This post is part of a series sponsored by IAT Insurance Group.
The perfect storm of inflation, supply chain disruptions and ongoing labor shortages add additional risk factors to construction projects in 2023.
Despite year-on-year growth, the construction industry still faces a shortfall of over 400,000 employees. At the same time, inflation is contributing to the rising costs of construction materials, and supply chain bottlenecks continue to affect the timely delivery of critical materials and products. These pressure points threaten the profitable completion of construction projects, which has the potential to affect the profitability of construction companies.
To stay on track despite economic headwinds, public and private project owners use surety bonds. In fact, surety bonds have provided this guarantee to the federal government since the passage of the Miller Act of 1935, which mandates bonds for federal construction projects exceeding $150,000. Many states have a version of the Miller Act commonly known as Little Miller Acts.
Like the government contracting space, a key benefit of private owner surety bonds includes reduced likelihood of default because contractors have been prequalified by a surety company and can take comfort in the fact that the project will eventually be completed, even if the bonded contractor is unable to do so on their own .
3 financial protection provided by surety bonds
While their primary goal is to reduce the risk of a contractor’s default, surety bonds offer several financial benefits to any bonded project, according to the November 2022 Ernst & Young report “The Economic Value of Surety Bonds.” prepared for The Surety & Fidelity Association of America (SFAA).
There are three important ways that surety bonds add financial value to private and public construction projects.
- Lower cost of project completion. In the event that a contractor fails on a project, the cost of completing it can swell significantly. In fact, projects without surety insurance cost 85% more to complete than projects with a surety bond, according to the EY report. A significant reduction in completion costs is driven by the expertise of a contractor’s surety. Surety bonds can help the contractor get through financial hurdles on the back end or they can use their large network of resources to complete the project in other ways. More than 90% of respondents in the EY report believe that project owners and developers do not have the same high level of competence and resources as the surety company to get a construction project completed.
- Lower frequency of project cancellations/good time to completion. According to the report, 50% of owner/developers believe that bonded projects are more likely to be completed on or ahead of schedule, while only 10% say that bonded projects are less likely to be completed on or ahead of schedule. In addition, nearly five times as many property owners agreed that contractors give higher priority to bonded projects in the face of financial hardship, compared to unbonded ones. The construction manager or architect is more likely to be involved in monitoring a connected project as well, which can help prevent loss.
- Lower contractor rates. Security bonding reduces contractor pricing, according to 75% of owner/developers surveyed. This cost reduction is based on confidence that the contractor will meet its project completion and subcontractor payment requirements that can only be obtained when a third party backs the contractor. In addition, contractor pricing on projects with a surety bond is an average of 3.2% below the project value.
Bonus protection offered by surety bonds
These financial benefits give project owners peace of mind in individual projects, but the overall greater effect can come from the surety company itself getting involved behind the scenes.
During the underwriting process, the surety underwrites the contractor using the three Cs:
- Character: Examines how a construction company interacts with those they do business with, such as their suppliers and subcontractors. It also reviews their credit reports to see if bills are paid on time, their claims history and if they are involved in lawsuits. In short, the reputation of the company and its key people and owners is carefully evaluated.
- Capacity: Focuses on the organization’s experience, area of competence and type and size of work performed. The guarantor evaluates the company’s previous expertise based on the scope of work, contract value, location and project owners. These factors are then used to evaluate new bond requests.
- Capital/competence: Digs into the company’s finances, including evaluating the profitability of current and past projects. Does the profit last from start to finish? The guarantor evaluates the balance sheet and determines whether the companies have the capital needed to support their business plan. What types of financing and credit access the company has is given a comprehensive review. Finally, the surety will see the company’s financial trends and whether they are pointing up or down.
Guarantors also act as consultants and business advisors. With a surety bond, owners and developers receive a higher level of oversight over the project timeline from the underwriting team. Once a contract has been executed and a bond has been issued, the bond will monitor the project for any significant changes during its life cycle that may increase the risk of the project: Examples of how the bond may work with the contractor during the course of a project include:
- Evaluate project priorities and promote discussion of adjustments that may need to be made
- Analyze technical and architectural plans and mediate any disagreements
- Assist with managing the contractor/owner relationship
- To help understand the need for a new strategy should the risks change during the course of the project
- Advise on the significance of any issues that arise and suggest priorities in the new risk landscape
- Work with the contractor to map out a revised approach to resolve any issues before they become claims
Security guarantors and professionals often work quietly behind the scenes, keeping the project moving in the face of challenges that threaten to stop a project. For example, if a contractor runs into unforeseen financial distress during the project, the surety company can step in (at its discretion) and keep the contractor afloat financially to ensure the project is completed without incurring a loss or having to buy in another contractor.
With a surety bond and contractor surety prequalification, project owners can minimize their risk and manage their budgets. Whether it is a public authority routinely engaged in the construction and surety procurement process or a private owner looking for a risk mitigation solution, the EY study provides a compelling, fact-based discussion of the economic value these risk mitigation tools provide.
Contact IAT’s surety team to learn more about how a surety bond can help you see your next project through to completion and minimize your risk.
 Associated Builders and Contractors “October construction jobs up 1,000, ABC says,” 4 Nov 2022.
 Associated General Contractors of America “2022 Construction Inflation Alert”, February 2022.
 The Surety & Fidelity Association of America “The Economic Value of Surety Bonds,” November 2022.
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