FOCUS ON SURETY
Caution is the watchword in a potentially volatile market
By Lori Widmer
What a difference a few years make. Or not. In 2017, surety experts were cautiously optimistic. The market was holding steady, claims were low, and pricing and capacity were improved. Two years later, Aon’s Surety Market Update 2019 reveals that contract surety was profitable in 2018, with low loss activity and continued premium growth. Large commercial surety capacity was at an all-time high, the report says, with combined ratios coming in well under 70%. For 2019, there appeared to be more of the same. Enter insurers looking to the surety market to offset losses in other business areas. That’s causing rates to continue to decline, says the Willis Towers Watson Insurance Marketplace Realities 2019 Spring Update.
The update suggests that pricing will continue to soften thanks to strong profit-ability in the line and low claims activity.
Where the action isn’t
That means more entrants, more capacity and more pressure on pricing, say the experts. Still, Rick Ciullo, chief operating officer of Hartford Bond, says that, unlike other lines, surety does not seem to be showing signs of hardening. “There doesn’t seem to be any upheaval,” he says. “The thing that brings upheaval in a surety market is where losses begin to bleed into the good environment.”
Yet it’s not happening, he says. The last several years have seen significant growth and profit, which is driving a continued upward trajectory. Why? “It’s an economically sensitive line. We’re in a good economy generally. Also, it’s because so many of the customers are building contractors, general contractors, road builders, bridge builders, and so on. The construction economy has been strong, and as a result, the market has been growing profitably.”
With such a strong market, there is ample capacity, and the market will most likely remain soft, says Matt Leskanic, surety executive with Surety Bond Professionals, Inc. And in the absence of significant claims activity, that soft market appears to be stretching out for quite a while. “Reinsurers have gotten into the game. Those large players need a place to park their capital, and the surety world seems pretty interesting right now.”
What’s more, Leskanic adds, it’s a good niche from a profitability perspective. He’s seen reinsurers starting their own surety operations. “There’s this inflow of capital that wants to pick up new business.”
And the pressure is on. Some of the new entrants in the surety market are “a bit more aggressive because of their need to pick up new business,” Leskanic says. As a result, agents have more options and more flexibility to offer surety customers.
Despite all the capacity, Leskanic says he’s not seen rock-bottom rates or competition so strong as to cause huge fluctuations in the market. “Markets have held their ground, which I think is good.”
New twist on existing products
Surety providers also have become innovative, a word not often associated with the surety market. While there are no truly new products, Ciullo says there are plenty of new uses for existing products. Currently, he says, surety bonds are being used as replacements for letters of credit. Bank credit is not tied up, and the rates may be lower than letter of credit rates.
It’s not an entirely new concept to use surety bonds in unique ways, Ciullo says. “Sometimes when there’s a new use of a product, it picks up steam. That’s been going on for several years. Also, getting back to the U.S. construction market, infrastructure projects have gotten bigger over the last several years. Performance and payment bonds are in a position to respond, meaning there’s enough capacity in the market to satisfy surety needs on large infrastructure projects. In private finance work, surety bonds are being used to guarantee the contractor’s performance.”
It’s a great time for agents and brokers, says Leskanic, because the innovation drives business for everyone. “Sureties are rolling up their sleeves. They realize there are a lot of options, so they’re trying to provide the best products and services to agents.”
Leskanic says some of the programs offered are for those who don’t have high credit scores, and other options are available for smaller contractors that make it easier for them to get coverage.
In such a profitable market, it’s tough even for the experts to exhale. According to Leskanic, “Larger losses will occur, particularly where some of the sureties have gotten too aggressive and extended too much capacity to a contractor that might not deserve it. Eventually the market will tighten, and it will become tougher to get these deals done.”
Until then, everyone in the surety market is riding a long profitable wave. That is, until claims catch up with capacity. And claims could arise from almost any use of surety bonds. “Claims are going to arise from financial weakness,” Ciullo says. “Not all financial weakness leads to bankruptcy, however, and claims don’t have to arise just because a project is difficult. Even a difficult project can be muscled through if there’s a skilled contractor and a strong enough financial position.
“Claims can arise not only from a weak project, but also because a contractor might have gotten over its skis relative to its capital,” he adds.
That scenario could become reality sooner than one might assume. Ciullo says the additional competition in the market has put pressure on underwriters to provide bonds that pay out quickly. He points out that, unlike traditional surety bonds, which are conditional obligations, quick-pay bonds allow the obligee to demand payment within a shorter period, such as 10 days. “That creates extra risk,” he says.
Advice for agents and brokers
The time for caution in the surety market is now, says Leskanic. “Especially when times are this good, it makes sense. You want to see growth, but you don’t want to see growth too fast. You want to see smart, prudent growth.”
How can agents and brokers know when growth is heating up too rapidly? Leskanic says to watch the customer’s progress. “Let’s say you have a contractor that did $6 million this year. Trying to do $10 million next year would make sense, but trying to go from $6 million to $20 million might be too big a leap.”
Ciullo says the role of the agent or broker in this market is critical. “What can agents do to help? Be good advisors and ask customers about their plans for growth.” Encourage customer growth, he says, but remind them that new projects should be approached in the context of a strategy.
“Right now, more agents are able to get certain types of bonds, but as the market tightens, it will get tougher,” says Leskanic. He thinks contractors need to be more conservative when considering projects outside their trade area, and he adds that agents can help bring clarity. “Advise your customers not to try to do too much. It’s good to be ambitious, but make sure they don’t have their business going in ten different directions.”
For more information:
Surety Bond Professionals, Inc.
Lori Widmer is a Philadelphia-based writer and editor.