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Complexities of Construction Risks Make Surety Bonds More Crucial

The evolving complexities of risks in the construction industry and commercial markets highlight the growing importance of surety bonds, said a joint study by the Associated General Contractors of America (AGC) and consulting firm FMI.

The survey, entitled “Surety Bonding and Risk Management Forum” polled 83 of the best-in-class construction companies with an aggregate annual volume nearing $ 50 billion, showed that a majority of contractors believe that the current construction risk environment is drastically different than it was five years ago.

The finding is a complete turnaround from previous experience of the construction industry, which for several decades, have not seen a sudden shift of the pace of change and productivity gains like other industries.

Industry players have noticed a rapidly changing landscape in the construction sector from Public Private Partnerships (PPP) to alternative delivery methods, including Integrated Project Delivery (IDP). As new technologies are introduced into the sector, construction projects are becoming more complicated, posing new challenges that are forcing the industry to adapt to the change. But the industry as a whole is not at synch in adapting to the changing times, with some still clinging to what they have been used to, while others have embraced the change.

According to the survey, contractors consider the risk for subcontractor default ranks in the top three risks facing the industry, together with shortage of skilled craft labor and one-sided contract language. Other risk factors identified by those surveyed include: Construction firms are managing risk differently today; Risk management effectiveness varies; and Mitigating and managing risk has become a strategic priority.

To mitigate hazards and to allow contractors to transfer some of the performance or payment guarantee risks, Surety Bonds play a more crucial role than ever, the survey suggested. Contractors are guaranteeing their investors and clients they could complete their projects within the terms of the contract by buying a Surety Bond or Construction bond. A Surety Bond also provides additional protection to owners and increased level of guarantee because sureties are expected to carefully scrutinize a contractors capacity to finish the project as specified in the contract, as well as conduct due diligence on its financial capability.

Failing to do so, means sureties would assume the claims against the bonds posted by the contractor.

Greg Rynerson, CEO and founder of full-service surety bond company Surety Authority, commented on the issue, “To be sure, no contractor can afford to use the same business model he was using five years ago. The market environment has changed and is still changing. You have to adapt your strategy and accept an entirely new playing field, from rebuilding, retooling and refitting.”

Luckily for clients, the surety industry has been at the forefront in recognizing the evolving risk landscape of the construction sector. In response, surety firms, including brokers and insurance firms, have expanded their teams of experts the past several years. Their years of experienced have allowed them to gain more in-depth knowledge of the complex construction risks. In turn, contractors are getting the necessary tools from surety experts that allows them to mitigate the performance and payment risk posed by their projects.

The FMI and AGC study said, “Still, we can cautiously point to a number of positive trends that are taking place. For example, the industry didn’t witness nearly as many surety losses or large contractor failures as expected during the downturn–a sign that contractors, sureties and banks are more conservative in their underwriting approaches. Contractors are exercising more self-discipline, and both sureties and banks are resisting the temptation to let contractors overextend themselves. Recent experience also indicates that the industry is getting more sophisticated:
Leaders are better-educated, think more strategically and, thus, are apt to run their organizations more effectively. However, with the risk of contractor default higher in a recovering economy compared to other economic phases, the industry needs to keep a close eye on the potential for an increase in default claims going forward.”

Rynerson added that looking at surety bonds from a pricing perspective, the surety industry is still a buyer’s market. Since 2007, the price for surety premium is on a downward spiral, to mimic the downturn experienced by the construction space. He added that new entrants in the surety markets are also increasing the amount of capital to the surety line, dwarfing the revenue growth of the space.

Despite all this, Rynerson stressed that Surety Bonds have become more important than ever to guarantee protection that projects are completed by contractors within the specified contract.

“Simply put, construction bonds provide assurance that the project developer will recover any financial losses if the contractor doesn’t complete a contract,” Rynerson said.

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