Since 1998, the surety industry has protected more than $9 trillion in contract and commercial surety exposure, including $600 billion in 2017 alone. The direct premium written increased from $5.9 billion to $6.2 billion in 2017. The industry premium has more than doubled during the past two decades—up from $2.9 billion in 1998.
Approximately $25 billion in losses were paid out, and another $50 billion in loss adjustment, underwriting and general expenses were incurred since 1998. The continuing low loss ratio signals that the adherence to underwriting criteria and prequalification, along with a greater emphasis placed on efficiency regarding expenses, remain strong factors in the industry’s growth.
Big Contractors Do Fail
The collapse of the U.K. construction giant Carillion PLC sent shockwaves through the global markets and prompted an immediate reminder that big contractors can fail.
As a multinational construction company and facilities management provider, Carillion PLC employed 43,000 individuals worldwide and held approximately 450 governmental contracts across the U.K. ministries of education, justice, defense and transportation. The company held operations in Canada, the Middle East and the Caribbean, and was a large construction services provider for the Canadian government.
In 2016, Carillion boasted £5.2 billion (.3 billion) in sales and a market capitalization of nearly £1 billion (.4 billion). The trouble for the company began due to losing money on big contracts and running up massive amounts of debt to offset its losses. Industry analysts argue that Carillion overreached and took on too many risky and unprofitable contracts, while it reportedly faced payment delays from contracts in the Middle East that have now been disputed.
In 2017, Carillion issued three profit warnings within a span of about five months and had to write off more than £1 billion ($1.4 billion) from the value of some of its contracts. In January 2018, the construction giant folded under more than £1.5 billion ($2.1 billion) in outstanding debts, which left U.K. taxpayers, and as many as 30,000 subcontractors and suppliers, to bear the cost of this insolvency. In Canada, four of Carillion’s companies were granted protection from creditors under the Companies’ Creditors Arrangement Act.
Construction is risky business. Research conducted by BizMiner between 2014 and 2016 indicates that 29.3 percent of U.S. contractors fail. That is more than one in four construction companies.
Most companies perform more than one job at a time. It is not uncommon that the loss that causes the collapse of a company is not the job being performed for a public entity, but rather one of its other projects.
The Canadian Centre for Economic Analysis reported that non-bonded construction firms are 10 times more likely to suffer insolvency at any given point in time, making the current situation in the U.K. possible.
Comprehensive Protection
Surety bonds protect not only governments, taxpayers and workers, but also private owners and lenders from unforeseen issues that arise during construction.
Compared to other risk mitigation tools, surety bonds provide additional benefits. For example, a letter of credit may provide financial compensation to a state or local government if a contractor defaults, but in a small amount. It almost never accounts for 100 percent of the project costs.
The biggest issue with using letters of credit or similar tools is that no one is responsible for completing the contract (and paying subcontractors and workers) in the case of default. By contrast, sureties enable the hiring of replacement contractors (or re-rebidding of the contract) and assume responsibility to save projects. Subcontractors can claim directly on the surety.
Sureties pay billions of dollars a year in claims. During the last 15 years, surety companies paid nearly $12 billion to complete construction contracts and pay subcontractors and suppliers what they were owed. These numbers do not include the significant amount of money sureties spent to finance troubled contractors so they could complete contracts and avoid the trouble caused to owners and subcontractors by a default.
In the wake of the Carillion collapse, one thing is certain: Surety bonds from licensed surety companies remain the smartest risk management tool for the construction industry.
Public-private Partnerships
P3s are the collaboration of public entities and private enterprise to design, finance, construct, operate and/or maintain many types of public infrastructure projects. Sectors that have traditionally and successfully employed the P3 project model include transportation, water and wastewater infrastructure, courthouses, prisons, hospitals and schools.
P3s are not merely the private financing of public works. At its core, the P3 arrangement aims to harness private sector technology and its access to capital in order to solve a public infrastructure need. Once delivered, the private entity may then operate the project and attempt to recoup its investment through concessions or fees.
Historically, P3s have been employed to a much greater extent outside the United States. Here in America, P3s are a more recent phenomena compared to conventional public projects financed with public funds. While domestic experience with P3s may be limited, the current level of interest in P3s is high (and growing) at both the state and federal level.
While the P3 arrangement transfers certain construction and financial risk to the private partner, the risk of project delivery still must be properly managed. Delayed infrastructure can critically impair the portion of society that depends on it.
Public entities in the United States understand the importance that surety bonds play in the transfer and management of construction risk. As a result, surety bonds have been required for more than a century to assure contract performance and payment for the nation’s public infrastructure projects.
The Surety & Fidelity Association of America has gathered data from its member surety companies that have underwritten surety bonds on P3s in the United States. A non-exhaustive list includes more than $15.87 billion in bonded P3 projects during the last five years alone.
The decision to require surety bonds is often dictated by legislative mandate; however, individual risk management also impacts bonding strategy. For instance, the state of Virginia does not currently have a P3 law that requires bonding, yet the recently awarded $984 million “Transform 66” P3 project to improve I-66 into an intermodal/multi-modal corridor was bonded, as was $2.1 billion in P3 tunnel upgrade projects in the cites of Portsmouth and Norfolk.
Absent legislative authority, state and local governments may not ordinarily have the power to encumber public property with a private partner’s lease or license, or to commit public funds to repay a private partner. Moreover, existing procurement codes typically address public works projects that involve contracts directly between a public entity and a contractor improving property. Investors also prefer to have clear legal authority to enter into a P3.
Given these factors, states with an interest in obtaining private investment for infrastructure projects have been moving to enact P3 laws in recent years. As the P3 market evolves, the legislatures are recognizing the value of bonding to secure these P3 projects. In the last five years, 20 states have enacted P3 laws and all of them include a bonding component.
