What affects a contractor’s ability to increase bonding capacity?

David Zabel
Associate Vice President, Surety Home Office Underwriting
IAT Surety, a division of IAT Insurance Group

As materials prices continue to rise and the competitiveness for labor creates an increase in wages, the size of a bid or final contract is naturally going to go up. That increase in contract price is going to require a greater bonding program from the contractor’s surety. First and foremost to increase that capacity, an open line of communication between the contractor’s broker and surety is key. Bonding companies respond the quickest and most favorably when there are no surprises. Predictability helps underwriters plan for their clients’ bond programs and what they will need to have in place to support their contractor clients’ business plans. Undisclosed changes to the financial condition, ownership moves, new scopes of work or branching out to new territories (to name a few) give the bonding company pause when being asked to increase surety support. Second, a well-thought-out business plan and path to execution helps increase a contractor’s surety credit. When bonding companies can buy into their clients’ plans and be a part of the success, they are more comfortable extending surety credit. Finally, it’s been said many times in the underwriting world that retaining or increasing Capital in the company and having an upstanding reputation (Character) in the community will help increase the Capacity a surety will provide.

Brock Masterson
Senior Vice President and National Engineering & Construction Director
Chubb
chubb.com

In the current inflationary environment, construction contract values continue to rise. The Producer Price Index for New Nonresidential Building Construction has risen over 19% during 2022 due to, among other things, the rising cost of materials and the scarcity of labor.* As contract values continue to increase, so do the surety needs of contractors. With a sound strategic vision, operational expertise and adequate financial support, contractors can better position themselves to secure bonding capacity to meet their business needs.

Contractors should engage in regular communication with their surety and producer to apprise them of performance under existing contracts and to discuss future opportunities. If contract sizes and backlog increase materially, additional care should be taken to explain how critical risks will be managed. Particular attention should be given to explain how projects will cash-flow and how subcontractors, labor and materials will be procured. Ensuring adequate profit margins, along with contingencies for inflation and supply-chain disruptions, is also important.

As contractor backlogs increase, it is common to see increased stress on the balance sheet. Financially, contractors should ensure that they have the necessary liquidity—both through cash on hand and available credit facilities—to manage the requested workload. Contractors should understand the billing terms of their contracts and the timing of payments to ensure that new work will not cause a financial strain on company operations. With appropriate planning and preparation, contractors can better position themselves to secure the necessary surety capacity to help realize their business goals.

Brenda Faust
Assistant Vice President, Contract Surety
Philadelphia Insurance Companies

When it comes to increasing bonding capacity, there are actions that can be taken to positively increase surety credit and actions to avoid. Surety credit is extended at two levels. The first includes a single limit of credit as to specific bond size for individual jobs. The second includes a program limit of support of the aggregate amount of work to be completed, often known as the contractor’s backlog.

Many aspects of surety relate to the “three Cs”—Capacity, Capital and Character.

There are a few things a contractor can do to increase surety Capacity. One is successfully completing construction projects with good margins and retaining the profits, thus increasing capital. Another is having good management skills and reporting systems. Having the right crews, equipment, subcontractors and suppliers exemplifies a good track record of capacity and proves the contractor’s know-how with talent management and relationships. Having reliable in-house reports can show that the contractor has command of their financials and proven success. Good credit from other sources, such as an adequate bank line, is also critical. A contractor should provide to their surety a full indemnity package with proven financial resources from each indemnitor.

The next “C” is Capital. We’ve all heard the phrase “cash is king.” Contractors should ensure they have good liquidity and are maintaining a positive cash flow.

The assessment of the last “C,” Character, results from ongoing dealings as a fair and honest partner. Character is proven over time and takes into account the contractor’s direct meetings and reference checks from others like project owners and other creditors.
There are also actions that contractors should avoid when seeking an increase in capacity. These include requesting bond support on projects that deviate from their historic type or locations, losing key people in the organization or anything that negatively impacts their financials.

How can contractors protect themselves from surety bond fraud?

Joseph Sforzo
Chief Operating Officer
Surety2000

There are multiple instances where an insurance agent or even a surety has fraudulently issued bonds to a contractor without their knowledge. Unfortunately, these fraudulent bonds do exist, negating the security the bond is designed to provide. Owner obligees, general contractors, subcontractors and suppliers may all face significant financial consequences if a fraudulent bond is uncovered after an issue arises.

