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How has the pandemic changed the surety market?

Lee Covington 
President & CEO
The Surety & Fidelity Association of America (SFAA)

Like the construction industry, the surety industry has remained resilient and strong throughout the pandemic. Our partnerships and collaboration with contractors, owners and developers are stronger than ever as the construction industry continues to work through many challenges we are facing, including labor and materials shortages, in addition to price increases.

Charles Nielson
Nielson, Hoover & Company

COVID-19 significantly impacted all credit markets, both directly and indirectly, including the surety credit marketplace. Based principally on supply chain issues, employee availability and productivity, as well as bank credit availability, surety markets have re-evaluated the credit they have been willing to extend—both on a general and specific account basis. 

The underwriting criteria and understanding between a contractor and their surety may have been quite predictable in the past; however, our financial world has radically changed and, at this point in time, nothing in that regard can just be assumed any longer or taken for granted.

In these continued challenging times, it’s more important than ever to have “backup surety lines of credit” for any account that depends on surety credit as a means of obtaining work. Now, like no other time in history, has a backup line of surety credit made more business sense.

Talk with a surety bond specialist or financial advisor to learn more about how they can help you navigate the changes taking place as a result of the pandemic and discuss the best way to secure a backup line of surety credit for your business.

William E. Eschert
Home Office Director- Contract Surety

The COVID-19 pandemic has impacted both the surety market and construction firms. However, one challenge that’s unique to surety has been remaining in communication with our agents and construction accounts to obtain timely information for credit risk decisions.

In the spring of 2020, most businesses—including sureties—sent employees home to work remotely. For most, that meant making upgrades to technology, an effort many had already begun as a way to attract younger talent while promoting work-life balance. Because of this trend, the quick shift in early 2020 caused less disruption than it may have otherwise.

At Nationwide, we were fortunate to be able to successfully implement upgrades and enhancements while continuing to support our agents and accounts. We were able to keep the business moving forward by using tools such as Microsoft Teams, smartphones, as well as broader and more flexible work hours. Like Nationwide, many sureties were up and running remotely within days of converting to a virtual workplace.

During the early days of the pandemic, sureties anticipated a potential for some delay in financial and banking information for accounts. Because much of our underwriting is based on account CPA and in-house financial reporting, we needed to create solutions to this obstacle quickly.

We worked with our agents to best understand feasible reporting timelines and effective methods of collecting this valuable information. We entertained exceptions for a broader timeline receipt of CPA year-end statements, banking information, PPP loan confirmations and other reporting tools. We also shifted to virtual account meetings and conferences to collect key information, such as financial reporting, business plans, bid prospects and discussions of labor and materials supplies.

While we have stayed connected virtually, relationships are at the heart of our business, and we are looking forward to meeting face-to-face with our partners again soon.

Andrew A. Dickson
SVP, Head of Surety
Hudson Insurance Group

The construction surety market has performed well over the last 18 months. At the beginning of the pandemic, the market was preparing for the possibility of surety losses—which, to date, have not emerged. One of the main reasons is construction firms’ successful use of Paycheck Protection Program money, which was an unexpected liquidity injection and, for the most part, has been forgiven. Another positive trend is the extremely low bank interest rates. When coupled with supportive financial institutions, this has benefited the construction companies. Overall, the industry has experienced an active bidding season and one of the items that is now front and center is the availability and pricing of construction materials. Contractors need to be smart with  estimating and materials sourcing; this will lead to additional questioning from the surety market on material-heavy jobs. Due to unfortunate loss of life during the pandemic, we expect the surety market to be inquisitive about construction company continuity planning. While there are continued insurance company consolidations, offsetting this are new capacity providers in the market, which keeps available surety capacity at a high level. Original signatures on bonds, powers, indemnity agreements and other legal documents will be less prevalent as we move towards electronic solutions. It is wise to collaborate with a strong nationwide surety company that understands your needs and can readily weather the different business cycles. Both the surety company and the producer are integral allies and must remain steadfast in advising construction companies during times like these.

