Risk
Business

2019 Executive Insights From Leaders in Surety Bonding

Read on for insights from industry experts on the ins and outs of surety bonding.
November 8, 2019
Topics
Risk
Business

During economic downturns, construction firms may be tempted to bid on projects outside their niche/region. What are the risks?

Ken Chapman
Executive Vice President, Surety
IFIC Surety, a member of IAT Insurance Group

There are a number of factors to consider when contemplating work outside a company’s normal geography. The question the contractor must consider is whether they are getting quality work such that they have a competitive advantage. Labor and subcontractor availability, not to mention familiarity with these two components come to mind; supply chain and material availability as well. A contractor new to the scene may not see the same product and pricing availability that local firms see. The project owner also presents a question mark—consider their reputation, how they manage work, their pay habits, as well as potential sophistication in managing a building program or complex project. Clearly there are many more considerations when considering regional expansion but, with the right strategy, proper planning and strong leadership, it can be done successfully.

Carl Castellano
Vice President, Contract Surety
Philadelphia Insurance Companies

One of the most common and costly characteristics of contractor failure (and therefore risk) is when a contractor significantly changes their niche/region: public to private construction or vice versa, becoming an electrical subcontractor when their experience is general building or performing work in a new geographic territory because they inadequately prepare. A well-considered business plan should incorporate the five “Ms”: money, machines, materials, manpower and methodology.

Money: detailed cash flow projections addressing the nuances of the planned changes; cash flow is very different between an electrical subcontractor and a general builder.

Machines: maintain or lease just enough equipment to execute work without resulting in too much idle equipment and avoid excessive costs when scrambling to find equipment.

Materials: establish good relationships with vendors and subcontractors, not only obtaining favorable payment terms, but also partnering with them to assist in receiving reasonable delivery time for materials and high-quality subcontract crews.

Manpower: include labor cost projections covering all categories, including field labor, project management, estimators, accounting, information technology, administrative and executive staff. Maintaining competent and adequate manpower in all categories is one of the industry’s greatest challenges and can be exacerbated with changes in niche/region. Address business continuity not only from a financial perspective (a solution usually involving life insurance) but also from an operational one.

Methodology: design and embrace systems and procedures to positively impact the bottom line, including the organization plan, checks and balances, estimating, scheduling, project management, cost, financial systems and reporting.

Remember, proper prior planning prevents poor performance.

Anthony J. Ueland
Territorial Underwriting Officer
CNA Surety

This is one of the more significant failure data points we see for construction firms. The ability for contractors to be successful while expanding geographically requires the discipline to recognize the increased risk factors in both subjective and objective areas. During economic downturns, leverage on resources to undertake the necessary risk mitigation efforts that are of paramount importance is often overlooked. The ability to assess owner reputation, subcontractor quality, labor market availability, as well as competitor advantages and disadvantages are subjective areas that often take time to develop. Objective issues that need to be taken into consideration include project delivery methods, e.g., competitive bid, CM/GC, design build, etc.; procurement risk; mobilization cost; geotechnical information; and a host of other hard data unique to the locale. Additional items that are frequently overlooked are the socioeconomic and microeconomic attributes of a new region or territory.

Construction firms expanding into new niches or constructability means often meet some unforeseen challenges in areas such as self performance of work, cash flow financing dynamics and organized labor obligations. An area potentially overestimated is a firm’s project and field management bench strength. During peak employment periods in the construction industry, additions to business development professionals, project management leadership, engineering staff and field level promotions may have been hastened or accelerated without seasoning to develop the necessary attributes to handle new expansion. This risk often manifests itself during challenging economic times when a firm can least afford it and results can have damaging effects.

Brady Mayer
Assistant Vice President — Underwriting
Old Republic Surety Company

With each job, there’s a lot at stake; step outside your niche or normal operating territory, and your risk increases dramatically. The lack of familiarity with local labor force, subcontractors or suppliers, site conditions, project owners and contractual language make establishing proper contingencies extremely challenging.

Expanding the typical scale and scope of work poses similar risks. Does the management team have the knowledge and experience to successfully lead this new type of project? Is the company’s financial profile adequate enough to support the relatively unknown cash flow demand? Consider all of these questions to avoid significant cost overruns or default.

When work opportunities are scarce, and the bills need to get paid, it may seem like there’s no other choice but to chase revenue. Taking a calculated risk can pay off but, without careful consideration, a poor strategic decision such as taking work outside your area of expertise can leave you worse off.

