Surfety Rates Head Upward

Nov. 1, 2002

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.