Assembling a Professional Advisory Team, Part 1

How Sure Is Your Surety Relationship?

Editor’s Note: This is the first in a three-part series that describes the profile of a successful contracting firm’s professional support team, including the surety agent, insurance agent and CPA. The surety industry is bracing for 2011 losses. Contractors have had some tough times during 2009 and 2010, and the bonding managers and underwriters expect to see some failures as backlogs are exhausted.

With surety losses and an increase in bankruptcies, re-insurers are demanding contract changes with their sureties and insurance carriers. As the sureties experience a tightening re-insurance market with increasing prices, contractors will experience the same with the sureties.

More than a year ago, many predicted 2010 would be almost catastrophic in the surety industry. To the surprise of many industry experts, however, the sureties posted high profits with lower volumes, even while reserving for future claims. Thus far, the recession and its devastating effect on the construction industry have not yet translated into large contractor failures. While many contractors have left the market and most have decreased in revenue volume, the surety industry has not seen the bond claim volume that many expected.

Direct losses for 2010 are expected to be less than 40 percent. A direct loss ratio exceeding 40 percent usually means a net loss after commissions and overhead. During 2000, the surety experienced its highest direct loss ratio since the devastating losses of the mid-80s. In 2001, the direct loss ratio exceeded 50 percent for the first time since 1987 and for only the sixth time since 1960. 

The expectations for the industry include increased bond and insurance rates, stricter limits on bonding capacities, the required return of indemnity agreements in all cases and a premium on accurate and timely job and financial information. In short, the industry has experienced (and will continue to experience) issues with capacity, availability and increased prices (known as CAP).

Secure and lasting relationships with surety companies, bonding and insurance agents and bankers who provide experienced and honest advice will be rewarded. Sureties and bankers will put more faith in information from CPAs with comprehensive industry experience and contractors who have consistently provided timely and accurate financials and work-on-hand information.

In this environment, it is advantageous for contractors to do the following:

• Meet with your agent/broker and discuss the market (and your surety), as well as your individual situation.
• Discuss the need for a backup surety.
• Meet with your CPA to take a critical look at your firm’s trends, financial condition and bondability.
• Prepare a strategic plan of direction to meet your firm’s bonding needs.

That strategic plan should include a review of your needed bonding capacity, current financial condition (as evaluated by the bonding company) and your contractor-specific advisory team. A contractor’s surety agent, legal counsel and CPA should operate at a high level within the industry. The confidence a surety receives from a contractor who chooses a team with profound industry knowledge can translate into expanded bonding capacity, less stringent indemnity and reporting requirements and potentially lower bond rates.

A Word of Caution

Many times, small and mid-market contractors use their property and casualty insurance agent as their surety or bonding agent. Only in rare cases is this agent an expert in the construction surety arena. Best practices (and these economic times should certainly drive contractors to best practices) dictate that the surety agent be a full-time contractor bonding professional. A contractor should ask about credentials such as whether the agent and agency are members of the National Association of Surety Bond Producers (NASBP), as well as local and/or regional NASBP affiliates. Ask the surety bond manager (usually the only person actually working for the surety who a contractor meets) about his or her perception of your bonding agent. The level of respect with which the surety’s bond underwriters view the agent and the agency can be influential in their underwriting. Each contractor should perform due diligence on their advisory team, and this includes the bonding agent.

Construction Business Owner, March 2011