Over the last 24 months, several high-profile insolvencies within the UK construction sector have led to a hardening of the Surety market. Many sureties have been reducing their capacity, while others have withdrawn from the market entirely. Employers are also increasingly requesting bonds as an additional form of security, typically with more onerous terms.
For contractors and subcontractors, following best practice is key to building a successful Surety programme. Prioritising early engagement, transparency, and a partnership mentality can help to streamline negotiations and achieve the best terms.
Bonds becoming a necessity for employers
Surety bonds are not something that contractors enter into lightly. But as the UK construction sector has been the victim of such a large number of insolvencies, bonds have become a ‘must have’ for some employers. At the same time, significant losses have driven sureties to increase their levels of due diligence and analysis when assessing risks. The ‘not so perfect’ storm has reduced sureties’ capacity for bonds, and has left many contractors unable to secure bonds altogether.
This is not the only challenge facing contractors. In parallel with declining availability, bond wordings included in tenders are becoming more onerous from the outset. Whereas contractors would previously have put forward an ABI wording with a Practical Completion expiry as a starting point, this is becoming less acceptable to employers. Sureties’ reluctance to issue onerous bonds can also cause unwanted project delays.
Although some contractors will negotiate the more onerous tender wording with the employer, others have adopted a ‘take it or leave it’ approach, and will walk away from a contract if an ABI wording isn’t accepted. This can be a wise decision: an on-demand bond could leave the principal with minimal defence in the event of a claim. The ABI wording is tried and tested in the courts, and it should provide employers with strong confidence that claims will be paid.
Premium and capacity trends
Recent high-profile insolvencies have inevitably affected appetite for many sureties. Due to the impact on capacity, even financially sound businesses can be negatively affected by the insolvency of others within their sector.
Nevertheless, there remains strong interest among sureties to write new business and issue bonds where possible. Premium rates have remained stable with minimal increases. However, some sureties feel the market has long been underpriced and that an adjustment is required. This is a common fear among contractors although for many, the ability to provide a bond has a greater importance than pricing.
Ultimately, Surety bonds provide security to employers in the event of default or insolvency. Recent claims show that the product is effective; however, the unprecedented level of claims has led to a hardening of the market. Nevertheless, as is often the case with market-cycles, new market entrants can help to soften this – increasing capacity and making it easier to place bonds.
In response to the hardening market, a small handful of contractors are opting to utilise offshore, unregulated, or unrated sureties (those without a credit rating from an internationally recognised agency). This is not advisable; these sureties are opportunist in their approach, offering capacity that they may not be able to settle in the event of a claim. In such a scenario, the employer will be left significantly out of pocket and without no government protection. Not only does this threaten the contractor’s reputation, in the event of a non-payment following a claim, it poses a broader risk of reputational damage to the Surety market as a whole, and it could devalue Surety products altogether.
Best practices for your Surety programme
Despite the challenges within the market, sureties always endeavour to provide capacity to clients where possible. Surety bonds will always remain available for well-run businesses with a suitable level of risk, but following best practice can help contractors to secure the best terms and streamline negotiations.
Key recommendations include:
1. Engage your broker or Surety provider as early as possible
This can be extremely beneficial, as it allows for most of the due diligence to take place before the Surety bond is required. Engaging earlier can also help to avoid onerous bond wordings and threatening contract amendments, and in turn provide greater protection. These discussions can be lengthy, and a great challenge should the bond wording already be pre-agreed without the Surety provider’s approval.
A specialist broker can add value by creating a diverse surety panel, managing capacity, and programming bond issuances.
2. Provide a comprehensive quarterly management accounts pack
This doesn’t have to be long, but it should pre-empt the underwriter’s questions and cover off all key elements of their review. Structuring the appropriate pack and presentation is important and can be assisted by your broker.
For sureties, the key information they expect to see will include:
An overview of the business’s structure (organisational and management)
A latest trading update (including filed accounts and management accounts)
Financial trends and analysis (covering balance sheet, profit and loss account as well as cash position)
A breakdown of latest aged debtors and creditors position
Cashflow forecasts – detailed 12-week forecast, and high level 12-month forecast
A Bank Information Form – consolidated for all group bank accounts and independently completed by your bank provider
Latest workload schedule/work in progress – if there is a high volume of projects, then key jobs are usually sufficient
Commentary around any problem contracts, loss making projects, adjudications and legal disputes
Commentary around any significant CAPEX spend or restructuring over the next 12 months
Anticipated bond requirements/forecast over the next 12 months.
3. Regularly change auditors
Ideally, an auditor change should take place every 3 to 5 years. New auditors can do a deep dive with a fresh pair of eyes, which is often beneficial to the contractors under audit.
Some contractors may already undertake half-year audited accounts and while this is likely to be beneficial, it is a heavy commitment requiring substantial resources for potentially minimal reward. Those likely to benefit most are businesses in their infancy without a strong financial history.
4. Hold annual review meetings
Although annual reviews may feel like a ‘tick-box’ exercise for some, they provide sureties with an important opportunity to ask their questions and get a feel for the people that are running the businesses that they are being asked to bond.
Where meetings are less beneficial, this can usually be improved via factors within the broker’s or contractor’s control (e.g. structure, size, content, and preparation).
5. Adopt a partnership mentality
Sureties are key stakeholders in a business, who equally want to see the success of the firm. As a result, when it comes to sharing information prior to and in review meetings, it is best to be transparent and share detailed packs where possible.
Future challenges
Over the next 12 months, demand for Surety bonds is likely to remain high, while both bond wordings and capacity will continue to pose an obstacle. Meanwhile, an uncertain political environment, labour costs, and infrastructure spending all present challenges and opportunities. The Building Safety Act is a particular area of concern, with general uncertainty as to how and when this will be solved, and the resultant impact on the industry.
Sureties do have a positive outlook, despite the expectation of further losses in the market. Scrutiny and due diligence will continue to remain high, however. This is true for all businesses: while large high-profile insolvencies are damaging to the market, smaller businesses going insolvent can be just as damaging due to supply chain impacts.
Any new regulated entrants to the UK Surety market will be welcome, especially where it promotes collaboration and a stronger perception of the construction industry. This should ease the strain and contractor reliance on existing sureties, for the benefit of the market as a whole.
For more information, reach out to a member of our team.
