The Three Cs of Surety Bonds for Construction Companies
By Jaime Noland, Senior Manager, Assurance Services
Construction Company XYZ has an outstanding opportunity to take on a significant development project in a thriving metropolitan business district. All that stands between the company and start of work is its ability to secure a surety bond. Will the financial underwriter deem XYZ worthy of the risk?
Surety bonds are a common need for companies operating within the construction industry. Often confused with insurance, these bonds work more like a form a credit—a guarantee that the construction company will carry out a contract within all applicable laws and regulations. In other words, if a company does not fulfill its responsibilities according to the terms of the bond, a project developer can file a claim and recover all financial losses.
Sureties primarily provide three types of bonds in the construction industry that provide varying forms of protection:
Bid Bond: Protection provided to a project owner if a contractor backs out of a project after winning a bid or fails to secure a performance bid. This type of bid provides a guarantee that the project will be undertaken within the terms at which the contractor bid.
Performance Bond: Financial loss protection provided to a project owner in the event that a contractor does not complete the project in accordance with the terms agreed upon.
Payment Bond: Assurance that a contractor has the financial capability to compensate workers and suppliers for labor and material utilized in the project.
While most construction companies understand the necessity of being able to obtain bonding, the factors that are considered by underwriters in determining the associated risk, and therefore their willingness to bond, are often unclear. As the ability to secure bonding is dependent on risk, it is important to maximize the attractiveness of the company from an underwriter’s perspective.
The following three Cs of a company are evaluated by surety specialists when determining a contractor’s risk level:
Capacity: Does the contractor have the necessary technical skills, knowledge, equipment, experience and staffing to complete the project? This question is answered by reviewing work in process (WIP) reports as well as previous jobs completed by contractors. WIP schedules are examined for contract prices, billings to date, costs to date and estimated costs to complete in order to determine job cost stability and profitability. Completed jobs provide historical trend of overall profitability.
Capital: Is the company financially viable? As there is financial risk associated with construction projects, it is imperative that a company is able to demonstrate its ability to meet obligations, sustain adequate working capital and generate positive cash flows. The proof of a company’s financial stability is generally illustrated in a company’s reviewed or audited financial statements. Since financial statements play an important role in determining whether a surety bond will be issued, it is important for companies to work with reputable accounting firms that specialize in the accounting industry and understand an underwriter’s perspective.
Character: What type of reputation does the contractor have within the construction industry? Character is determined by evaluating a contractor’s history and relationships; reputation for taking unusual or unnecessary risks; integrity; commitment to obligations; and past and pending litigation against the company.
By gaining a clearer understanding of how surety specialists use these three Cs to evaluate a construction company, you will be able to better understand how surety specialists will evaluate your company. Similar to assessing risks a company may face, analyzing your own company in this manner will allow you to make improvements and increase the likelihood of securing bonding.
Questions about this article or other construction matters? Contact Jaime Noland, Senior Manager, Assurance Services.