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The middle to late 1990s
were boom years for both construction and surety bond companies.
Through the decade, there were basically no rate increases in surety
bonds.
"It was primarily
because of the competition among surety companies," says Marla
McIntyre, executive director of the Surety Information Office in
Washington, DC. "Surety companies wanted to write bonds. Surety
was very profitable in the 1990s." In some cases, surety companies
relaxed underwriting standards and wrote business they might not
have written in tighter times.
Now, in a tighter economy,
all that has changed. Surety industry losses in 2001 jumped to $2.75
billion–up from $1.55 billion in 2000, says the Surety Association
of America. In 2001, the ratio of losses to surety premium incurred
nearly doubled, from 45.4% to 82.5%. (The numbers include both members
and nonmembers of the association.) "The industry had record
losses in 2001," says Gary Woodward, bond manager for Acordia,
a Bloomington, MN, surety bond agent.
Reinsurance Increases
Surety companies insure
against various levels of bond loss obligations through reinsurance
companies. Due to large losses sustained over the last few years,
reinsurers are now raising the rates they charge surety bond companies,
says Michael Holmes, vice president of surety for Brown & Brown
Bonds, a Ft. Lauderdale, FL, surety bond agent. "So the surety
companies are paying more for their reinsurance and getting less
for it. The reinsurance industry is trying to recoup its losses.
So the surety companies have to pass those increases on down."
Part of the problem,
explains Woodward, is that bonding companies were guaranteeing Enron's
performance. "When Enron went out of business, they were bonded
to the extent of $1.5 billion, roughly. So that resulted in claims
of $1 billion to $2 billion." In addition, he says contractor
defaults, or surety claims, have been on the rise. Some bonding
companies have been liquidated or sold to other firms.
Rate Increases
The cost of a performance
bond is a one-time premium, and typically it ranges from 0.5% to
3% of the contract amount, depending on the size and type of the
project and the contractor's bonding capacity. Often there
is no charge for the bid bond, and the payment bond may be issued
at no additional charge when issued in connection with a performance
bond.
As a result of their
losses and higher reinsurance rates, surety bond companies are raising
their rates and reducing their capacity (the dollar amount of bonds
they can write), reports Woodward. And in many cases, surety bond
companies are tightening underwriting standards (see sidebar on
this page).
"We are seeing rates
increasing across the board by 10% to 30%," states Woodward.
"The increase depends on the bonding company and what experience
they've had in the past year or so."
Adds Holmes, "Since
January 1, 2002, most of [the surety companies] have raised rates
by 10% to 30% on a performance and payment bond."
A Contractor's
Experience
At Jack L. Massie Contractor
Inc. in Williamsburg, VA, surety premiums have risen by 12% in recent
months, notes Gary Massie, a vice president with the firm. "I
hadn't had any bond increases since 1986, and there was a decrease
in rates in 1993."
Massie does road building,
site work, and utility construction, all within a 40-mi. radius
of Williamsburg. The firm does all of its own grading, utility,
and erosion control work, and sometimes it subcontracts for concrete
work. "We like to program 7% growth annually," he says.
He adds that bond prequalification
standards have not gotten any tougher for the firm. "We meet
with our bond broker for business meetings at least twice a year
and numerous times socially. We review our account once a year.
We maintain a relationship with both the broker and the underwriter.
We try to tell them everything we're doing with respect to
our personnel."
The bond broker and the
surety firm monitor 11 top employees at Massie–everyone from
the head estimator upward. "Those are the key people, and we
want them to know how we're staffed," says Massie. "We
talk about our market area and how we're doing."
Massie points out that
while his company's construction volume has averaged about
7% annual growth over the past three years, the firm's bonding
capacity has risen by 10% a year over the same time. "As our
balance sheet has improved, our bonding capacity has increased,"
he reports. "We've got excess bonding capacity, and we
just need to put it to work."
Having a relationship
with the firm's surety bond company and broker helps the company
in several ways, Massie says. "They take a hard look at the
company and make us take a hard look at the company to make sure
we're doing things correctly and profitably. We talk about
our assets and the condition of our assets. And we talk about long-term
strategies that we have and any different markets that we might
enter."