Josh Penwell
Senior Vice President, Contract Underwriting
Merchants Bonding Company

When construction spending decreases and available work dries up, contractors are faced with challenges to maintain profitability. Best practice is to “right-size” the company and align overhead with the decreased revenues. Contractors who keep a portion of their overhead flexible have a better chance of success in the long term.

Contractors also try expanding beyond their normal geographic territory during these times. This approach is not advisable. Although some contractors may experience success, a majority of them will face significant challenges. The obvious difference when performing work further afield is the additional costs, such as travel expenses, available labor in a new market, renting office space, storage areas for materials and mobilization costs. Additional risks that contractors need to consider when entering into new territories, and must price accordingly, are:

  • General contractors will be working with unfamiliar subcontractors and subcontractors will be working for unfamiliar general contractors.
  • Site conditions could be drastically different, especially for underground contractors.
  • Weather patterns may be different or more unpredictable.
  • State and local government rules and regulations are different, particularly licensing, lien filing deadlines, in addition to claim-preservation and claim-perfection filing deadlines.
  • Procurement requirements and procedures vary from state to state.
  • Varying reporting requirements, such as sales and use tax, payroll and unemployment issues, income tax and personal property taxes.
  • Cultural differences, such as local business practices and the competitive environment.
  • Different state union practices and possible jurisdictional or strike issues.

Successful contractors adequately price risk, and the increased risks of performing work in a new geographic area are high. Contractors that decide to venture into new territories should do so very cautiously with a very detailed plan and comprehensive strategy.

Bruce Bergstrom
AVP – Head of Contract Surety
Nationwide

It’s common for contractors to consider broadening their geographic scope when economic conditions deteriorate in their region and work becomes scarce.

Bear in mind, however, that other areas may be just as competitive as your current territory. Outsized opportunities rarely last in a modern economy with so much capital chasing returns, and you won’t be the only contractor moving to the new location.

The first thing to consider when your territory is experiencing economically challenging times should be an internal review. Would it be better to right-size your organization for the market you are in? It might be easier to manage a down economy in your own backyard than to assume new risks in an unfamiliar territory.

That being said, when real opportunity exists in another market, how should you approach it?

First, do your homework. Talk with industry organizations you belong to. Ask your broker and your surety about a particular market and be prepared to address their concerns since they will view this change as an increase to your risk profile. Also, consider alternatives, such as following an existing client to a new area or partnering with a smaller contractor in that market that may need your expertise or capacity.

Second, assess the risks: production rates, subcontractor base, labor availability, suppliers, owners, legal issues, current staff’s availability to travel and if your internal systems are adequate for distance oversight.

When considering a new territory, the bottom line is to be deliberate and thorough in your analysis.

Andrew Thome
President, St. Louis Office
Marsh & McLennan Agency

When branching out to geographies or niches outside of your core discipline, proceeding with caution is the best approach.

For example, after the 2008 financial meltdown, there was a significant flight to federal work. The government speaks a unique language and operates in a world known as FAR (Federal Acquisition Regulations). While transparency abounds, FAR rules are substantially “different” than those in the private sector. Many contractors underestimated the backroom demands and utilized their “go-to” subcontractors, which were also new to the process. Contractors that chose to engage with a government contracting specialist performed better than those that didn’t, but few of the general contractors that dove into the government sector have stayed the course.

In another instance, multi-family and senior living facilities have been a hot market for years. While many contractors have performed well, several problems arise when general contractors utilize“residential plus” subcontractors versus commercial light subcontractors. Depending on the plans, owner and geography, the quality of the building envelope system has been an ongoing source of concern. Construction defect (CD) litigation is on the rise, and negotiating an equitable contract that has proper contract “hygiene” can be crucial to a project’s success.

Challenging your team to talk through the risks associated with a new opportunity is a great way to vet the project. Including your surety agent and insurance professional in the discussion (if you feel they are qualified to have a seat at the table) puts you in the best possible position to make sound decisions as you endeavor to move into a new niche or region.

How can contract surety bonds help contractors secure more private sector work even when a bond is not a requirement?

Michael P. Cifone
Senior Vice President, Surety
Hudson Insurance Group

Contractors that have the ability to provide a bond, whether required or not, are confirming they have the confidence of a surety company willing to use accrued financial strength to support the contractor.

Contractors seeking a qualified surety agent illustrate a combined financial strength and expertise. The surety firm is looking for contractors that understand the risks they face (e.g., labor and subcontractor issues, contract terms, weather and unforeseen conditions) and have implemented a plan to avoid, eliminate, reduce or accept those risks.

Contractors that qualify for an approved surety bond line identify as both vetted and capable of performing certain work. A bondable contractor attracts a following of similarly qualified subcontractors and vendors to assist with the project. Therefore, private owners understand that contractors with an approved bond line have met specific financial and experience criteria.

