Guaranteed bonds provide protection and economic benefits for both public and private sector construction

This post is part of a series sponsored by the IAT Insurance Group.

A perfect storm of inflation, supply chain disruptions and ongoing labor shortages is adding another risk factor to construction projects in 2023.

Despite year-on-year growth, the construction industry still faces a labor shortage of over 400,000 workers.^[1] At the same time, inflation is contributing to rising costs of construction materials, and supply chain bottlenecks continue to affect the timely delivery of critical materials and products. These pressure points can threaten the profitable completion of construction projects and affect the viability of construction companies.^[2]

To stay on track despite economic headwinds, public and private project owners are leveraging guaranteed bonds. In fact, guaranteed bonds have provided this guarantee to the federal government since the Miller Act of 1935 was enacted. The Miller Act requires indemnification for federal construction projects over $150,000. Many states have a version of the Miller Act commonly referred to as the Little Mirror Act.

Similar to government contract space, key benefits of guaranteed bonds for private owners include reduced likelihood of default as the contractor is pre-qualified by the surety company. increase. Do it yourself.

Three economic protections offered by guaranteed bonds

Their main purpose is to reduce the risk of contractor default, but according to Ernst & Young’s November 2022 report, Economic Value of Guarantee Bonds, guarantee bonds can be added to any bonded project by some amount. of economic benefits.^[3] Prepared for The Surety & Fidelity Association of America (SFAA).

There are three important ways in which guaranteed bonds add economic value to private and public construction projects.

1. Low cost of project completion. If a contractor neglects a project, the costs to complete it can be significantly inflated. In fact, according to an EY report, projects without warranty insurance cost him 85% more than those with warranty. Significant reductions in completion costs are driven by the expertise of contractor guarantors. Guarantors can help contractors overcome back-end financial hurdles or utilize a high-speed network of resources to complete projects by other means. More than 90% of his respondents to EY’s report believe that project owners and developers do not have the same level of expertise and resources as insurers to complete construction projects.
2. Low project default rate/high timeliness of completion. According to the report, 50% of owners/developers believe that projects with guarantees are more likely to finish on or ahead of schedule, while projects with guarantees will finish on or ahead of schedule Only 10% believe they are unlikely to. Additionally, almost five times as many property owners agree to prioritize projects with guarantees over those with guarantees if their contractors face financial difficulties. Construction managers or architects are also likely to be involved in overseeing bonded projects, which can help prevent losses.
3. Lower contractor prices. According to 75% of surveyed owners/developers, the security deposit reduces the contractor’s price. This cost savings is based on confidence that contractors meet requirements for project completion and subcontractor payments. This can only be obtained if a third party is assisting the contractor. In addition, the contractor’s price for a guaranteed project is on average he 3.2% lower than the project’s price.

Bonus protection provided by guaranteed bonds

While these financial benefits give project owners peace of mind about their individual projects, the greater overall impact can come from the behind-the-scenes involvement of the guarantor companies themselves.

During the underwriting process, the Guarantor underwrites the Contractor using the 3 Cs:

• letter: Find out how construction companies interact with business partners such as suppliers and subcontractors. Also, check your credit report to see if your bills were paid on time, your billing history, and whether you were involved in litigation. In short, the reputation of the business and its key executives and owners are closely evaluated.

• capacity: Focus on the organization’s experience, area of ​​expertise, and type and scale of work completed. The guarantor evaluates the company’s previous expertise based on the scope of work, contract amount, location, and project owner. These factors are used to evaluate new bond requests.

• Capital/capacity: Dig into company finances, including evaluating the profitability of current and previous projects. Will profits be retained from inception to completion? The guarantor evaluates the balance sheet to determine whether the company has the necessary capital to support its business plans. The type of funding and credit access the company has undergoes a comprehensive review. Finally, the guarantor confirms the company’s financial trends and whether they are up or down.

Guarantors also act as consultants and business advisors. With a security deposit, owners and developers receive a higher level of oversight from the underwriting team throughout the project timeline. Once contracts are signed and security deposits are issued, the guarantor monitors the project for significant changes during its lifecycle that may increase project risk.

• Evaluate project priorities and facilitate discussion of necessary adjustments
• Engineering and architectural planning analysis and disagreement mediation
• Assistance in managing contractor-owner relationships
• Helps understand the need for new strategies when risks change over the course of a project
• Advising on the significance of emerging issues and suggesting priorities in the new risk environment
• Work with contractors to plan a revised approach to resolving issues before they become claims.

Underwriters and claims professionals often work quietly behind the scenes to keep projects going in the face of challenges that threaten to bring them to a halt. For example, if a contractor encounters unexpected financial difficulties during a project, the surety company may intervene (at its discretion) and keep the contractor financially viable to incur losses or procure another contractor. You can allow the project to be completed without the need to

Security deposits and prequalification of contractors help project owners minimize risk and control budgets. Whether you’re a public agency regularly involved in the construction and warranty procurement process, or a private owner looking for solutions to reduce risk, EY research shows the economic impact these risk mitigation tools provide. provide a compelling, fact-based argument for public value.

reach out to IAT Assurance Team Learn more about how guaranteed bonds can help you complete your next project and minimize risk.

[1] Associated builders and contractors ‘Construction jobs to rise by 1,000 in October, says ABC’ November 4, 2022.

[2] Associate General Contractor of America “2022 Construction Inflation Alert” February 2022.

[3] The Surety & Fidelity Association of America “Economic Value of Guaranteed Bonds” November 2022.

topic
construction