Strong construction growth drives bonding demand, but also a labor shortage, giving rise to increasing claims The fortunes of the surety sector are, naturally, directly linked to those of the construction industry. After reaching a high mark of more than $5.5 billion in premium in 2008, that number decreased as the recession took hold and took construction activity down with it. Then, surety premiums rebounded as the economy improved and construction activity increased, and in 2015, finally surpassed the $5.5 billion mark again. Yet one doesn’t have to examine statistics to know that the construction market has rebounded. “One way I measure what’s going on in the construction industry is how many tower cranes I can count on my drive to work every day,” says Susan Hecker, director of national contract surety and area executive vice president at Arthur J. Gallagher & Co. “Over the past few years in the San Francisco area, it has gone from a handful to more than 50.” More bonds are being issued on private projects as well, which is good news for sureties. There has been a trend of lending institutions requiring bonds in more instances to finance projects on the private sector, notes Bill Minderjahn, vice president of surety for RT Specialty LLC. Public project spending has not quite seen the same level of recovery: Peaking in July 2009 at $323 billion, public construction in July 2016 was $278 billion. “The drop in spending reflects the lack of funds that state and local governments have,” says David Hewett, U.S. contract surety leader at Marsh. “However, the demand for projects is there, and governments are finding creative ways to meet infrastructure needs.” One way is through public-private partnerships, or P3s. “We’re seeing more interest in P3 projects than ever before, which is driving discussion on the surety side about how to be most relevant in the space by offering bonds that are more liquid,” says Patrick Pribyl, senior vice president and surety team leader at Lockton Cos. Shortage in skilled workers However, strong growth in construction can be a mixed blessing. On one hand, the construction rebound has driven bonding demand. However, there is growing concern over the availability of skilled worker Maintaining a qualified workforce is one of the top concerns for construction company executives, says Jack Gibson, president and CEO of the International Risk Management Institute, which hosted its Construction Risk Conference in Orlando, Florida, early in November. “The unemployment rate for construction nationally is the lowest it has been in 10 years, which is positive, but it has constrained available labor,” says Ed Titus, senior vice president of surety for Philadelphia Insurance Cos. “We see the Texas, California and Florida construction markets struggling with not having enough of an available trained, skilled workforce for contractors to start bidding on new projects,” With the labor shortage, sureties are watching a rise in claims. “Without enough workers, it’s hard to finish on time, and that triggers damages,” says Larry Taylor, chairman of the board and president of Merchants Bonding Co. “The flow of money from owners down to the sub-trades is also slower than it has been,” he adds. “If the owner pays the general [contractor] slowly, and the general pays the subcontractor slowly, and the sub pays suppliers slowly, that can trigger a claim because our bonds guarantee that labor and material providers are paid.” Energy sector Another area of potential concern for sureties is the energy sector. Law firm Haynes and Boone, which tracks bankruptcy filings, reports that more than 100 North American oil and gas producers have declared bankruptcy since the start of 2015, with 58 filing as of September 2016 and more expected this year. “We don’t anticipate there being many full-bond penalty losses, but I know that sureties have taken reserves toward losses in the energy sector,” Pribyl says. “The bonds tied to that space, such as well plugging bonds and reclamation bonds, are becoming a bit harder to place, although there hasn’t yet been real hardening.” “You have to remember that the biggest surety loss ever was Enron,” adds Hecker. “When you see so many energy companies file for bankruptcy, it’s a concern because a lot of bonds are written in that sector. The coal sector is really concerning.” Appetite for business The surety market’s current strength is perhaps best illustrated by what happened when XL Catlin left the primary market in March 2016, taking more than $1 billion in capacity with it. “It had no impact,” says Hewett. “It would take the exit of two or three mid-size carriers to have an impact.” Several sureties have entered the market over the last few years, including both new capital and property and casualty carriers looking to expand their revenue by writing an additional line of business. “We have heard from many different insurance companies that are not in the market of their desire to get in, particularly in the middle-market sector,” Hewett adds. Existing sureties have been working to increase their business as well. “Surety underwriters are under pressure to grow,” says Taylor. “Most sureties are public-stock companies, so they need to show their shareholders earnings growth.” With the profit being earned in the surety business, the appetite for business is not surprising. According to the Surety & Fidelity Association of America, for seven of the past 10 years the industry’s loss ratio has been below 20 percent. For the first half of 2016, it was just higher than 18 percent. Contract surety, commercial surety The market divides into two sectors: contract surety for construction (“sticks and bricks”) and commercial surety, which covers other bonding needs. Competition is tough in both areas, and is particularly keen in commercial. “Where we see severe competition to the point where rates are significantly impacted or underwriters are complaining about other companies doing things that are ‘hypercompetitive,’ it’s typically in the commercial surety space. That’s also where we see most of the new entrants as well,” Hecker says. On the
