Written by: Lynne Cook, Senior Vice President of Surety
Do we really know where the Mid Atlantic construction market will be by year end 2014? The more I read about it, the more I doubt anyone really knows. However, I can tell you what the surety executives are saying and offer a few observations that may help you make wiser business decisions as respects your surety program and risk management…
It appears the economy is improving slowly and the fact we have a budget for the first time in many years should help the situation.
But I offer a few caveats:
- Construction spending is still less than in 2007.
- This region will continue to feel the impact of federal budget cuts.
- Margins are still thin.
- Payments from owners/general contractors are slower. If the old norm was 45-60 days, the new normal is 90-120 days.
The Surety and Fidelity Association of America’s results for the last six quarters have shown a steady increase in the loss ratio, but with overall acceptable results from a return on capital perspective. Claim activity is definitely up for the same period and continues on that trend. Historical data tells us that construction firms are three times as likely to fail during the economic recovery versus on the way down, so the expectation is that loss trends will continue upward. Some Sureties have reassessed prior year reserves and accounted for a repayment which has a positive affect on loss ratios. A number of the regional Sureties have experienced significant loss ratio increases, but the long anticipated slaughter of the industry has not occurred.
The surety executives I have spoken with are still cautious and attribute the better than expected results to underwriting discipline. A reasonable person would expect the surety companies to maintain this discipline. Sureties have maintained their basic underwriting; the three C’s; Capital, Capacity and Character.
There is a noticeable trend toward “continuous underwriting” as compared to only on an annual or semiannual basis. If your company uses its surety line, it is not unusual for the carrier to expect quarterly and possibly monthly financial statements along with a current work in progress schedule and an aging of accounts receivable in order to stay very current with your capital levels.
Sureties rely upon the quality of your internal accounting and cost controls to make credit decisions so they need credible numbers and reports. While software for cost accounting and the capabilities of your internal accountant are critical, another aspect of information credibility is the relationship between the field and the office and the quality of the information exchange. How frequently are costs updated? Do your folks review the labor and materials budget to actual costs incurred weekly? Do your PM’s understand that they need to bill for at least all costs incurred in particular period? Are your estimators accurately reflecting “overhead burden” in their bidding?
What does your business want to accomplish this year and the next two? Sharing your business plan with your surety for feedback and hopefully concurrence will enhance the confidence in your management and the partnership that underwriters appreciate.
The third “c” character is a bit more subjective. Initially the underwriter relies on the agent’s word and their market intelligence of your reputation as a good and fair business person. However, while your relationship develops, the most effective way to prove yourself to your surety partner is to be honest, conduct open communications, and follow through on commitments. If you agreed to add money to your company, make sure it is done within the allotted timeframe. If you told them you are cutting overhead in order to be more profitable, cut your overhead. You may have heard that Sureties do not like surprises, well, I’d like to reiterate that statement one more time. Sureties do not like surprises!
Underwriters can handle most situations as long as they are expecting it, so if you know a job is going bad; tell your agent and underwriter. If there is a claim situation brewing, warn them about it and be transparent providing all information that is relevant. Former positive experiences with your surety go a long way toward mitigating a situation in the future.
Right now there is a robust market available to small contractors, $10 million in revenue or less. Many of the carriers have embraced underwriting tools such as escrow accounts and collateral to more effectively secure their position and give contractors bonds that may not have been available without the additional security. While these tools can help a company in the short term to get work and hopefully strengthen the financial condition of the company, the surety is looking for the company to develop into a firm for which bonds can be provided without the need for additional security. Working with a professional surety agent, a construction oriented CPA, and having a bank line will enhance your presentation and credibility to a surety while the additional profits will improve the financial situation.
So what can you expect from the surety industry in 2014? Overall, there is plenty of capacity available. Construction companies that are well financed have a reasonable business plan, and the operational experiences to execute the plan have many options available to them. Because Sureties are still concerned the worst is not over yet, in order to make the most of your surety relationship, be prepared for diligent financial analysis and questions concerning your choices. Open communication, current credible financial information, and reasonable expectations, are key elements to creating or maintaining a successful relationship with your surety.