In the construction industry, few partnerships are as vital as the one between contractors and sureties. A strong surety relationship, especially in a volatile economy, can assure contractors they will have the stable and predictable bonding support necessary to accommodate their business plan.
From the surety’s perspective, the bonding relationship’s strength is based on the underwriting process, during which the contractor’s management, operational capabilities and financial strength are assessed. However, it is equally important for the contractor to perform due diligence on the surety to ensure consistent bonding support.
Every surety has its own business philosophy, financial strength, operations and depth of management, so contractors should work with the surety that is best equipped to meet their long-term needs. The right surety can provide bonding capacity that is considered a competitive advantage, while a poor choice can result in the contractor losing business opportunities and tarnishing its reputation.
According to the Surety and Fidelity Association of America (SFAA), loss ratios in the surety industry increased approximately seven points from 2011 to 2012, largely due to greater claims frequency. In the last three to four construction industry cycles, a period of increased claims typically was followed by a rise in claims severity—meaning larger losses for the surety industry emanating from contractor defaults.
This could lead to some sureties being vulnerable to significant losses now and down the line, which will impact their profitability. Deteriorating financial results may impact a surety’s risk appetite, and in severe cases can lead the surety to insolvency or to exit the business. All of these scenarios can mean lost business opportunities and leave a contractor scrambling for a new surety.
Best Practices and Due Diligence
In addition to reviewing the listings of certified and approved sureties maintained by the U.S. Treasury Department, contractors can assess a surety’s financial strength by reviewing quarterly reports compiled by investor rating agencies, such as Standard & Poor’s, Moody’s and Fitch. A.M. Best Company also provides independent financial strength ratings for insurance companies.
Beyond current results, contractors should consider asking the surety about its track record in terms of profitability and compare this information with data compiled by the SFAA, which publishes quarterly and annual industry results.
In addition to the financial assessment, a contractor should take time to determine how its needs and business philosophy compare to the surety company. Start the operational analysis by determining how long the company has been in the surety business and assessing its commitment to the product line. Among other things, longer tenure demonstrates staying power through down cycles.
Similar to construction companies, successful sureties are run by experienced management teams. The surety should communicate a clear strategy and exhibit a culture that is executed effectively by knowledgeable and dedicated underwriters. The presence of an active training program further demonstrates a commitment to maintain a talented pipeline of professionals to service the surety’s customers.
Understanding the surety’s target market also is important. Is it focused on large general contractors or small subcontractors? Does the surety offer adequate bonding capacity to support a contractor’s business plan? What key factors does the surety use to evaluate the quality of a contractor? Is the surety experienced in working with small business set-asides, LEED requirements and public-private partnerships?104
Finally, ask for references; a professional surety producer can be tremendously valuable in this process. Speak with other organizations that do business with the surety, as well as CPAs and attorneys experienced in working with the construction and surety industries.
Before committing to a partnership, contractors should take the time to fully “underwrite” their surety to help ensure a stronger, mutually beneficial relationship.