Private sector owners can minimize their risks by working with contractors that have the ability to provide both payment and performance bonds. When problems occur, history has proven that projects with bonded contractors are less of a financial burden than projects with unbonded contractors.

Kevin M. Waldron
Senior Vice President & Director, Surety
Chubb Surety

As part of their discussions with private project owners when either proposing or negotiating a contract, contractors should always indicate their ability to provide surety bonds in connection with the contract. Many contractors will state their bonding program limits in both single and aggregate terms, reassuring the owner that pre-qualification has been obtained by a surety company that is able to provide a bond in connection with the contract.

A letter from the surety firm indicating its willingness to provide surety support in connection with the private contract under certain terms and conditions may provide contractors with an advantage over other contractors who do not have a surety program. While the owner may ultimately decide not to require surety bonds in connection with the contract, the demonstration of this capability may give the owner greater comfort when awarding the contract to a pre-qualified contractor.

Henry W. Nozko, Jr.
President
ACSTAR Insurance Company

A contractor that performs only private work might consider performing government work to enhance the contractor’s possibilities for growth. One advantage might be that performing more projects within the existing footprint of the company’s operating area could add to the revenue stream and lead to more earnings. Many contractors have performed (and do successfully perform) a mixture of private and public work.

A contractor that performs only private work, and is considering to engage in federal work, should carefully evaluate some characteristics common to federal construction projects. These differentiating aspects of federal work are not normally encountered in performing private work and they typically increase cost.

For example, payment requisitions can take on the form of an arcane computer obstacle course that may take weeks or even months to decipher and implement, which can delay payment. There are many costly operating requirements contained in the procurement regulations, which will increase the cost of construction.

It may also be necessary to implement and maintain an approved safely program, activity hazard analysis (AHA) and employ both a quality control (QC) representative and a site safety and health representative (SSHA). Noncompliance could cause a work stoppage and precipitate liquidated damages.

Payment and performance bonds are almost always required, which add to the cost of the work. If a large change order surfaces, there may be a defense contract audit agency (DCAA) audit to verify costs.

Having a root canal is more fun. The federal stream of red tape can slow down the pace of work and adversely affect production and the ultimate project cost.

Public work is not bad, it just usually costs more money to perform. Be aware of the peculiarities associated with federal government work and carefully evaluate the associated costs prior to entering into a federal government construction contract.

Fraudulent surety bonds have become more commonplace. What steps should a contractor take to verify whether a bond is legitimate?

Dennis Richmann
Vice President & Director of Surety
UFG Insurance

Fraudulent surety bonds continue to be an issue for the construction and lending industries. Fortunately, steps can be taken to reduce the risk of buying an illegitimate bond.

Bonds are usually sold through an insurance agency or brokerage. Reputable and well-established agents and brokers will not sell bonds through companies that they have not fully vetted—let them do the qualifying work for you. Excessive bond rates can be an early warning sign. How and the type of payment accepted or a payee on the check that does not make sense could be other clues. Make sure you or your agent researches the individuals and companies you’re going to work with. If the agency or brokerage selling you the bond seems off or they do not feel that professional, trust your instincts and consider going elsewhere.

If you do not recognize the surety name, search them online—what do you find? Many, but not all companies can be found on the U.S. Dept. of Treasury C 570 listing. Even if you recognize the surety company name, it does not mean the bond is real. Make sure you contact them and vet the surety company to verify the legitimacy of the bond. Many surety companies have websites that can verify bonds, or you can contact them either by phone or email to verify legitimacy.

If you are the obligee, project owner or general contractor that is receiving the bond, you might also contact your agency/brokerage to send them a copy of the bond. They would be happy to research that surety company and the bond in question.

Surety bonds come with a promise to perform but, first, let’s make sure you’re buying a legitimate bond.

John Bustard
President
National Association of Surety Bond Producers

Nothing replaces a company’s own due diligence. Verifying the legitimacy of a bond is a critical but relatively easy process. A contractor can employ a straightforward, two-step inquiry procedure.

First, the contractor should ascertain that the surety is properly authorized to issue the bond in the location of the project. Every surety must possess a current certificate of authority to act as a surety insurer, which is issued by the insurance commissioner in the jurisdiction of the project. A mere business license is not enough and does not entitle a person or an entity to lawfully act as a surety insurer. All state insurance departments maintain current lists of those that have obtained certificates of authority; a quick call to the insurance department in the state of the project will confirm whether or not the bond is from a legitimate surety.

