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Surety

Surety as a Solution For Billion-Dollar Construction Projects

Disaster recovery plus infrastructure projects stretch builders; sureties could be next.
By: | May 1, 2018 • 6 min read

Building is booming in the United States. Billion-dollar projects are no longer unusual. The trend toward larger projects is mostly a boon to contractors and to the surety-bond underwriters who back the developments, but the volume and size of the work is becoming a matter for concern for some underwriters.

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“It is a very different thing for a general contractor to do $800 million in revenue from two $400 million projects or from 10 $80 million projects,” said Geoff Delisio, senior vice president of surety, Berkshire Hathaway Specialty Insurance.

In another example, Delisio noted that typically the electrical work is 20 to 25 percent of a project. On a billion-dollar project, that is a $250 million subcontract.

“Risk managers [at owners and contractors] are dealing with this daily,” said Delisio. “We have similar thoughts: How much risk do we want to take on a single project? As we look ahead, we don’t see anything but larger projects. Are $5 billion or $10 billion projects too far in the future?”

“Ten years ago, I could count the number of billion-plus-dollar projects on one hand,” said Peter Quinn, head of bonding/surety, Euler Hermes Americas. “That has increased four or five times.”

Questions Around Capacity

The regulatory requirements for surety in the U.S. have resulted in higher barriers to entry for new surety underwriters than in some other lines of insurance. The regulatory regime also means offshore markets are generally not open.

Delisio said capacity could become a concern depending on the size of the project and where a surety underwriter attaches: “We may see the first push on tightening this year or next.”

“Ten years ago, I could count the number of billion-plus-dollar projects on one hand. That has increased four or five times.” – Peter Quinn, head of bonding/surety, Euler Hermes Americas

For now, most remain confident that capacity is adequate but, as Delisio advised, there are contributing factors to keep an eye on.

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Susan Hecker, national director of contract surety, Gallagher, said, “At a project size of $2 billion or more, it might become an issue, but many of those projects are joint ventures and have a co-surety structure.

“There are always underwriting questions around large public-private partnership projects as well as when mega-contractors secure multiple large contracts,” she said. “However, those situations could also be a credit case … more individual contractor capacity issues rather than an indication of a restriction of overall surety capacity.”

“We have not seen overall tightening in the surety market,” said Joanne Brooks, vice president and counsel, The Surety & Fidelity Association of America. “But as an industry, we should be prepared to tighten, or we are going to be called upon under the bonds to finish some of these projects and ensure subcontractors and suppliers are protected and paid.”

Brian Fogle, vice president and regional underwriting officer, Liberty Mutual Global Surety

Brian Fogle, vice president and regional underwriting officer, Liberty Mutual Global Surety, said the issue is currently more of a capability crunch than a capacity crunch.

“There has been plenty of surety capacity since the recession and the lag in construction. The building surety businesses have been waiting for this recovery. But it can be a challenge when it all comes at once.”

The volume of work is of increasing concern, said Brooks. “The issue is not really capacity in the surety sector, even for large projects. It is more a matter of a given contractor’s capacity. There are a limited number of contractors at the top end who are capable of performing billion-dollar projects.”

Not only is there a greater demand for builders, but projects are also lasting longer, Fogle added.

“When projects last five or eight years, rather than two or three, capital and commitments are tied up for longer. That also increases risk. Owners understand this.”

Brooks has observed that sureties could consider reining in capacity because of several trends in the construction sector. Subcontractors are already getting a great deal of work and new tariffs may raise the price of construction materials, notably steel and aluminum.

“There is also the number and scale of natural disasters, hurricanes, mudslides and fires,” she added.

Delisio noted, “There is a whole generation of experienced individuals moving to or are already in retirement. Here we are 10 years on from the recession, and there is a bit of a gap now that the business is revving back. The 10- to 20-year people are few and far between.”

Phasing Projects

One possible response to the burgeoning size of projects is to subdivide them: “Sometimes an owner will float a long-duration project and there are only a limited number of underwriters that can bond a billion-dollar project,” Fogle explained.

“But there are more who can bond a series of four $250 million projects. There are more contractors who can handle that size project as well. Contractors like to phase their work and resources as well.”

Phasing a project gives owners more capability to bring in more contractors and more underwriters, he said.

Phases also extend bonding capacity, but Fogle said that is not as much of a concern. “We’ve got a huge Treasury listing, and we can write billion-dollar projects, but we like to diversify our risk. We have some projects we write on a sole basis, but most of our larger accounts we write on a co-surety basis.”

“Sometimes an owner will float a long-duration project and there are only a limited number of underwriters that can bond a billion-dollar project.” – Brian Fogle, vice president and regional underwriting officer, Liberty Mutual Global Surety

He noted that “co-sureties are liable joint and severally, so we have to be careful. We underwrite our co-sureties just as we underwrite our clients.”