Joy Provost
Underwriting Director, Construction Services

Contractors and sureties have proven to be resilient throughout the pandemic.  The industry has seen the adoption of new tools and technology, including electronic document execution and videoconferencing, that will remain a normal part of business after the pandemic recedes. While videoconferencing does not replace face-to-face meetings, it does provide efficiency and flexibility in the sharing of information and collaboration that is important given the pace of change in the construction market.

There has been little shift in the underwriting fundamentals throughout the pandemic. Underwriting has always contemplated a variety of risks in changing business and economic situations. The industry is seeing more focus on supply chain and materials disruption, scheduling and production impacts due to health protection measures, inflation and other pricing volatility related to the impact of the pandemic. While materials and labor fluctuations have always been an underwriting consideration, the volatility we have seen during the pandemic has emphasized the importance of identifying and mitigating these risks, whether through business practices or contract terms.  

The pandemic highlighted the importance of contractor resiliency and adaptability. The surety market has become more than the provider of bonds. Contractors are looking to the surety market to help them build an enduring business and protect their personal wealth. Sureties should now be more consultative with clients, helping contractors recognize the threats and opportunities for their business.    

Tracy Tucker
National Association of Surety Bond Producers (NASBP)

From my vantage point, the surety market and surety bond professionals are again proving resilient and responsive despite all of the unexpected changes and challenges continuing to be caused by the COVID-19 pandemic. Bond producers continue to provide services, advice and guidance regardless of whether delivery is in person or virtual. Surety professionals continue to focus on being nimble and communicative so that construction clients receive bonds as needed. Greater adoption and use of technology, such as electronic signature technology, help ensure that bonds or other supporting documents are executed and furnished, regardless of the work environment. 

The COVID-19 pandemic will mark a turning point for the industry, where surety automation and electronic bonding will rapidly increase and become the norm in the near future. Already, the surety industry, through a broad and diverse consortium, is exploring the best means to digitize surety processes through use of blockchain technology, a distributed ledger technology that holds tremendous promise to make the execution and delivery of bonds more secure and efficient. Bond producers also continue to be on the lookout to protect the interests of their construction clients through review of and issue spotting in contracts, especially important now that contractors have to bear higher risks associated with materials price escalations, supply disruptions and more risk-shifting provisions. In effect, the continuing impacts of the COVID-19 pandemic are reinforcing the value brought to the table by skilled surety professionals and by surety bonding.

Sean Deakin 
Vice President & National Surety Manager
CNA Surety

The near-term impacts on the surety industry are obvious, an increased sensitivity to contractual terms and conditions, a tightening of underwriting criteria and a restriction or reduction of capacity in certain sectors. Aside from these, the global pandemic has forced many surety underwriters to “take the blinders off” and identify non-traditional areas of risk outside of a contractors normal trading, credit and contractual relationships, their financial management and existing backlog. Perhaps the two most obvious examples of this are global supply chain issues impacting material and equipment procurement and costs, as well as government wage subsidy programs that have only further strained a challenged labor market. Additionally, many sureties are now more closely underwriting the owners in irrespective of their historical attitude towards claim management and project financing. Such issues now form part of an underwriter’s daily conversations and considerations.

There remains some level of uncertainty around the long-term impacts, but the overall health of contractor solvency and cash flow over the next six to 12 months will tell the tale. As contractors replace “pre-pandemic” work with “pandemic-era” projects. Current expectations are that there will be a strain on contractor profitability and cash flow resulting from increased costs, more aggressive bid margins, increased project management requirements, continued supply chain and labor challenges to name a few. If a wave of contractor defaults does emerge as a result, these issues will only compound a surety’s challenges with claim resolution.

