond solution is safer, more secure and more reliable. This will be the standard in a post-COVID world.

Therese Wielage 
Chief Marketing & Communications Officer
Merchants Bonding Company

While preparing for a digital transformation event, a surety agent told me they had to keep a typewriter in the office because some states require surety bonds on their gold-colored paper. If the surety bond is not typed out on that specific piece of paper, it is invalid. WOW! In 2021 if their “Selectric” breaks down (for you young people, that’s an IBM typewriter brand) who do they call? Tom Hanks? (Did you know the movie star collects vintage typewriters?)

Some states and other obligees in the U.S. have resisted change, requiring raised seals and wet signatures. In the past, this gave the U.S. surety industry an excuse to avoid transformation, while in Europe they had been moving forward with electronic bonding and use of block chain technology for efficient and permanently verifiable record keeping.

Surety’s silver lining from the pandemic has been the wider acceptance at the federal and other levels of digital seals and electronic signatures. The question about e-signatures holding up in court has been asked and answered with a ruling in favor of knowledge-based authentication being presumptively valid. Many surety leaders believe our industry progressed 10 years in 2020, but we are still woefully behind. Consider this: The very first paperless home sale took place July 25, 2000.

Surety will continue to provide bonds in the form our customers and obligees need, but the future will see the spread of e-bonding, updating antiquated requirements and embracing digital transformation.

Renee Llewellyn 
Vice President, Agency Management & Distribution
Liberty Mutual Surety

It’s no surprise that COVID-19 has advanced technology exponentially. One way this manifests itself in the surety industry is electronic signatures. Products like DocuSign are quickly becoming the norm. And why not? The functionality makes it easier and faster for agents and their contractors to get bonds. The signing process is streamlined as notary signatures aren’t required, and all parties receive confirmations and links to the document once completed.

Many sureties already accept electronic signatures for bonds, non-disclosure agreements, collateral agreements, subordination agreements, co-surety agreements and claims documents. Contractors are likely already noticing more instances of their agents asking them to electronically sign documents.

One area where wet signatures are still preferred is indemnity agreements for construction bonds. These aren’t as suitable for digital signatures because many indemnity agreements contain attorney-in-fact provisions. The provisions vary by state and require physical witnesses and notarization. Until there is state uniformity, wet signatures will likely be required for construction indemnity agreements.

The increased acceptance of electronic signatures is motivating surety carriers to consider other ways to do business online. Contractors may soon be able to complete bond applications online or on their agents’ websites. What previously required in-person meetings could potentially be done on a smartphone!

As all parties, especially obligees, become more comfortable with the technology, the industry is likely to see not only increased electronic signature usage, but increased electronic bonding functionality in general.

What are your top recommendations for construction firms to mitigate risk in the current economic environment?

Jeff Deldin
Principal, Executive Vice President, Head of Surety Bonds Unit and New England Region
World Insurance Associates LLC

The COVID-19 pandemic continues to impact the overall national, regional and local economy with marketplace uncertainty, restraints placed on businesses, and increased operating costs due to mandatory safety protocols. While federal programs (e.g., PPP loans) have helped, contractors should be highly strategic by implementing proactive measures to help guide their businesses through this period and mitigate risk.

I have five top recommendations for construction firms to mitigate risk in the current economic environment:

1. Continue to diversify and strengthen your labor pool, subcontractors and suppliers.
2. Review your operating expenses and keep them flexible.
3. Strengthen your company's balance sheet by increasing your liquidity position (cash on hand), being aggressive in collecting your accounts receivable and talking to your bank about increasing your line of credit in case of an emergency.
4. Do some proactive, strategic planning for your company regarding increasing its sales, reducing costs and managing labor. Consider targeting specific projects to bid with an adequate profit margin and find additional ways to be more productive and efficient on the job. For example, invest in job training for your field employees, as well as supervisor training.
5. Keep in frequent touch with your office management team and outside trusted advisors (e.g., CPA, attorney, insurance/bond agent, bank). Keep them informed of your company's current situation and seek advice on better ways to manage your business.

