January 2002
A year ago, I wrote about how the surety market would be hardening after years of what had been a soft market. During these years, the sureties reaped unprecedented profits. Today, the results of the past 12 months, combined with the effects of the Sept. 11 tragedies and the Enron debacle, have dramatically altered the surety landscape for the worse.
For many years during the soft market period, bonding companies were practically falling all over each other to compete for business. Underwriting standards were relaxed, new players entered the field and pricing became very competitive. While the contractor shopped for the best rate with the least restrictive standard and increased capacity, allegiance to their surety became a thing of the past. Ultimately, the surety came to be seen as a product provider rather than a service provider.
In 2000 the market leveled off. For the industry, the loss ratio exceeded 50 percent of premiums (versus an average of 34 percent during the preceding 12 years). Because operating expenses averaged 51 percent of premiums, the industry as a whole lost money in 2000. Results for 2001 are expected to be similar. Even the top-of-the-line sureties were not immune to the turnaround. Of the top 15 sureties in 2000, two failed and only five had loss ratios under 50 percent.
As a result of Sept. 11, sureties will have a harder time placing bonds in the reinsurance market because of the claims being made on reinsurers. Since the Enron bankruptcy, there are more than $2 billion in open liabilities on surety bonds that could potentially be called.
For contractors this means that sureties will be writing fewer bonds for contractors or may be faced with going out of the business, especially if they can do better in other lines of insurance. General insurance premiums will increase and it will become more difficult to obtain insurance in certain industries, regardless of the rate. In addition, bond premiums will rise, and underwriting standards will tougher. Be aware that sureties will be paying more attention to key financial ratios. The surety that doesn't do all this will find it difficult to succeed in the current climate.
As a surety evaluates a contractor, so must the contractor evaluate the surety. It does no good for a contractor to obtain bonding from a surety that is losing money and may be going out of business. A contractor should know how the surety is rated by the rating agencies (e.g. Am Best, Standard & Poors, etc.). A contractor should be able to review the surety's financial statements and should know if a surety's combined loss and expense ratio exceeds 100, which means that the surety is losing money. Additionally, a contractor should understand the surety's reinsurance program, and be fully aware of the surety's plans and intentions to go forward.
Because of the current climate, the surety will also be scrutinizing the contractor more closely. The contractor should be prepared to face up to higher standards. The surety will want to see a well-capitalized company capable of performing the jobs it wants bonded. Character and integrity will count. The surety will expect the contractor to be forthright and communicative. The surety will want to see high quality, timely and informative financial statements and will expect the contractor to have a well thought out business and succession plan. The surety will be paying close attention to financial ratios, contract performance and financing strategies.
Both contractors and sureties face tremendous challenges in the current market. There will be fewer players (sureties) in the market, and those that remain will no doubt hold contractors to higher standards. However, a properly positioned, well-run contractor will still be able to get bonding from the right surety, one that will be in the business for the long haul. Here, your accountant can be a valuable resource, helping the contractor become more attractive to the surety and in evaluating the surety's performance. Those contractors that don't understand the realities of today's market will be in for a rude awakening as they seek bonding for their jobs or general insurance for their companies.
About the author: Mr.
Anchin is managing partner of Anchin, Block & Anchin, LLP, a New York City
certified public accounting firm that specializes in meeting the needs of
contractors in the tri-state area.