Dawn Nevill
Vice President of Contract Surety
IAT Surety, a division of IAT Insurance Group

Surprisingly, we haven’t seen a significant change in the surety market—yet. In March 2020, when the uncertainty of the pandemic hit, we didn’t know what to expect. Were contractors going to experience huge losses because of long-term job shutdowns, project terminations, employee illness, etc.? There were so many unknowns.

We stayed close to our accounts and agents, read and watched the news and economic updates, performed book-of-business reviews and waited for the shoe to drop. For many businesses, the Paycheck Protection Program saved them and, for others, the pandemic impact was not as financially severe.

In early 2020, there was great concern around what the year-end surety results would reflect. Many were pleasantly surprised when the 2020 results were published, as the year ended far better than anticipated.

Fast-forward to late 2021, companies are experiencing project delays, supply chain issues and labor shortages, along with increased pricing for materials and labor. All of that said, the surety market remains quite soft. There is a lot of capacity and some markets remain aggressive. The pandemic is not over;  it’s important for businesses to be nimble and pivot in response to ongoing market changes.

While some things have changed, such as a greater focus on contract terms and increased frequency of virtual meetings, we are still waiting to see if there will be significant losses and, in turn, changes in the way we do business.

Hunter Bendall, Jr. 
Senior Vice President
Marsh McLennan Agency

From worker shortages, to labor rates, to materials or lack thereof, COVID-19 has affected virtually every facet of the construction industry. With that said, the industry was very fortunate to have been deemed essential in most states, and was well equipped to establish processes and procedures to keep jobsites as safe as possible. While we did see some jobsite shutdowns, most were back open within a day or two.

The most difficult piece to manage has been the supply chain. Many items are substantially delayed and some contractors aren’t able to lock in pricing until they ship, which leaves them vulnerable to price increases. This is being managed through price escalation clauses in contracts, but there are many instances where the owner or general contractor will not accept them. Setting clear expectations early and establishing open communication are the keys to success.

The construction industry led the way on PPP funding, taking in 470,000 loans with an average value of $137,000. These funds were helpful in bolstering balance sheets and offsetting losses, when certain industry segments halted or shelved projects.

There is a silver lining in that overall demand for construction services has increased. The challengenow is finding enough qualified contractors and materials. Looking into 2022, most contractors will have a healthy backlog; therefore, the industry can remain cautiously optimistic, without any macro-economic indicators that will lead to a slowdown in the near-term.

What should construction firms do to maintain their credit and reputation with a surety bond underwriter?

Todd A. Feuerman, CPA, CCA MBA
Ellin & Tucker

Managing a surety relationship is no different than managing any other business connection. A construction firm must understand that a surety is financially exposed during the life of the job and therefore has a real interest in the construction firm’s operations and success. It is critical for firms to establish open lines of communication with the surety, especially now, as the industry contends with the pandemic’s ability to shut down a jobsite or a company’s operations overnight. Sureties do not like “bad” surprises, such as job fade issues, litigation or changes in bank financing and personnel. This is important when things are going well, only to have a sudden project challenge present itself with little or no warning.

Sureties are also looking to see how firms handle the impact of a bad project as this may determine whether the business will maintain its bonding relationship or not. While it may be tempting to hide this information from the surety, waiting to address bad news is a mistake. At a minimum, and to maintain integrity with the surety firm, communication should occur on an interim basis. To a greater extent, this should continue once the firm’s CPA completes the final, year-end financial reporting.

The firm must understand that viewing a surety as a business partner, rather than an adversary, can be the difference between a firm finding success in today’s global crisis or wondering what could have been done differently to avoid shuttering its doors for good.

Are there best practices for contractors to maintain and increase bonding capacity?

Michael Ceschini 
Managing Member
Ceschini CPAs

Financial statements play a major role in maintaining and increasing bonding capacity and it is critical that they are in full conformity with the current financial reporting requirements for contractors. Timely interim and year-end financial statements show a company’s commitment to the surety process.