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Quinn concurred that co-surety is a common solution for large projects. He also noted “there are opportunities for owners to accept something less than 100 percent, down to as low as 50 percent. That means they are accepting a lower bond amount.

“The reality is that there are 130 sureties in the U.S., but only about eight that can participate in bonds of the largest size. That does increase costs [for the projects] some, but that is not holding projects back.”

“We do have underwriting capacity for large projects, especially those performed in joint venture or consortium,” said Brooks. “There might be limits imposed for a given contractor that has reached the top of its aggregate capacity.”

Adapting to Scale

Quinn expressed confidence the industry will get itself sorted in time.

“There are newer players, and as project size has grown, the industry needs to respond, even though there may be fewer people participating at the highest levels.” The scale and scope of the business may be changing, but the fundamentals have not, he said. “It still comes down to underwriting and individual risk.”

At the other end of the market, there are no concerns for underwriting or the capacity of contractors to handle and complete projects.

“We play at the smaller-project level, $100 million or less,” said David Layman, vice president and chief underwriting officer, Argo Surety. “There is plenty of capacity for us and for our clients.”

Given the nature of the construction business, that ample capacity on the part of contractors for smaller projects is not a resource that can easily be aggregated for the larger projects where there is a capability crunch.

“Our clients are general builders themselves,” Layman explained. “They are not going to sub-contract to other [larger] general builders.” &

Gregory DL Morris is an independent business journalist based in New York with 25 years’ experience in industry, energy, finance and transportation. He can be reached at [email protected]

More from Risk & Insurance

More from Risk & Insurance

Insurtech

Kiss Your Annual Renewal Goodbye; On-Demand Insurance Challenges the Traditional Policy

Gig workers' unique insurance needs drive delivery of on-demand coverage.
By: | September 14, 2018 • 6 min read

The gig economy is growing. Nearly six million Americans, or 3.8 percent of the U.S. workforce, now have “contingent” work arrangements, with a further 10.6 million in categories such as independent contractors, on-call workers or temporary help agency staff and for-contract firms, often with well-known names such as Uber, Lyft and Airbnb.

Scott Walchek, founding chairman and CEO, Trōv

The number of Americans owning a drone is also increasing — one recent survey suggested as much as one in 12 of the population — sparking vigorous debate on how regulation should apply to where and when the devices operate.

Add to this other 21st century societal changes, such as consumers’ appetite for other electronic gadgets and the advent of autonomous vehicles. It’s clear that the cover offered by the annually renewable traditional insurance policy is often not fit for purpose. Helped by the sophistication of insurance technology, the response has been an expanding range of ‘on-demand’ covers.

The term ‘on-demand’ is open to various interpretations. For Scott Walchek, founding chairman and CEO of pioneering on-demand insurance platform Trōv, it’s about “giving people agency over the items they own and enabling them to turn on insurance cover whenever they want for whatever they want — often for just a single item.”

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“On-demand represents a whole new behavior and attitude towards insurance, which for years has very much been a case of ‘get it and forget it,’ ” said Walchek.

Trōv’s mobile app enables users to insure just a single item, such as a laptop, whenever they wish and to also select the period of cover required. When ready to buy insurance, they then snap a picture of the sales receipt or product code of the item they want covered.

Welcoming Trōv: A New On-Demand Arrival

While Walchek, who set up Trōv in 2012, stressed it’s a technology company and not an insurance company, it has attracted industry giants such as AXA and Munich Re as partners. Trōv began the U.S. roll-out of its on-demand personal property products this summer by launching in Arizona, having already established itself in Australia and the United Kingdom.

“Australia and the UK were great testing grounds, thanks to their single regulatory authorities,” said Walchek. “Trōv is already approved in 45 states, and we expect to complete the process in all by November.

“On-demand products have a particular appeal to millennials who love the idea of having control via their smart devices and have embraced the concept of an unbundling of experiences: 75 percent of our users are in the 18 to 35 age group.” – Scott Walchek, founding chairman and CEO, Trōv

“On-demand products have a particular appeal to millennials who love the idea of having control via their smart devices and have embraced the concept of an unbundling of experiences: 75 percent of our users are in the 18 to 35 age group,” he added.

“But a mass of tectonic societal shifts is also impacting older generations — on-demand cover fits the new ways in which they work, particularly the ‘untethered’ who aren’t always in the same workplace or using the same device. So we see on-demand going into societal lifestyle changes.”

Wooing Baby Boomers

In addition to its backing for Trōv, across the Atlantic, AXA has partnered with Insurtech start-up By Miles, launching a pay-as-you-go car insurance policy in the UK. The product is promoted as low-cost car insurance for drivers who travel no more than 140 miles per week, or 7,000 miles annually.

