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Focus on surety bonds

Focus on surety bonds

Focus on surety bonds
January 30
09:32 2018

Emerging trends present new opportunities for agents

In the surety bond market, nothing changes, except when it changes.

What was expected to be some serious upheaval in the construction industry post-recession turned out to be a non-event. Instead of an influx of claims from what was predicted to be a rapid acceleration in projects, there was a slow, steady increase in business. The inundation of claims never happened. The industry remained steady.

“Our agents are our first line of defense. If they see their clients’ capacity being stretched beyond their means, it’s important that we partner with the agent to discuss these issues with our mutual client.”

—John Welch
President and Chief Executive Officer
CNA Surety

So did conditions in the surety bond market. An Aon Risk Solutions report shows the market enjoyed profitability over the last ten years that topped the previous 100 combined. Losses expected from the housing bubble bursting didn’t appear, and 2016 construction spending grew by 4.2%.

(Almost) status quo

Within the industry itself, conditions have remained stable. Susan Sallada, president of Universal Service Agency, says 2017 delivered little change in the surety industry, which has resulted in flat or lower pricing. “There is more than adequate capacity in the industry,” she says. “Pricing and capacity on reinsurance renewals have been similar or improved from previous years. There has been little noticeable effect from earlier hurricane claims.” Sallada adds that the outlook for the next 12 to 18 months is steady.

The macro story of surety is strong profitability, according to Rick Ciullo, chief operating officer of Hartford Bond, The Hartford’s surety and fidelity bond practice. That profitability is driving competition. “The industry is on a strong run of profitability; as a result it’s attracting capital from insurance companies that could otherwise put their capital in P-C lines or into investments. Standing alongside those, the surety industry looks pretty good. As you’d expect, it’s driving competition in the usual way: rates, commissions, capacity, even terms of engagement.”

Yet the micro story of surety is that pressures still exist, although the impact is not huge. Steve Kuykendall, surety manager at J.M. Wilson Corporation, believes that although the market may still have some post-recession contraction, “there is still a good supply of bond markets, so bonds can still be written, but they may come with a higher premium and/or more conditions/stipulations. Most brokers and a few of the larger agencies represent several surety markets, so competition remains healthy.”

John Welch, president and chief executive officer of CNA Surety, says market stability, coupled with steady growth since 2008, has attracted more than 40 new entrants into the surety market. He’s seen plenty of smaller sureties enter the market as well as reinsurers, bringing ample capacity. “Some of the larger insurance companies that didn’t participate before got into the market. From a competition standpoint, that’s started to affect us over the last three or four years, but not in the loss results. That’s still pretty healthy.”

Claim drivers

As a result, Welch says, claims are modest. Ciullo says claim results in the construction bond arena are “quite good” and have defied predictions that the market would bear a lot of losses post-recession. “As it turns out, the industry weathered its way through that very well,” he says. “There are losses, but the industry is well prepared to deal with them.”

Yet some emerging issues could affect claims going forward, Ciullo says. In particular, changes to a construction contractor’s business operations often drive claims. Welch agrees. “It’s been the same my whole career: Two of the biggest factors leading to difficulty are firms entering an area of expertise with which they have no familiarity and venturing out of their home territory,” he says.

Another risk that both Welch and Ciullo see: contractors expanding geographically. “Construction is very local,” says Welch. “It’s difficult to go into new geographic territories and beat out the local competition that has some of the best labor, subcontractors, and supplier relationships. This is not to say nobody succeeds; it’s just a bigger driver of loss severity in surety.”

Kuykendall says claim drivers vary with the kind of bond involved. Contract bonds, he says, see claims arise from contractors growing too fast, taking on too large a job, trying to do too much work at once, and having too little working capital. “Claim drivers for commercial bonds include unscrupulous/dishonest insureds, apathy, non-responsiveness, lack of a sense of urgency, insureds taking advantage of their position or what they do, and so on. Agents and brokers need to try to understand and get to know their insureds,” he adds.

Ciullo says commercial bonds see claims stemming from what he calls “tough bond forms—a perfectly solvent customer or principal, but the underwriter has written a bond that leaves it with very few options in the event of trouble,” he says.

Influences from the financial sector may put pressure on the commercial surety market, particularly because surety bonds tend to be underwritten with the principals’ personal credit reports taken into consideration, says Sallada. “With the Equifax situation still unfolding and the future availability of personal credit reports in question, the current underwriting strategies of many sureties may be affected.”

Emerging issues

Another change Sallada sees is that more states are requiring $100,000 wholesale drug license bonds; Mississippi and Iowa are the most recent. What hasn’t changed, however, is how surety handles marijuana. “Most all surety companies still will not write any bond for the marijuana industry because the federal government still considers it an illegal substance,” Sallada says. “At the present time, the principal must use an alternative form of security such as a letter of credit, if they can find a bank willing to issue the required instrument to satisfy the bond requirement.”

Sallada also sees online bond filing as an emerging trend. “It is the decision of the individual states to require bonds to be filed using this platform, and utilization is constantly changing. The process is still in its infancy and is difficult to navigate,” she says.

It’s all part of what Ciullo sees as the changing needs of customers, which he says also are influencing changes to the surety bond itself. After subcontractor default insurance came into vogue, Ciullo says the risk was that the product would replace subcontractor bonds. The product has had some challenges in the last few years, he says, so general contractors are asking for subcontractor bonds much more frequently. “It increases the use of surety bonds, and surety bond underwriters are becoming more flexible in their use of the product.”

Another emerging issue: private financing of major infrastructure. Ciullo says that although it’s still a small percentage of the market, such financing is pushing changes in the bond. “The people involved in the finance aspect often want not just a guarantee like a surety bond, but access to liquidity or a bank letter of credit. The surety industry is evolving its product to be more responsive to the changes in the financing of public infrastructure.”

Welch says that if handled correctly the evolution of such public-private partnerships in government projects could be good for the surety market. Project owners, he says, “want protection that their project will be built, as repayment of project financing is dependent on eventual revenue streams of the completed project. At times partial letters of credit are requested to cover short-term extended financing costs of potentially delayed projects. The surety industry has made great efforts to promote the surety bond product as a more comprehensive mechanism to protect against contractor default. On many projects the two instruments may be used in tandem. This evolving construction delivery method and how surety will complement the process will require a higher level of sophistication on the part of the surety industry,” he says.

Workforce impact

A larger issue, say the experts, is attracting and retaining skilled labor. Ciullo says a shortage of experienced labor and field supervision is having a significant impact on construction, which could affect claims going forward.

Welch says a good portion of the workforce left the industry after the downturn in 2008. The construction industry’s ability to attract both labor and project management will be key to surety companies’ avoiding an uptick in claims. “If the construction market accelerates any more than it has, I don’t know where the industry is going to find the people,” Welch adds.

Sallada says the problem isn’t limited to construction. “Similar to the insurance industry, the surety industry continues to struggle with employees’ lack of expertise. The aging of its experienced workforce and specialization of the industry have contributed to this problem.”

With skilled workers in short supply, Welch says it’s important for agents to stick close to their accounts to better understand how they are managing their labor risk. “Our agents are our first line of defense. If they see their clients’ capacity being stretched beyond their means, it’s important that we partner with the agent to discuss these issues with our mutual client.”

The author

Lori Widmer is a Philadelphia-area freelance writer and editor who specializes in risk management and insurance.


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