Make sure your company’s financials are strong and present a positive financial picture of your company while always working towards improving cash flow. Sureties are concerned with how well you handle money. Are you collecting receivables? Are you profitable? Do you have adequate liquid assets and working capital? Typically, higher working capital and net worth indicate greater bonding capacity.

The following suggestions can assist a company with presenting its financial statements more favorably to maintain or increase its bonding capacity:

  • Increase cash position by holding payables prior to your financial statement reporting date and paying the week after.
  • Reduce inventories if they are reflected on your balance sheet by converting them to contract billings.
  • Repay officer or affiliate loans receivable.
  • Convert underbillings on contracts to unbilled contacts receivable whenever possible.
  • Do not make loans or advances to employees.
  • Keep equipment off the balance sheet, if possible. Consider using a separate equipment holding company.
  • Eliminate short-term bank borrowings on lines of credit.
  • Pay off notes payable to stockholders or consider subordinating to the bonding company.

Always work with a construction CPA firm that is known to the surety community because they are experts in presenting your financial information to facilitate the surety’s evaluation.

Emilio F. Alvarez
Managing Partner Audit Division

I have had a front-row seat from which to observe the operations of many contractors during more than  40 years as a “construction CPA.” I have seen tremendous success stories and I have seen some failures. Overall, I have concluded that there is, without any doubt, a set of best practices for contractors to maintain and increase bonding capacity.

We often hear that the road to surety capacity is paved with good decisions. I totally agree with that notion. The contractors that enjoy excellent surety programs all have characteristics in common:

  • Giving passionate attention to liquidity and proper cash flow management.
  • Providing timely, accurate and unsolicited financial reporting to the surety.
  • Maintaining cost-to-complete and cash flow projections, analyzed and compared to actual monthly.
  • Understanding and managing all areas of risk (legal, financial, etc.) in the enterprise.
  • Being transparent with their surety partners; consulting with them ante facto on major corporate and contractual decisions while adhering to a policy of full disclosure.

A payment and performance bond is a financial guarantee that is generally unsecured and risky. Contractors are well advised to cooperate with their surety partners in making a positive decision possible.

One final note: The best practices cited above should be maintained at all times regardless of abundance or scarcity of surety capacity in the marketplace.

What should contractors be aware of when hiring subcontractors in a post-pandemic economy?

Brock Masterson
Surety Director - National Engineering and Construction Accounts
Chubb Surety

Buoyed by business reopenings around the country, public and private entities have released a wave of construction projects that have accumulated during the economic uncertainty of the past 18 months. This has been a welcome event for most contractors. However, there is growing concern surrounding the ability of subcontractors to manage the multitude of new projects that could break ground simultaneously. General contractors should take special care to evaluate their subcontractors to ensure that projects will be completed on time and on budget.

Unfilled construction jobs have remained near 10-year highs throughout 2021 despite industry unemployment of 4.6%. Has the general contractor confirmed that the subcontractor has dedicated project leadership available to support the project? Is field labor available? Who is contractually responsible for any increase in costs?

Construction input costs have increased 26% in the past year and pandemic-related factory shutdowns continue to impact the availability of materials. Has the general contractor confirmed the purchase orders for materials and equipment? Has the supplier provided a firm delivery date? Who is contractually responsible for any delay in material delivery or increased cost?

Paycheck Protection Program loans provided by the U.S. Small Business Administration offered needed liquidity for subcontractors during the pandemic. Without additional financial support, does the subcontractor have the cash and bank facilities to support the payment cycle for all ongoing projects? How often is the general contractor requesting subcontractor financial updates?

Maintaining greater transparency with subcontractors on these topics could mitigate many unique challenges before they impact project success.

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

Joseph Sforzo 
Founder & CEO

Over the past decade, the surety industry has been trending toward electronic surety bonding at an ordinary pace. COVID-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. They have seen a proliferation of other technology throughout the insurance and financial services sectors with surety bonding technology lagging.

