When construction started on the Hoover Dam in 1931, it was one of the largest single construction projects ever undertaken in the United States.
The gravity arch dam across the Colorado River cost $49 million, making it one of the nation’s most expensive and complex construction projects. The Hoover Dam project marked the first time that surety companies pooled their capacity to provide a co-surety bond. Twenty-four surety companies came together to provide a $5 million bond securing the contract. At the time, it was the largest bond ever written.
Eighty years ago, a $5 million bond needed the participation of nearly every surety in the United States, but today, dozens of sureties can routinely write a $5 million bond on their own. Over the years, the surety marketplace has seen significant changes—the rate of change and capacity requirements are higher today than ever before.
Since the 1930s, the construction marketplace and the surety marketplace have evolved, with projects growing larger and more complex and the surety requirements growing in parallel. It may be astonishing to some that a bond that required the mobilization of virtually the entire surety industry now falls within the delegated authority of many brokers and agents. For those who have been in the industry for many years, it is more astonishing to see how the market has evolved. Project delivery methods that went from hard bid, fixed priced contracts to design-build are now being bundled as public-private partnerships (P3s).
Projects that just a few years ago topped out at $500 million are now pushing into the billions. The Tappen Zee Bridge replacement project in New York is just one example. First built in the 1950s for $81 million, the new contract for the replacement span currently being built is more than $3 billion.
Twenty years ago, when design-build contracts were becoming more mainstream, the surety industry began debating: How could surety cover design-build risks? Did the underwriters understand the “new” risks they were assuming? At the time, quite a few companies refused to bond design-build contracts. Today, that debate is being replayed with more frequency as owners use new project delivery methods. Traditional hard bid work is being supplanted every day by more complex and challenging delivery methods, such as integrated project delivery (IPD), gap financing and P3s. IPD, an approach based on risk sharing and collaboration, presents challenges to the contractor, owner and surety.
In a risk-sharing approach, where do the traditional bonded risks end and the shared risks begin? While there is no clear answer, sureties are working closely with both contractors and owners on solutions.
In its 2015 Infrastructure Report Card, the American Society of Civil Engineers estimates an annual infrastructure funding gap of $201 billion. The gap arises from the need for continued investment in infrastructure and the lack of federal, state and local funding. P3s are viewed as a way to fund this gap. P3s mobilize private funds—from investors, pension funds and banks—to finance projects that were once funded by the government with tax revenue. The introduction of P3s to the marketplace changes the nature of the owner-contractor relationship. Traditionally a government entity was the project owner, but in a P3, a concessionaire is the owner.
The relationships among the different stakeholders in a P3 project are more numerous and complex than in a traditional project. The concessionaire, the contractor, the banks, the rating agencies and the government all have a financial or public policy interest in the success of a P3. This elicits a new set of challenges for the surety providing performance security for the contractor.
The surety industry has responded by creating innovations targeted at satisfying the needs of the various stakeholders. Traditional performance bonds have been modified to provide short-term liquidity to a P3 project in the event of default. For example, a recent P3 project was bonded using a performance bond with a fixed claims period. As a result, all parties knew when a claims determination was going to be finalized. Although the debate continues on the “right” approach to bonding P3 projects, sureties are not waiting on the sidelines. They are out there innovating.
With regard to capacity, the surety market continues to demonstrate appetite for larger facilities and projects. Just a few years ago, conventional wisdom was that $500 million was the largest surety bond available for a single project—and that required multiple sureties. In the past few years, new capacity has entered the surety market with an eye toward providing surety to mega-projects and the largest contractors. At a time when the costs of construction projects are increasing, surety capacity is keeping pace. Today, surety companies are routinely seeing performance and payment bonds exceed $1 billion. Surety companies are getting these bond deals done a few times a year without fanfare or press. While there clearly is still a limit to surety capacity, the industry is responding with more willingness to provide multi-billion-dollar facilities to companies with the financial strength and capacity to deliver.
While the surety market has evolved since the days of the Hoover Dam, many aspects remain the same. The industry continues to rely on the traditional three “Cs” of character, capacity and capital in underwriting risks, whether it is for a $10 million road builder or a $10 billion multinational engineering company. On the foundation of more than 100 years of industry experience, the surety industry has and will continue to innovate and adapt to the changing needs of customers and the marketplace.
Looking beyond the horizon, more challenges will impact how surety operates: technology, new construction methods and the globalization of the construction industry, to name a few. Sureties are working closely with customers so they can continue to be a relevant and trusted partner in the construction marketplace of tomorrow.