An ebonding solution can help contractors—and everyone else in the chain—protect themselves against fraud. Ebonding platforms such as Surety2000 can provide a unique bond number and digital staple associated with each bond as well as a power of attorney preventing a fraudulent execution of the bond, verification of the surety's authenticity, verification that the insurance agent has the authority to execute the bond on behalf of the surety company being used to execute the bond secure, digital signatures from all parties and collaborative communication to all parties to the bond upon execution of the document.

What ratios and benchmarks does a surety use to evaluate financial health?

Stephen Ruschak
Executive Vice President, Surety
Arch Insurance

Sureties look at many different financial ratios and benchmarks when considering bonding support for construction firms. Surety underwriters are most concerned about whether the contractor is able to positively cash-flow its projects and ultimately earn an attractive profit margin that can strengthen the balance sheet. In periods of economic downturns like we seem to be heading toward in 2023, the emphasis on working capital, profitably completing projects and strategically acquiring new work will be more pronounced than ever.

Working capital, or current assets less current liabilities, are the financial resources available to a contractor to cash-flow its projects and pay its overhead. Current assets include accounts receivables, and so the ability to convert AR into cash is critical. Underwriters are also concerned with underbillings, which are classified as work performed but not yet billed or paid by the owner or general contractor. While firms believe that they will be compensated for work performed under the contract, it is never completely guaranteed until the check clears. Conversely, overbillings or work billed but not yet performed increase a surety's exposure, since contract balances have been reduced without the corresponding scope of work completed.

Underwriters want to support contractors that can successfully complete bonded obligations, including timely closing out projects. The longer it takes to close jobs and collect retainage, the more likely there will be profit fade. Bidding on difficult projects and working for tough owners can also hinder the ability to close out jobs. This all negatively affects working capital and net worth, which underwriters compare to the overall bonded work program extended to the contractor. Reductions in those benchmarks can lead to a surety reducing the bond line or even exiting from the account if the deterioration is significant.

What are the most common reasons why contractors default and what are the surety’s options?

Shawn Kelly
Director, Surety Claims
Nationwide Surety

The specific reasons why a contractor may be declared in default of its contractual obligations are as diverse as the type of projects found in the construction industry itself. However, most contractor defaults can generally be classified into one of three main categories: contractor insolvency, non-conforming/defective work and unexcused schedule delays. Each situation will be highly dependent upon the specific facts surrounding each project to which they relate, but most project defaults can be classified into one or more of these three main classifications.

When the bond obligee has complied with the conditions of the bond and made demand upon the surety to perform, the surety can generally select from the following five performance options:

1. In an insolvency situation, finance its bond principal through the completion of the project;

2. Re-bid the remaining scope of work on the project and tender a completing contractor to the obligee. The completing contractor provides a new bond to the obligee to cover its completion scope, while the original surety makes a payment to the obligee for the difference between the completion contractor’s bid and the remaining original contract balance;

3. Takeover the contract and complete the remaining scope of work with a new contractor selected by the surety. The surety usually engages a construction consultant to assist with project completion administration in this scenario;

4. Enter into a monetary settlement with the obligee; or

5. Deny liability based on the legitimate legal defenses of the principal and/or surety.

What are the most common reasons a surety bonding application is denied?

Hank Nozko Jr.
President
ACSTAR Insurance Company

There are lots of reasons why surety applications might be denied. Some may just be the result of an administrative procedure. For example, a surety may require the applicant’s full company name, address and tax ID number and the full name(s), address(es) and Social Security number(s) of the principal(s) in order for the submission to be entered in the surety’s information system. The submission may ultimately be denied simply because of the lack of information.

Declinations may also occur because of poor communication. For example, there may have been a payment claim that was resolved without incident or payment, because it was invalid. Answering o to the question “Have you had any claims?” would be insufficient. The better answer is yes, we have had claims, but such claims were not valid and disposed of without any payment or surety intervention. An incomplete fill-in might get misunderstood or misinterpreted as a misrepresentation, resulting in a denial that might have been avoided. Go overboard on disclosure. Lack of complete information could cause faulty assumptions that could lead to disapproval.