Vincent Cardella
Director
Nationwide® Surety and Fidelity

The answer is the same one I would give during optimum economic conditions: Construction is a risky business, and there is never a time when the economic conditions are so positive as to preclude the need to adhere to basic fundamentals.

These best practices include maintaining a strong emphasis on cash flow management, coupled with internal review systems to continuously evaluate ways to improve cash flow and billing practices, as well as soliciting ongoing feedback on project performance and thorough post-completion analysis to identify areas for improvement in cost estimating, management of labor and scheduling. It’s also critical to only pursue projects that are truly within a contractor’s proven capability, including a sufficient margin to deliver reasonable profits after all costs are considered. However great the temptation may be to meet a desired revenue target by bidding work below margin sufficiency or beyond a company’s ability, this approach is riskier than waiting to bid on projects that meet a company’s criteria, even if it means missing annual revenue targets.

Contractors must also be forthright in insisting on reasonably fair contract terms and be disciplined in walking away if those terms cannot be met. Sureties will consistently reinforce these and other messages to help their contractors succeed regardless of the state of the economy. Remember: Just as these best practices will help contractors weather the storm in challenging times, failure to adhere to the fundamentals will substantially increase the risk of failure even in the best of times.

What should contractors know about the “Three Cs” (character, capacity and capital) used to evaluate contractors for surety capacity?

Stephen Poleman
Vice President
Rich & Cartmill, Inc.

Contractors should know that there is only one of the "Three Cs" you cannot overcome—character. Discovery in underwriting issues of moral turpitude, such as honesty, integrity and fair dealing, should be enough to close an underwriter's file with no offer. While equally important, capacity and capital concerns may be overcome.

Capacity focuses on the size and nature of the job being considered and a comfort with the contractor's ability to complete such projects. While the contractor may not have completed a single job of that size, or carried an uncompleted work on hand so large, a case might be established to gain that underwriters comfort. Steps such as creating the right makeup of key experienced staff members, outlining that the nature of the project is less risky than it appears, bonding subcontractors, access to needed equipment and phasing the job are just a few ways to overcome a question of capacity.

Sufficient capital reflects not only the ability to finance work programs with adequate excess capital for emergencies, but it also serves as an indicator of a contractor's past performance. Should there be an acceptable reason for a currently weak financial statement, you may be able to build your financials with one of numerous methods seen by surety underwriters on a frequent basis that they are comfortable with. These include use of equity in your fixed assets, the help of your bank and support of outside parties.

How do you measure up to the Three Cs?

Jason C. Walton, AFSB
Bond Manager
Old Republic Surety Company

The “Three Cs” of surety are paramount in a surety’s decision-making process when making a determination to support a contractor. Contractors should understand how each one can affect their ability to obtain surety capacity and how they go hand-in-hand.

First and foremost, character is the most important of the “Three Cs”. It is so important because it greatly influences the other two of the “Three Cs”, capital and capacity. This may be the hardest thing for a surety underwriter to judge and underscores the importance of in-person underwriting meetings. There are many aspects that go into evaluating the character of a contractor. When talking with a contractor, I want to know how well they understand their market. How do they mitigate risk? Do they have a well-defined business plan?

Contractors with good character establish their own limits based on capacity. They will know how much revenue and/or backlog they can handle, and will have a good understanding of the territory they work within.

A contractor’s capacity can also be influenced by the amount of capital that they have. The balance sheet and cash flow of a contractor must be able to support their operations. They must also understand how to manage their cash flow in order to properly manage projects and maintain healthy profit margins.

When a surety is meeting with prospective and even current contractors, they are analyzing how strongly the contractor represents and defines each of the “Three Cs."

Which questions should I ask when considering doing business with a new surety bond producer?

