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Risk Focus: Surety

Letters of Credit Too Expensive? Surety Bonds Can Lower Your Borrowing Costs

Energy, litigation and commercial real estate are driving growth in commercial surety.
By: | August 30, 2018 • 5 min read

Increasing interest rates for competing letters of credit and ease of access are combining to drive strong growth in the commercial surety business. More carriers and plenty of capacity are also fueling growth, experts said.

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According to the Surety & Fidelity Association of America, in 2017, direct premiums written in surety increased from $5.9 billion to $6.2 billion, the fifth straight year of a steady increase.

Surety is usually a three-party arrangement in which an obligation from one party to another is guaranteed by a third party: the surety underwriter. According to Rick Ciullo, the chief operating officer for the Hartford Bond, about 80 percent of the surety market in the U.S. is applied to construction projects. The other 20 percent is classified as commercial surety.

Not Just for Construction Anymore

Both segments are seeing growth, but commercial surety, in particular — and for a variety of factors — is on the move, according to experts.

According to Dave Hewett, who leads the surety practice for Marsh, one area where commercial surety is being applied increasingly is the oil and gas business in Houston and along the rest of the Gulf Coast.

Dave Hewett, surety practice leader, Marsh

“We are seeing a lot of growth, especially out of the Houston energy sector, and we are seeing it in a couple of different ways. We are seeing an increase in surety bonds around gas supply — which traditionally has not been a huge use of surety bonds — and are seeing quite a bit of uptick in that,” Hewett said.

He added there’s also an active business in plugging and reclamation of oil and gas wells that are no longer in use.

Surety is also used in mine reclamation work, sources say, but that business is more stable and is not seeing the growth that oil and gas-well reclamation is seeing.

“The pipeline business is very active,” Hewett said, adding that parties looking to secure the purchase or sale of gas or oil at a given price are using surety bonds to guarantee purchase prices.

“We don’t think of that as construction; that really is a guarantee of a commodity purchase,” Hewett said.

Underwriters Entering Commercial Surety

Surety underwriters traditionally compete with banks, which offer letters of credit to cover obligations from one party to another. But recently, within the past 18 to 24 months, letters of credit are becoming increasingly expensive, and premium rates in surety are down, as are loss ratios.

“If you were running a property/casualty company, you could be in the marine business or the D&O business or the surety business — for example, the surety business has been profitable and looks like a good business to be in,” said The Hartford’s Ciullo.

Ciullo noted that for those underwriters looking to get into the business, commercial surety is the easiest point of entry. He said construction surety requires teams of surety professionals in most major cities to build the necessary relationships.

“Commercial, on the other hand, can be started by focusing on a handful of cities,” Ciullo said.

Low loss ratios and an increasing comfort level with surety of those companies seeking guarantees is helping drive the business.

“We don’t see any indication of any strain in surety capacity, and our largest clients who need the largest obligations are still able to come up with them without any undue pressure.” — Dave Hewett, surety practice leader, Marsh

According to Robert Duke, the general counsel for the Surety & Fidelity Association of America, direct loss ratios in surety in 2016 were just over 10 percent.

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Surety, as opposed to a letter of credit, is an off-balance-sheet liability and thus can free up more credit for other purposes.

According to Hewett, in addition to the oil and gas business, litigation appeal bonds, lease bonds in commercial real estate, insurance program bonds and the use of surety in private equity M&A are other growth areas.

Surety’s Litigation Impact

According to Marsh, a big uptick in patent infringement and intellectual property disputes is driving up the use of surety bonds to cover the appeals process.

“As litigation continues to heat up in both frequency and severity, it’s not surprising to see appeal bond requests in the billions of dollars today versus about $500 million just five years ago,” the company relates.

“While new sureties have entered the market, the major players have doubled and even tripled their available capacity during this time,” the brokerage added.

“Appeal bonds allow defendants to post a bond rather than pay out a trial court award until the appeal is decided. For plaintiffs, appeal bonds ensure that if the trial judgment is affirmed on appeal, money will be available even if the defendant goes bankrupt or is not in a position to pay the judgment amount,” Marsh said.

In an example of an insurance program bond, Marsh said, an $84 million letter of credit for a company that self-insures for workers’ compensation was replaced by a combination of a letter of credit and surety, which freed up $19 million in letter of credit capacity for the company.

