Surety for Today’s Construction Environment
Vice President, Client Executive
The surety premium component comprises a small sliver of the overall premium pie of the insurance industry, but don’t underestimate the power of what a surety facility can do for a contractor or an owner of a construction project.
Typically, surety bonds are required in various public sector projects to properly manage taxpayers’ money used to finance construction work. They were first introduced in the US in 1893, where the Miller Act was created to obligate the Federal Government to bond all public sector contracts in excess of $25,000. The threshold limits of bonds have increased since then, but they remain a requirement to contracting with the public sector.
A surety is distinctly different from an insurance policy:
- A surety bond is a three-party contract comprised of the Principal, the Surety, and the Obligee. On the other hand, a Contract of Insurance is a two-party contract between the Insured and the Insurer.
- Insurance premiums are set on the assumption that losses will occur and therefore that the premium is a risk premium. Surety assumes no losses to occur. The premium is charged for the extension of credit.
- There must be an underlying obligation between the Principal and the Obligee before a surety can be involved. Thus, the surety’s obligation is always secondary to that of the Principal. With insurance products, the obligation of the Insurer is always primary.
Nowadays, many aspiring contractors will apply for a surety facility with the desire of opening up bidding opportunities. This could be the beginning of a very long and beneficial relationship between the contractor, the broker and the surety company. When working with contractor clients, the broker and the underwriter learn a lot of detailed information about the contractor’s business in order to better help that contractor reach his or her goals and aspirations. This translates into deep and meaningful conversations, jobsites visits and, generally, the creation of a partnership between the client, the broker and the underwriter. Yes, personal information is shared, in confidence, between these people; all with the objective of seeing the contractor’s business thrive.
For public sector bonds, their cost is part of doing business. In the private sector though, the cost of the bond is often one of the first line items to be crossed off the budget. It’s only after the fact that we get to hear from general contractors, private owners or developers on how they wished they had an option which would get the job finished or clear the lines when their contractor or a sub-trader fails to perform. Surety bonds, especially performance bonds and labour & material payment bonds are valuable financial risk management tools that mitigate the risk of non-performance by a contractor. The surety does the legwork to prequalify the contractor’s ability to complete the work, pay the bills and meet warranty provisions to the contract.
With the unforeseen consequences of the current economic downturn, an owner or a general contractor may not be privy to the latest insider information on the contractor they are about to hire. The tides can turn quickly – a contractor’s failure in the middle of a major project could spell the demise of the project itself.
We see more private owners looking to use surety bonds on many types of projects, from large residential condominium developments to seniors’ housing and other industrial or commercial projects. Lenders often require the prime contractor and major sub-trades to be bonded to offer financing for their projects.
In summary, the surety bond is an important risk management tool for an owner as well as an important facility for a contractor wanting to expand his or her business.