The general services administration 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, the e-signing process must be conducted under one platform and not through email or other mediums that are prone to cyber-attack. The electronic signatures on each bond must be unalterable and contain a full audit trail with a certificate of completion.

The impact of COVID-19 on the traditional paper surety bond process has resulted in many government agencies arriving 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-19 world.

What are some key benchmarking ratios sureties use when evaluating contractors?

Robert Murray
Head of Surety
Zurich North America

Early in my underwriting career, I was told of a minimum working capital-to-backlog ratio that needed to be achieved for a surety risk to be acceptable. Armed with that insight, I reviewed my entire portfolio only to learn that if I applied the rule blindly, I would have had no bondable accounts! At that point, I realized that effective ratio analysis in surety underwriting needs to consider the nature of the contractor’s business, the type of contracts and risks being contemplated and the management controls in place to have the proper context for interpreting the ratios. 

To varying degrees, underwriters will consider a contractor’s current ratio, cash position, capitalization, debt structure and profitability. These measures and ratios are considered both in absolute terms and relative to the contractor’s backlog. Experienced underwriting teams are also able to provide a contractor with insight into these ratios with benchmarking to a meaningful peer group. This sort of comparison helps both the contractor and underwriter identify areas for further consideration in assessing risk and supporting the contractor’s continued success.

Jason Dettbarn
Vice President Contract Underwriting
Merchants Bonding Company

Sureties use a number of benchmarking ratios when evaluating construction companies. Three of the most common ratios analyzed by sureties are liquidity ratios, leverage ratios and profitability ratios. The primary liquidity ratio is the current ratio. Current ratio is simply current assets/current liabilities and measures a company’s ability to pay off short-term liabilities with current assets. The key leverage ratio used by sureties is the debt-to-equity ratio. Debt-to-equity ratio is total liabilities/equity. Finally, the most important profitability ratios are operating margin ratio and return on equity. Operating margin ratio is operating income/sales, and return on equity is net income/equity. These ratios are examples of standard ratios surety companies use to evaluate construction clients but there are numerous other financial ratios sureties can use to evaluate their clients. A good surety partner will use these tools combined with common sense and the willingness to consider the contractor's individual merits. Rather than be forced to inject funds due to inflexible ratios, a contractor should look for a surety partner with common sense flexibility.

Henry W. Nozko, Jr.
ACSTAR Insurance Company

The truth may be that sureties do not really have absolute benchmark ratios etched in stone that they rigidly follow when evaluating current or prospective contractor clients.
For instance, if a contractor runs into a bad job that throws balance sheet ratios into an unacceptable range, under a long-term relationship the surety will usually continue to extend surety credit while the contractor’s balance sheet slowly rehabilitates to acceptable levels. Like all other businesses, sureties are always trying to grow their customer base. To win a new client, a surety may stretch its underwriting benchmarks to approve a prospective contractor that may fall short on certain ratios.  
In reality, there are probably no specific surety industry underwriting benchmarks strictly adapted by every surety. However, to have a realistic expectation of obtaining surety credit, a contractor will likely need to stay clear of and avoid bankruptcies, tax liens, judgments and low credit scores. Sometimes even one of these could significantly diminish or even preclude a contractor’s ability to achieve surety credit.  Truthfulness and credibility are also crucial. An undisclosed problem usually sends a surety to the exit door. A contractor that has a good performance record and extensive experience will probably find surety support even if their ratios are on the wobbly side.

What should a construction firm take into consideration when signing a lien waiver?