Daniel Ruggeri
General Manager
Worldwide Insurance Specialists, Inc

Q: What working capital thresholds do you have?
A: In times of constraint, this might make your deal dead on arrival. Each carrier has its own working capital requirements, but the typical rule of thumb is 10% Available Working Capital x 10 = Bonding Capacity.

Q: Which items are you looking at to determine my working capital?
A: Cash + Accounts Receivable + ½ of Inventory - Current Liabilities = Available Working Capital.

If you're with a flexible bonding company, they may consider your bank line of credit as part of your working capital. This will increase your bonding capacity. Also, we are not at the 10 percent threshold.

Q: Do you have sureties that can consider collateral or funds control?
A: Sometimes you might bite off more than you can chew and the surety may consider the job too large. If you run into this situation, the surety may require funds control or collateral, and if they cannot offer these tools, you will have to turn down the job. You should also ask which forms of collateral you should consider. Most carriers only want ILOC, but some will accept cash and bank wires, too. If you have a good bonding company and you can’t come up with the collateral, they can use funds control to seed the collateral, so you do not need to tie up additional working capital.

If a surety company offers collateral, ask how long they hold onto it after your job is completed.

Q: At what size will the surety require a CPA-prepared financial statement?
A: CPA-prepared financials can be costly and are used to validate income and working capital. If you are only getting CPA financials for bonding purposes, it might not be worth it. You need to find out at what bond amount the surety will require them. The markets have loosened quite a bit over the last few years and, in most cases, we are not requiring them until we hit the $2 million mark. We can use alternative methods for validation and have markets that can validate income from tax returns.

Dale M. Braue 
Vice President, Surety
IAT Surety, a member of IAT Insurance Group

A long-term relationship between a contractor and their surety bond producer/surety company signifies operational stability and steady management. Changes in these relationships necessitate gathering financial documentation, answering underwriting questions and conducting meetings with representatives from all parties. Fortunately, when a contractor needs to seek new representation, there are key factors they can focus on to ensure that they select a producer who can service their needs now and well into the future.

It’s important to choose a producer who specializes in placing and servicing surety bond programs for companies engaged in the specific type of construction work that you perform. They should be actively licensed to transact business by the Department of Banking and Insurance in every state/country you wish to work in. They should have power-of-attorney appointments with numerous sureties that meet your project owners’ minimum A.M. Best Rating and U.S. Circular 570 Treasury Listing requirements and should not have a history of appointment termination.

A well-established producer should be able to precisely articulate their processes for receiving and fulfilling bond requests in a timely manner, maintaining underwriting files and protecting their clients with a back-up bond program. They should employ full-time personnel dedicated solely to bond program service and maintain comprehensive errors & omissions insurance.

The best producers have proven track records of balancing a contractor’s changing needs against the surety’s requirements in order to maintain strong relationships with both over time. Ask them to share their greatest success stories for insights into their abilities to do both.

William Chapman 
Assistant Vice President, Surety Division
Philadelphia Insurance Companies

A surety bond producer should add value and grow into a trusted long-term business partner, consultant and advocate for your business. Ask these questions to find the right fit:

Experience and Reputation:

• What is your experience and background?
• How long have you been a surety producer?
• What percentage of your business is construction?
• How many construction companies does your firm handle?
• Can you provide information for references?
• How many sureties do you represent?
• Who are your top five sureties by volume?

Staff and Service:

• How many of the firm’s employees are dedicated to surety?
• Will we have a dedicated customer service representative and/or account executive?
• What is the depth and continuity of the firm?
• What is the process for ordering surety bonds?
• What systems are utilized?
• What can we expect in regards to service and turnaround time?
• Are you licensed in the states we operate in?

Industry Involvement and Knowledge:

• Which accounting, surety and construction industry associations are you active in?
• Do you have regular interaction with local bankers, CPAs and attorneys?
• Can you walk me through the surety underwriting process?
• How do you define the three Cs (i.e., character, capacity and capital)?
• Can you discuss your experience with contracts and subcontracts?
• Can you discuss your knowledge of construction accounting?