Being bonded distinguishes
a contractor from the competitors who might not be able to get a
bond, observes Massie. He says the firm lets private-sector customers
know that the Massie firm can offer the guarantee of a surety bond
for a nominal cost. "My rate for my performance bond is usually
a little less than the competition's, so that tells my customer
that I'm probably a little stronger financially and that I
can perform for him. We can provide a performance and a payment
bond for less than the competition, and that saves our customer
money."
No Increases Yet
Rate increases for bonding
had not yet reached some firms at the time of this writing. In fact,
three heavy-construction contractors interviewed had not yet experienced
any recent rate increases for surety bonding: E.L. Yeager Construction
Company in Riverside, CA; Gulf Atlantic Constructors Inc. in Pensacola,
FL; and Fred Weber Inc. in Maryland Heights, MO, a suburb of St.
Louis. "If a firm is a currently sound, well-managed contractor,
they should have no trouble getting a bond," says McIntyre
of the Surety Information Office. "And if the contractor has
a good relationship with a surety bond producer [broker] and surety
company, they should have no difficulty getting a bond."
At Yeager, bonding capacity
has not increased or decreased, reports Michele McGrath, chief financial
officer. Yeager is a large contractor; revenue in 2000 reached $190
million. "What we've been producing has not given [surety
firms] any cause for concern," says McGrath. "The bonding
limit they've got us on is extremely high, and we haven't
come close to it.
"We're running
at about two-thirds of our bonding capacity, so that leaves us room
to contemplate some of these large projects. There's a lot
of infrastructure work here in southern California–projects
ranging from $50 million to $400 million–and we're actively
bidding a lot of public work." Yeager builds heavy/highway
projects and interchanges and does some residential grading work.
Speaking for Gulf Atlantic,
Controller Roger Slorahn says, "We've got a very strong
reputation and a very strong balance sheet, and so far we haven't
seen any tightening of bond prequalifications." Gulf's
rate for a bond is about 0.4% for a project up to $5 million, and
the percentage decreases for costlier projects. Gulf Atlantic's
annual volume of construction runs between $12 million and $15 million.
Dale Hoette, chief financial
officer for Fred Weber Inc., says the firm's bonding capacity
has kept pace with its growth rate–27% per year for the past
three to four years. Hoette says the firm has not experienced any
change in prequalifications required to get a bond. Weber's
average dollar volume of construction placed for the past five years
is $156 million.
Trouble With Start-Ups
Meanwhile, Woodward,
the broker with Acordia, says surety companies in recent months
have turned down at least half a dozen of his bond applicants. The
reasons are unprofitable operations and, in some cases, start-up
companies. "We are having a problem getting start-up companies
bonded," relates Woodward.
"Producers are hearing
the word ‘No' more often," says Holmes. "Surety
companies are tightening up quickly and rapidly–within the
past six months."
Woodward notes two prequalification
ratios that get a hard look from surety companies these days are
(1) the ratio of work program, or backlog, to net worth and (2)
the ratio of work program to working capital. "Those ratios
are getting more conservative," he reports. Underwriters like
to see both of those ratios reach about 10%; anything less than
5% on either ratio is riskier business.
A good surety broker
can help a contractor in a number of ways, Woodward points out:
- "We try to assist
in providing our clients with quality CPAs to work with.
- "We get better
accounting systems in place, thereby improving cost control.
- "We review contracts
for onerous language.
- "We provide a
control feature on their work program to keep contractors from
becoming overextended. We don't want them to take on more
work than they can manage.
- "We can review
their subcontractors to determine any poor-quality operators.
- "We assist them
in finding quality new employees. If they need a controller or
financial person, we may know of one."
And would those services
cost a contractor more? "We would not charge anything other
than a premium for the bond," assures Woodward.
Author Dan Brown is
the owner of TechniComm, a communications business based in Des
Plaines, IL.
GEC
- November/December 2002
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