surety

COVID-19 and surety market challenges

Surety underwriters must now consider pandemic-related risks
Wednesday, April 7, 2021
by Graham McIntosh

While we are all no doubt extremely tired of hearing the acronym, COVID-19 presents challenges for the surety industry. How contractors respond to those challenges will go a long way to ensure relationships remain healthy, and maximum surety support can be maintained.

On a global basis, the surety market was valued at US$ 16.04 billion in 2019 and is projected to reach US$25.18 billion by 2027. It is expected to grow at a compound annual growth rate of 6.4 per cent during 2020-2027.

While of course much smaller, the Canadian market has also seen, and is expected to see further, growth with results over the past few years indicative.

While the industry remains healthy for the most part, surety underwriters must now consider pandemic-related risks on a backdrop of a recession, the severity and length of which is unknown. These related risks are for the most part outside the contractor’s control. They are difficult to quantify and evaluate. While not limited to, these include labour shortages, supply chain disruptions, reduced productivity due to safety measures, uncertainty over subtrade performance and in some instances, additional uncertainty over the owner’s ability to pay, particularly in the retail and tourism sectors.

Sureties support both single jobs and aggregate work programs that are, often, multiples of net worth. Projects can also run for two years or more. In most instances, the only security held is an indemnity agreement that states, among other things, the indemnitors will make the surety whole in the event of a valid claim under a bond. An interesting credit risk profile.

Surety underwriting is both a science and art. It involves a rigorous evaluation of creditworthiness and the ability of the contractor to perform without incurring a loss and indeed claims under both performance and labour and material bonds. While each surety is unique with respect to underwriting standards and may disfavour one sector of the industry over another due to experience, there are some common underwriting principals.

Many are familiar with the three Cs of underwriting: Capital – does the contractor have the financial wherewithal to carry a project and overall work program to completion? Can the contractor carry multiple holdbacks and absorb losses on a project? Due to many factors including productivity, unforeseen work conditions and subtrades, not all projects make money. Capacity – does the contractor have the experience, management systems, equipment and overall resources in place to successfully complete their backlog? And finally, Character – is the operation run fairly and with integrity? Will the owners and other management identify actual or potential problems and communicate these to the surety?

A fourth C which is related to character is communication. At a minimum, annual meetings, albeit virtual at this time, should be taking place. No underwriter can obtain a satisfactory comfort level with the contractor’s operation and character without them. This is especially true in a stretch situation. Suretys want to set up a programme that will meet the contractor’s needs. The last thing they like are surprises and last-minute requests that are not within normal parameters either with respect to job size, location or scope.

As noted above, while remaining profitable, the industry is tightening, and any contractor can now expect additional new questions and to provide more details. While not limited, these will include:

  • What federal and provincial relief programs have you availed yourself of if any?
  • Is there a COVID-19 strategy and business plan in place? Are there safety protocols in place with respect to both the field and office?
  • Capital levels and contingency plans. Are you reducing overhead, furloughing or laying off employees?
  • Banking relationships, operating facilities, margin requirements and covenants – have these been stressed tested to determine operational parameters and additional funding needs. Assess overall relationship with credit providers.
  • Access to funds to pay for ongoing operations. These could include repatriating funds lent to related entities, shareholder injections etc.
  • Is your construction lawyer reviewing contracts – the performance bond points directly to the terms of the contract?
  • What contractual provisions are there for force majeure and delays related to COVID-19?

Other changes occurring in the market place due to COVID-19 relate to surety bond placement, both at the tender stage and the provision of final bonds. With concern over physical distancing, closed or reduced staffed offices, and general distancing requirements, some owners are opting for electronic or e-bonds. There are several vendors in the market that provide online software solutions and services. The Surety Association of Canada has noted for the process to be effective, the provision of e-bonds must meet several requirements:

  • Integrity of Content: assurances that the document received is the true document executed and the content has not been changed or altered.
  • Secure Access: Restricting the access to the document to those authorized to view and/or download it.
  • Verifiability and Enforceability: All parties are assured the document was executed by the parties identified and that it is enforceable in law.

Having used e-bonds on numerous occasions, the automation of the process provides many benefits including the ease and economy of transmission, reduced chance of errors and instantaneous delivery.

COVID-19 and possible future pandemics present many challenges to the construction community and surety industry. But with challenges comes opportunity. Be prepared, engage with your surety, and embrace technology.

 

Graham McIntosh, senior vice president, construction services group at Aon Risk Solutions.

 

 

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