Surety Market Update

While the surety industry is generally a business with predictable results, there have been periods of turmoil over the years. When those rough waters hit and contractors suffer meaningful financial setbacks and surety losses mount, sureties will turn to more stringent underwriting to restore stability.

Certain economic indicators may have given cause for the surety community to tighten their appetite for risk in the last couple of years, however, we continue to see a marketplace that is surprisingly ‘friendly’, and surety bonds are still being provided on a generally supportive basis. A key reason for that is the continued influx of new entrants into the Canadian surety space, ensuring abundant capacity.

But there are other factors: first, new procurement models which offer better support to a contractor’s downside risk are gaining traction. And second, contractors are increasingly sophisticated, with a deeper understanding of their risks and costs, and an unprecedented ability for gathering real-time project information and analytics. What can be measured, can be managed, and contractors are getting better and better at knowing where their risks lie, and are now quicker than ever in responding to manage them.

In our introduction, we outlined some of the economic forces at play that are producing mixed economic forecasts. Sureties, who are traditionally good students when it comes to predicting worsening construction climates, anticipate that interest rates and general uncertainty will mean opportunities in the private sector will likely diminish. But even public work is suffering due to affordability issues – the number of over budget or cancelled tenders is unprecedented. The pent-up demand for necessary infrastructure is growing and will need to be addressed at some point.

Most surety insiders expect that the frequency of claims will rise in 2023 (one senior surety executive commented to us that there is clear historical evidence of claims trending upwards within a year or two of a spike in interest rates). The severity of claims is an issue of concern too, as inflation is already having a meaningful impact on the cost of settling surety claims.

So, the question becomes what can contractors do to avoid financial risk in this tenuous climate? The answer remains quite fundamental:

1. To the degree possible, reduce debt loads to avoid the impact of an increasing burden on cash flow and the inherent loss of control that comes with significant dependency on outside financing.

2. Monitor the financial health of your customers and business partners (owners, GCs, and trades), and mitigate counterparty risk by seeking proof of financing from owners you’re unsure of and subtrade bonding from larger critical path trades whenever possible.

One final observation. We’ve noticed that while contractual disputes and payment issues are more common than ever, the use of prompt payment mechanisms and arbitrations (where statutorily available) remains uncommon. This may be an under-utilized tool for contractors to leverage regulation to their potential benefit (for a change).