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Big PICTURE INFRASTRUCTURE SPENDING

Big PICTURE INFRASTRUCTURE SPENDING

Big PICTURE INFRASTRUCTURE SPENDING
July 29
09:31 2022

THE BIG PICTURE

What infrastructure spending means for surety producers

 Surety agents can look to middle-market construction companies as an opportunity.
Not only might there be a shorter line of agents calling on them … but they also may be growing

By Dan Pope


The 2021 Infrastructure Investment and Jobs Act (IIJA) provides $1.2 trillion in federal spending over five years. Since construction spending relies heavily on surety bonds, and surety bonds are often provided through independent agents and brokers, this represents a business opportunity. That’s why it’s important to understand the bill and how it might affect surety bond producers.

According to rating-analyst firm A.M. Best Co., the bill “is expected to result in more business opportunities for surety companies given the new and sizable investments that the transportation and energy sectors will see.” Best revised its market segment outlook on the U.S. surety segment to stable from negative in late 2021 after the bill passed.

Best pointed out the bill “includes $550 billion in new spending on infrastructure over the next five years and billions more to promote environmental and social investments, such as clean energy technologies. The infrastructure bill also calls for expanded broadband internet access and other investments to protect against droughts, floods and other weather-related challenges.”

This comes on the heels of a surety bond business “slowdown in premiums as the pandemic led to reduced construction spending during the 2020 recession,” said Best.

So the infrastructure bill boosts the market, but how big and how soon?

Chatter in the surety market heightened expectations for the spending bill in terms of construction activity. The figure of $1.2 trillion doesn’t translate immediately to construction and thus to surety activity. Rather, funding will be released gradually over five years.

The bill delivers federal money through distributions to states and municipalities, which will build and run infrastructure projects. The federal government as of mid-2022 is figuring out how much funding the states will receive; after that, then the states will in turn pass funding on to municipalities for projects. (Notable exceptions are flood control and U.S. Army Corps of Engineers projects, which are handled at a federal level.)

Today, while some projects are being brought to the bid phase at a state level, most funding is still being sorted out and most projects have a ramp-up time before starting.

Bottom line: The spending is coming, but it’s probably lower and slower than market expectations.

A broad definition of infrastructure

An interesting aspect of the infrastructure bill is the broad definition of the term. IIJA goes well beyond projects traditionally thought of as infrastructure.

Here’s a look at the categories of spending in the infrastructure bill, according to international accounting firm EY:

  • Roads, bridges: $110 billion
  • Power grids: $73 billion
  • Railways: $66 billion
  • Broadband internet: $65 billion
  • Drinking water: $55 billion
  • Resilience, climate change: $50 billion
  • Airports, waterways: $42 billion
  • Public transit: $39 billion
  • Environmental spending: $21 billion
  • Transportation safety: $11 billion
  • Electric vehicles: $7.5 billion
  • Electric buses, ferries: $7.5 billion

Preparation phases are a snag

Another significant factor affecting infrastructure construction is the preparation work necessary for projects. Federal spending, while delivered by the U.S. government, is administered by state and municipal agencies, such as state Departments of Transportation. Those state highway departments are impacted by labor shortages and may not be fully staffed to design and get projects out to bid.

Many of those departments have had cutbacks for the last decade or so, and they might not have enough staff to organize their plans and projects at their desired pace. So states might not be ready to be put funding to work on projects right away.

That process of administering spending involves defining projects, creating designs, and developing bid solicitations. More states are using “design build” as the delivery method. That means the state puts out a performance specification and bidders come up with a design solution and construction proposal. Whatever process is used, design and bidding take time.

A.M. Best Company said, “[L]abor pressures could delay expected construction growth, and as a result, the impact of the infrastructure bill could be muted in the near term.” On that point, a 2022 poll taken by construction publication Engineering News-Record revealed that only 10% of construction firms called themselves staffed at optimal levels, while 90% said they were staffed below optimal levels.

Yet another factor is cost inflation in materials. Another Engineering News-Record poll found that 93% of construction firms said that construction materials prices were up year-over-year by anywhere from 10% to 30% or more since January 1, 2022. With the infrastructure bill authorized as the economy went into an inflationary phase, this funding may not go as far as expected when the bill was passed.

Surety producers have opportunity

Independent agents active in the surety business play a vital role for contractors. More construction work increases the need for surety bonds and thus surety bond producers. The phased rollout of funding means there will be a sustained market for surety.

The timeframe of implementation means that contractors who don’t have the experience and profitability in infrastructure work can gain it to capture bids in future years. They can build up their business so they can serve as a contractor or subcontractor on a project going forward.

Surety bond producers have an opportunity to guide construction firms about a financial aspect that sureties consider to be vital: the capitalization of the construction firm. Some construction firms tend to want to take capital out of the company, but it is the firm’s capitalization that plays a large role in its capacity for surety credit. Surety bond producers can remind construction firm leaders that the stronger the firm’s capitalization, the more likely they can get greater surety credit when it comes time to bond their next construction job.

Construction firms can strengthen their capital levels by retaining profit from successful projects, seeking additional capital sources, and keeping federal pandemic Payroll Protection Plan (PPP) funds in the company (rather than distributing them). Tax-mitigation measures taken by construction firms, which can adversely affect surety credit capacity, are another consideration.

In short, producers can counsel construction accounts to build equity using these means in order to be more likely to qualify for greater surety credit to pursue infrastructure projects.

To serve the surety market now, bond producers can look for existing or prospective accounts in growth mode and serve them as they grow. Infrastructure funding, once it arrives at state and local levels, can support that kind of account development.

Surety producers with relationships with road, power, sewer, water and other contractors have the advantage of an existing network. It is difficult for an agent to walk into those industries and be accepted readily. But agents can be encouraged that the landscape where funding will be disbursed is broad. An agent needs to figure out which industries might fit his or her marketing efforts best, not only by industry but by geography.

Another good preparatory step for agents is to talk with surety companies about how their markets, insights and appetites are affected by infrastructure spending. It’s important to ask for local perspective, not just a broad national viewpoint, on the funding. Asking for that knowledge can help an agent know where to turn when they do have a surety risk.

There’s so much more construction funding coming that emerging and middle-market companies have a real chance of getting projects with larger revenue streams. Surety agents can look to middle-market construction companies as an opportunity. Not only might there be a shorter line of agents calling on them compared with large contractors, but they also may be growing.

Another opportunity for surety producers is to meet with surety underwriters to cover how accounts can qualify for greater surety credit, enter into new scopes of work, and/or enter a new geographic area. Most surety underwriters would welcome the opportunity to meet with bond producers and construction firms to discuss how to take advantage of the forthcoming infrastructure funding. Sureties are eager to see and hear about contractors’ business plans in this infrastructure bill era.

It’s up to the agent to bring the contractor to the table with the surety. All three parties must consider what works for everyone. With infrastructure funding, sureties and contractors will need good surety agents to work with them.

 

The author

Dan Pope is senior vice president of underwriting for Old Republic Surety. Old Republic Surety, part of Old Republic Insurance Group, ranks among the top 25 largest surety firms in the U.S. by A.M. Best Co., based on 2020 direct premiums written. For information, visit www.orsurety.com.

 

 

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Jim Brooks

Jim Brooks

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