Shoshana Rothman 
Smith, Currie & Hancock LLP

Whether the waiver provides for a “conditional” release or an “unconditional” release is critical. The difference may have severe consequences to payment and claims. With a conditional lien waiver, the release of claims only takes effect after the contractor receives payment. If an owner requires an unconditional release, all claims are waived when the contractor provides the lien waiver, even if payment has not yet been made. Worse yet, if an unconditional release is given and the owner never pays the contractor, the contractor still releases the owner from all liability. Contractors should also note any dates on the lien waiver. Lien waivers often waive claims for work through a certain date, but if the work is ongoing, or there are outstanding, unresolved change orders, a contractor may inadvertently waive claims to that work. It is imperative for the contractor to preserve unresolved claims, or risk forever waiving them by the release. One way to preserve claims is to physically write on the lien waiver form the specific claims or ongoing work the contractor does not intend to release. Another way is to send contemporaneous correspondence (i.e., an email) stating the contractor does not release its outstanding claims. Ideally, contractors will only sign a lien waiver for amounts received, and clarify the release does not waive outstanding claims.

How can contractors safeguard themselves against material price volatility and labor shortages?

Tim Mikolajewski
Liberty Mutual Surety

One of the best ways contractors can protect themselves against these issues as well as supply chain disruption is to consult with their surety. Sureties, especially larger ones, have significant experience helping contractors with these challenges. For example, in order to manage potential price escalation risks, contractors should identify which materials are volatile and discuss those with their general contractors or owners during the bidding process. As much as possible, contractors and subcontractors should also make sure the bid documents don’t put them on hook for price increases with no chance at adjustments down the line. If that language isn’t included in the bid documents, they should push for contingencies to allow for price escalation. Contractors should seek advice now because, as the economy grows and if the infrastructure package passes, these issues may become even more significant, which could impact their bottom line.

When should a general contractor require a subcontractor to be bonded?

Kevin McCann 
Vice President/Chief Contract Officer - Surety Division
Philadelphia Insurance Companies

The surety marketplace wants subcontractors on projects to be bonded back to the general contractor when possible. However, “bond-backs” of subcontractors are not always possible. Many general contractors  have policies in place requiring subcontractors to secure bonds on projects. These situations usually come with either minimal thresholds (i.e., subcontractors over a certain dollar amount) or new relationships to the general contractor. Sureties review the bond-back of the subcontractors on a case-by-case basis and in some cases accept that certain subcontractor trades (specialty or smaller) simply do not have bond programs in place to satisfy the general contractor  requirement. But a general contractor may view that a particular subcontractor trade on a project is of a specialty nature—and thus more difficult to replace—and will therefore require a bond regardless of the price of the subcontractor’s work required. Some general contractors have very good working relationships with their various subcontractors and have several companies in each discipline that they provide work to. This is a healthy and smart way of doing business as it avoids the “all eggs in one basket” syndrome. Good general contractors know which subcontractors they can work with and at which levels those subcontractors thrive .

Jim H. Kawiecki
President, Surety
The Hanover Insurance Group, Inc.

Generally speaking, it is sound risk management for general contractors to bond their subcontractors. This helps preserve their margins and protects them against claims from third parties.

By requiring bid bonds from their subcontractors, general contractors can guard themselves against increased costs that may be incurred if a subcontractor does not enter the contract. At the same time, it provides assurance the subcontractor was prequalified by a surety underwriter, ensuring they have the experience and financial wherewithal to complete the project.

Subcontractor performance and payment bonds not only provide assurance the subcontractor will complete the project according to the contract terms, but also that all bills for labor and materials incurred by the subcontractor will be paid.

There are several factors that should be considered when deciding whether to bond a subcontractor. For example, the size and importance of the subcontract; the size of the bid spread between a subcontractor and other bidders; and the past work experiences, financial strength and payment history of a subcontractor can all play a role. At the same time, the availability of replacement subcontractors in the event of a default; any specialty materials or equipment within a subcontractor’s scope; any aggregation exposure to a subcontractor; and a general contractor’s previous experience with a subcontractor can also come into play.

Contractors also can leverage the knowledge of carriers and agencies that are deeply experienced in the intricacies of construction surety bonding.


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