“Due to the growing need for these products, companies such as Marmalade — cover for learner drivers — and Cuvva — cover for part-time drivers — have also increased in popularity, and we expect to see more enter the market in the near future,” said AXA UK’s head of telematics, Katy Simpson.

Simpson confirmed that the new products’ initial appeal is to younger motorists, who are more regular users of new technology, while older drivers are warier about sharing too much personal information. However, she expects this to change as on-demand products become more prevalent.

“Looking at mileage-based insurance, such as By Miles specifically, it’s actually older generations who are most likely to save money, as the use of their vehicles tends to decline. Our job is therefore to not only create more customer-centric products but also highlight their benefits to everyone.”

Another Insurtech ready to partner with long-established names is New York-based Slice Labs, which in the UK is working with Legal & General to enter the homeshare insurance market, recently announcing that XL Catlin will use its insurance cloud services platform to create the world’s first on-demand cyber insurance solution.

“For our cyber product, we were looking for a partner on the fintech side, which dovetailed perfectly with what Slice was trying to do,” said John Coletti, head of XL Catlin’s cyber insurance team.

“The premise of selling cyber insurance to small businesses needs a platform such as that provided by Slice — we can get to customers in a discrete, seamless manner, and the partnership offers potential to open up other products.”

Slice Labs’ CEO Tim Attia added: “You can roll up on-demand cover in many different areas, ranging from contract workers to vacation rentals.

“The next leap forward will be provided by the new economy, which will create a range of new risks for on-demand insurance to respond to. McKinsey forecasts that by 2025, ecosystems will account for 30 percent of global premium revenue.

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“When you’re a start-up, you can innovate and question long-held assumptions, but you don’t have the scale that an insurer can provide,” said Attia. “Our platform works well in getting new products out to the market and is scalable.”

Slice Labs is now reviewing the emerging markets, which aren’t hampered by “old, outdated infrastructures,” and plans to test the water via a hackathon in southeast Asia.

Collaboration Vs Competition

Insurtech-insurer collaborations suggest that the industry noted the banking sector’s experience, which names the tech disruptors before deciding partnerships, made greater sense commercially.

“It’s an interesting correlation,” said Slice’s managing director for marketing, Emily Kosick.

“I believe the trend worth calling out is that the window for insurers to innovate is much shorter, thanks to the banking sector’s efforts to offer omni-channel banking, incorporating mobile devices and, more recently, intelligent assistants like Alexa for personal banking.

“Banks have bought into the value of these technology partnerships but had the benefit of consumer expectations changing slowly with them. This compares to insurers who are in an ever-increasing on-demand world where the risk is high for laggards to be left behind.”

As with fintechs in banking, Insurtechs initially focused on the retail segment, with 75 percent of business in personal lines and the remainder in the commercial segment.

“Banks have bought into the value of these technology partnerships but had the benefit of consumer expectations changing slowly with them. This compares to insurers who are in an ever-increasing on-demand world where the risk is high for laggards to be left behind.” — Emily Kosick, managing director, marketing, Slice

Those proportions may be set to change, with innovations such as digital commercial insurance brokerage Embroker’s recent launch of the first digital D&O liability insurance policy, designed for venture capital-backed tech start-ups and reinsured by Munich Re.

Embroker said coverage that formerly took weeks to obtain is now available instantly.

“We focus on three main issues in developing new digital business — what is the customer’s pain point, what is the expense ratio and does it lend itself to algorithmic underwriting?” said CEO Matt Miller. “Workers’ compensation is another obvious class of insurance that can benefit from this approach.”

Jason Griswold, co-founder and chief operating officer of Insurtech REIN, highlighted further opportunities: “I’d add a third category to personal and business lines and that’s business-to-business-to-consumer. It’s there we see the biggest opportunities for partnering with major ecosystems generating large numbers of insureds and also big volumes of data.”

For now, insurers are accommodating Insurtech disruption. Will that change?

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“Insurtechs have focused on products that regulators can understand easily and for which there is clear existing legislation, with consumer protection and insurer solvency the two issues of paramount importance,” noted Shawn Hanson, litigation partner at law firm Akin Gump.

“In time, we could see the disruptors partner with reinsurers rather than primary carriers. Another possibility is the likes of Amazon, Alphabet, Facebook and Apple, with their massive balance sheets, deciding to link up with a reinsurer,” he said.

“You can imagine one of them finding a good Insurtech and buying it, much as Amazon’s purchase of Whole Foods gave it entry into the retail sector.” &

Graham Buck is a UK-based writer and has contributed to Risk & Insurance® since 1998. He can be reached at riskletters.com.