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3 Potential Red Flags to Discuss with Your Surety Clients

The surety industry is one of the most complex markets in insurance—which makes it a great avenue for independent agents to prove their value. But in a persistent soft market, adding value beyond price is easier said than done.
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The surety industry is one of the most complex markets in insurance—which makes it a great avenue for independent agents to prove their value to commercial clients.

But in a persistent soft market, adding value beyond price can be easier said than done. Here are three hot topics to discuss with your surety prospects and clients in order to build and maintain a strong reputation as a trusted surety adviser:

1) Free-form and modified owner-design-build contracts. Surety and insurance entities are beginning to see an uptick in these types of contracts, which “require design-build contractors to meet a heightened standard of care relative to the design component of design-build contracts,” explains Tad Nelson, regional underwriting officer for Bond & Specialty Insurance Construction Services at Travelers.

This creates an issue for the design-build contractor, whose design professional “might not agree to be bound by the heightened standard of care,” Nelson says. “Doing so would create a situation where the design professional may not have coverage under its professional liability policy.”

The contractor, then, may wind up on the hook for damages—“with no recourse against a third party to recover those damages,” Nelson cautions.

Nelson encourages agents to “be mindful” of this trend when reviewing clients’ surety contracts in order to ensure contracts don’t impose “a standard of care that is not insurable and for which the design professional would not be responsible.”

2) Subcontractor bond-backs. Whereas larger contractors may have figured out efficient strategies for dealing with the ongoing labor shortage in the construction industry, “if you’ve got a smaller contractor and they don’t have the manpower, what is the risk for the contractors relating to those subcontractors?” points out Jack Anderson, president of Goldleaf Surety.

If a subcontractor defaults due to lack of labor or any other reason, and the prime contractor hasn’t secured a bond-back, “the prime contractor is covering it under their bond,” Anderson explains. “Sometimes you’ll see prime contractors who don’t want to drive up the cost of the project by having the subs bond back. But if you end up with a subcontractor default, it’s going to be much more costly.”

The question, then, is whether it’s “better to go without the subcontractor bond-backs, or just admit you don’t really want that project if you can’t build in the cost of the subcontractor bond-backs,” Anderson says. “Each contractor’s got to figure that answer out for themselves.”

But remember, if the industry starts to harden in the near future, “that just puts even more emphasis on prime contractors requiring bond-backs from subs,” Anderson adds. “If the economy turns slightly, usually that means more defaults. You don’t want to be caught with one of your subs defaulting and now you’ve got a mess to clean up.”

3) Continuity planning. Is your contractor client a business owner who is nearing retirement and plans to either get a child involved with the business or sell it to a third party? “A lot of times the contractor will hire an attorney to help put the stock transfer in place, and they’ll hire an accountant to make sure it gets properly done,” Anderson says. “But nobody’s ever looking at what the transaction is going to do to the financial statements from a bonding perspective.”

Because of that oversight, “the stock transfer could end up destroying the bonding relationship,” explains Anderson, who says the story is more common than you’d think. “Buyers will find out after the transaction’s complete how this negatively impacted them, and a lot of times we’ll get submissions on files where the bonding’s been destroyed, and it leaves us with two options—we can try to figure out a way to fix it, or it may now require additional terms to be added to the bonding that the contractor’s not going to like.”

“There are no other options,” Anderson warns. “A big way for an independent agent to add value is by talking to their contractors about their continuity planning and making sure it gets done in a way that is not detrimental to bonding. If I’m the buyer of a company that can’t qualify for bonding, I just terribly overpaid for something—end of story.”

Jacquelyn Connelly is former IA senior editor.

Tuesday, June 2, 2020
Builders Risk