If you have done a complete and accurate presentation in preparing the surety’s application but difficulties disclosed cause a declination, approval might still be achieved with another surety. An insurance agent that specializes in surety and is knowledgeable about the dissimilarities of the surety markets might help you find a home for your surety needs. Some markets that underwrite more difficult situations may undertake intense examination and verification. If your disclosure list is complete and accurate, that will immensely enhance the possibility of finding a surety partner. Openness can be a path to approval.

Why do some owners require surety bonding for private sector projects?

Robert Murray
Head of Surety for Zurich North America
Zurich North America

Private owners often wonder about the cost versus the benefits of requiring bonding from contractors. Simply stated, a bond significantly increases the owner’s probability of having a project completed on time and on budget, and the benefits of bonding far outweigh the costs. Recent studies completed by the global consulting firm EY under the guidance of the Surety & Fidelity Association of America indicate that the prequalification efforts of the bonding companies significantly decrease the likelihood of a contractor defaulting on a project. Further, in the unfortunate event of a contractor default, the same study indicates that post-default costs are considerably less as the sureties have the tools and resources necessary to help complete a project in the most cost-effective manner. This reduces the burden for the owner in resolving the completion issues and is especially important as the pain associated with a contract default can be severe if managed unsuccessfully.

The current economic environment brings with it uncertainties that we have not seen for some time. Inflation, labor shortages, supply-chain disruption, rising interest rates and the possibility of a recession are issues we have previously seen, but the current combination makes the road ahead especially slippery. Private owners wishing to increase the probability of successful project completion would be wise to include bonding as a part of their risk-mitigation strategy.

For reference, the full EY study can be reviewed further on the Surety & Fidelity Association’s website at https://surety.org/suretyprotects/.

What should a contractor consider when selecting a surety?

Jay Farley
Vice President, Claims Manager
Merchants Bonding Company

Contractors face a number of considerations when selecting a surety. But perhaps the most overlooked, yet very important, aspect of the surety relationship is claim service.

When a contractor purchases a bond, the contractor is buying claim services. Indeed, in a claim situation, it’s the claims department, not the agent or underwriter, which becomes the surety representative to investigate the claim and carry out the surety’s obligation under the bond. And due to the three-party nature of the bond agreement, the claims representative becomes the face of the interaction, providing service to the contractor as well as the obligee.

Unfortunately, many contractors only become aware of this reality after the fact, learning it the hard way. Dissatisfaction with claim service, or a perceived “bad” claim experience, can be the reason a contractor leaves a surety. But that situation is avoidable.

With claims, as in all aspects of surety, relationships matter. In addition to claims handling, claims departments typically provide support to underwriters and perform various value-add services for agents and contractors. Regular interaction with the claims team allows the contractor to utilize various legal-support services, navigate performance and payment situations and truly maximize the relationship.

Contractors should partner with a surety whose claims department shares the contractor’s values. This includes not only a common-sense philosophy with respect to claim handling but also a business-minded and pragmatic approach to all matters. As with any trusted relationship, communication and transparency are key and can serve to establish and strengthen the relationship over time and ultimately serve to minimize the risk of loss.

How should contractors approach their plan renewals this year?

Steven D. Davis
Director/Senior Vice President
McGriff Construction Insurance Services

Contractors with upcoming insurance renewals should consider four best practices to assure that they are getting optimal results from the underwriting community. First of all, start the renewal process earlier than normal, about 90+ days in advance. Underwriters are getting to look at multiple accounts due to the current market conditions, and the objective is to allow ample time to sort through options, coverage issues and any required actuarial analysis. Secondly, the underwriting submission should be comprehensive and recommend that the AGC risk profiler be completed, which will allow a deep dive into the construction operations as well as risk management and safety/loss control practices.

Relationships matter in this business and can make a difference when managed well. Think about delivering your renewal jointly and in-person, with key individuals from the construction company.

Lastly, more and more contractors are looking at captive or other risk-financing solutions to better manage their insurance programs. Whether a construction group captive or single-parent facility, contractors do have options to evaluate during the process.