As construction spending in the U.S. continues to expand—especially bolstered by investment in transportation and public utility infrastructure—contractors must balance the wealth of project opportunities with countervailing forces.

Margins are still under pressure from inflation’s impact on costs, and an always litigious environment makes it essential to thoroughly go over RFP’s and contract terms before the bidding stage to guard against potential risks. Weighing the rightness of prospective new projects has never been more important, along with adequately evaluating whether subcontractors are sufficiently qualified.

For contractors that expect to grow and continue their success, it is essential to fortify their surety program. Establishing a bonding program is integral to that success, not just to protect owners and customers, but the business, too. It can provide the capacity to bid on larger projects, help grow the project backlog, and avoid last-minute fire drills when securing a bond.

Right now, the surety market is under some pressure itself. Many re-insurers, which provide support to primary insurers, are taking heavy losses due to inflation, rising interest rates, and contractors that are biting off more than they can chew. The battered re-insurers are passing these costs back down to the primary insurers, which is leading to stricter underwriting in some cases and possible changes in terms. This makes it even more important for contractors to brush up on their familiarity with surety bonds and to find ways to streamline the underwriting process without cutting corners.

IMPORTANT ROLE

A surety bond is a guarantee that a company or individual will deliver on an obligation. Bonds are required of contractors, suppliers, subcontractors, and project owners to minimize risk, required by law for all public construction projects in the U.S. and many in Canada.

There is a rising need for surety bonds on private projects, as owners and lenders look for added protection against growing risks posed by rising interest rates and costs and labor shortages. A survey of private construction contractors conducted by the Surety & Fidelity Association of America pointed to other benefits:

  • More rigorous prequalification and review was performed by bonded projects (96%) versus non-bonded ones (61%).
  • Nearly five times as many respondents prioritized bonded versus non-bonded projects during financial difficulties. 
  • Bonded projects tend to be finished ahead of schedule, five times as many public and private owners said.

Other benefits include a reduction in risk of project default, ensuring business continuity, and providing technical and financial assistance. Surety bonds also make the transition from construction-to-permanent financing easier by eliminating liens, and they can even lower construction costs through improved bidding competition.

TYPES OF SURETY BONDS

The three most common surety bonds for construction are:

Bid bonds, required for some projects (typically government), are necessary to submit your bid. It ensures you will meet certain requirements, like entering into the contract in a certain timeframe and providing performance and payment bonds. It also demonstrates a business’ financial standing, helping it prequalify for larger and more complex projects.

Performance bonds are the most common type, a guarantee that work will be completed according to a contract’s specifications. It’s a recourse against defaults, whether by a principal or a subcontractor (which are often required to secure them).

Payment bonds guarantee the principal will pay all subcontractors, laborers, and suppliers under the contract.

Pricing can vary, depending on particulars like contract scope and project duration. Payment and performance bonds typically are coupled as one bond, priced between 0.75 to 3 percent of the contract price.

MEETING THE “THREE C’S”

Contractors need to have a certain standing as solid businesses to qualify for a surety guarantee. Underwriters look for these characteristics:

Character: The applicant—or principal—must show a credit record and business history that reflect good character and integrity. Also important is a record of meeting obligations. Sureties will examine such things as references and reputation, quality of relationships with primes, subcontractors, and vendors, as well as credit reports, bank records, and even the owner’s personal financial statements in many cases.

Capacity: It’s also key for the principal to have what it takes to fulfill the contract, from skill and experience to staff and equipment. To this end, sureties look into the success of past projects, the backlog of new and existing ones, and contractual language. Continuity and succession planning are also examined, as are the project-management systems and controls.

Capital: It’s instrumental for the principal to have the financial strength to take on new projects while managing current obligations—and be able to respond to unforeseen problems. Extensive current financial documentation is required, including a CPA-prepared annual report and interim financial statements. Also necessary are work-in-progress schedules, a bank line of credit, and personal financial information.

Securing a surety bond can be an onerous business. Having a broker partner with surety experience and know-how is key, not merely as a guide through a rigorous application process but to identify and remove potential barriers on the path.

Marty Moss is the president of Surety/Bonds at global insurance brokerage Hub International, overseeing surety operations and managing a team of 25 dedicated surety professionals. Marty specializes in working with large clients and those with advanced technical complexity across a variety of industries, including construction, mining, manufacturing, environmental, and disaster Recovery. He has underwritten and managed a wide variety of companies from large, diversified programs for Fortune 500 clients to middle market privately held companies.