Second, determine if the surety actually issued the bond. The state insurance department has contact information for each authorized surety, and the U.S. Treasury Department Circular 570 lists contact information for each surety that is certified to write bonds on federal contracts.

Don’t forget that your professional surety bond producer is a ready source of information and intelligence on the surety marketplace, as well as on the capabilities of sureties, and can provide further feedback on their reputations.

Francis J. McGrath
Senior Vice President & Chief Credit Officer – Contract
Liberty Mutual Surety

Despite advancements in safeguards, contractors can’t always be certain that surety bonds received through electronic transfer or hard copy are free of fraud.

While most surety bonds are issued properly, contractors can help avoid becoming a victim of fraud by consistently following some best practices prior to accepting and paying for bonds:

  1. Work with your trusted professional bond producer—Review information for completeness. Handwritten content in the bond form should raise suspicion. A “Power of Attorney” form must accompany the bond, having proper surety corporate seals.
  2. Check state insurance commissioner website—Confirm the surety company is admitted in the jurisdiction. Ensure there is an exact match of the name of the surety on the bond form to the authorized entity listed on the website.
  3. Check U.S. Treasury Department website—All surety companies engaged in issuing Miller Act bonds for federal construction projects must have a certification from the Treasury Department. After financial review, the “T Listing” indicates the surety company’s single bond underwriting limitation. Ensure the surety company name listed in the bond exactly matches the name on the “T Listing”. https://fiscal.treasury.gov/surety-bonds/list-certified-companies.html
  4. Check rating agency website—Independent rating agency companies such as AM Best and S&P provide useful information assessing the financial capacity of insurance companies.
  5. Contact the surety/insurance company—Contact the surety company directly to validate bond propriety. Having an ongoing relationship with a surety broker and provider will accelerate the surety process and minimizes the chance of fraud.

What advice do you have for contractors considering making a claim on a surety bond?

Michael B. Bomba, Esq.
Director and Counsel, AIA Contract Documents
The American Institute of Architects

Surety bonds are valuable mechanisms to assist a project in moving forward as smoothly as possible. Payment bonds, for example, allow subcontractors to recoup unpaid amounts for work performed without placing a lien on the owner’s property or bringing a separate claim against a contractor that has failed to pay. In both instances, the payment bond should respond to make the subcontractor whole and allow the project to proceed.

Anyone making a claim, typically referred to as a “claimant” under a surety bond, however, must understand that the bond is a separate agreement from the contract the claimant signed to perform work on the project. That bond will have its own set of terms and conditions, and a surety will not be obligated to respond under the bond unless those terms and conditions are met. Accordingly, it is very important for contractors to understand the requirements in a bond before making a claim.

For a payment bond, that means the surety will not simply make payment to a claimant just because it has not been paid in accordance with the terms of the claimant’s agreement. Rather, the claimant must satisfy all the procedural conditions set forth in the bond before the surety will respond. In the case of the AIA Contract Documents A312-2010 Payment Bond, lower tier subcontractors (those not under contract with the contractor named on the bond) must provide notice of non-payment to the contractor within a prescribed time period and send a claim to the surety. The A312 also has specific requirements for what must be included in the claim to the surety. Under the terms of the bond, the surety has no obligation under the bond until those exact conditions are met.

Electronic bonding continues to evolve. What should contractors know about purchasing surety bonding online?

Mike Bond
Head of Surety, North America
 Euler Hermes North America

Electronic bonding continues to evolve as our customers are demanding more streamlined, web-based solutions. In Europe, online procurement of surety bonds, from submission to underwriting to issuance, is already under way. Clearly, the much more fragmented U.S. surety market is behind the curve of digital evolution. Progress may be slow, but the trend is inevitable—more surety business will be done online. That trend is evident today, with some carriers offering the ability to obtain a surety bond online. In an era where many of us buy car insurance or home insurance online, there is something appealing about the ease and efficiency of getting surety credit from your computer or mobile device.

But I can’t help to go back to the basics of the product. In surety, we are selling a promise of performance: our principal’s as well as our own. We can argue about pre-qualification or other ancillary benefits of surety. But the obligee and the principal look to the surety to respond in the time of crisis. To me, that means you need to look for a surety provider that has the experience, capability and financial strength to respond when difficulties arise. I am not saying that the online surety providers don’t have those characteristics. But many are untested.

I would look to the best surety company that meets your needs, not the surety that provides the bond the quickest. Ultimately, more carriers will deploy electronic platforms, so the choice will be greater. But today, the development of electronic bonding is still in the early stages and the number of carriers is too limited to give the level of choice that a business may need.

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