Analyzing Best Practices

Like Hewett, The Hartford’s Ciullo said the increasing cost of letters of credit is making surety bonds more competitive.

“At the end of the day, an underwriter’s job is to assess the risk and reach their own decision about what an acceptable price would be and sometimes that matches up with what bankers do and sometimes it doesn’t.” — Rick Ciullo, chief operating officer, Hartford Bond

“Cost of letters of credit would be one of the governing factors in a customer or an agent’s decision to use surety bonds instead,” Ciullo said.

But, he said, from the underwriting side, surety underwriters conduct their own analysis. How banks evaluate a risk doesn’t come into their reckoning.

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“It’s not always easy for a surety underwriter to benchmark against letters of credit even if you had access to that kind of information,” Ciullo said.

“At the end of the day, an underwriter’s job is to assess the risk and reach their own decision about what an acceptable price would be and sometimes that matches up with what bankers do and sometimes it doesn’t,” he added.

Some say that the increasing size of construction projects and the need for infrastructure improvements will constrict surety capacity. Hewett said he sees no sign of that.

“We don’t see any indication of any strain in surety capacity,” he said. &

Dan Reynolds is editor-in-chief of Risk & Insurance. He can be reached at [email protected]

More from Risk & Insurance

More from Risk & Insurance

2018 Risk All Stars

Stop Mitigating Risk. Start Conquering It Like These 2018 Risk All Stars

The concept of risk mastery and ownership, as displayed by the 2018 Risk All Stars, includes not simply seeking to control outcomes but taking full responsibility for them.
By: | September 14, 2018 • 3 min read

People talk a lot about how risk managers can get a seat at the table. The discussion implies that the risk manager is an outsider, striving to get the ear or the attention of an insider, the CEO or CFO.

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But there are risk managers who go about things in a different way. And the 2018 Risk All Stars are prime examples of that.

These risk managers put in gear their passion, creativity and perseverance to become masters of a situation, pushing aside any notion that they are anything other than key players.

Goodyear’s Craig Melnick had only been with the global tire maker a few months when Hurricane Harvey dumped a record amount of rainfall on Houston.

Brilliant communication between Melnick and his new teammates gave him timely and valuable updates on the condition of manufacturing locations. Melnick remained in Akron, mastering the situation by moving inventory out of the storm’s path and making sure remediation crews were lined up ahead of time to give Goodyear its best leg up once the storm passed and the flood waters receded.

Goodyear’s resiliency in the face of the storm gave it credibility when it went to the insurance markets later that year for renewals. And here is where we hear a key phrase, produced by Kevin Garvey, one of Goodyear’s brokers at Aon.

“The markets always appreciate a risk manager who demonstrates ownership,” Garvey said, in what may be something of an understatement.

These risk managers put in gear their passion, creativity and perseverance to become masters of a situation, pushing aside any notion that they are anything other than key players.

Dianne Howard, a 2018 Risk All Star and the director of benefits and risk management for the Palm Beach County School District, achieved ownership of $50 million in property storm exposures for the district.

With FEMA saying it wouldn’t pay again for district storm losses it had already paid for, Howard went to the London markets and was successful in getting coverage. She also hammered out a deal in London that would partially reimburse the district if it suffered a mass shooting and needed to demolish a building, like what happened at Sandy Hook in Connecticut.

2018 Risk All Star Jim Cunningham was well-versed enough to know what traditional risk management theories would say when hospitality workers were suffering too many kitchen cuts. “Put a cut-prevention plan in place,” is the traditional wisdom.

But Cunningham, the vice president of risk management for the gaming company Pinnacle Entertainment, wasn’t satisfied with what looked to him like a Band-Aid approach.

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Instead, he used predictive analytics, depending on his own team to assemble company-specific data, to determine which safety measures should be used company wide. The result? Claims frequency at the company dropped 60 percent in the first year of his program.

Alumine Bellone, a 2018 Risk All Star and the vice president of risk management for Ardent Health Services, faced an overwhelming task: Create a uniform risk management program when her hospital group grew from 14 hospitals in three states to 31 hospitals in seven.

Bellone owned the situation by visiting each facility right before the acquisition and again right after, to make sure each caregiving population was ready to integrate into a standardized risk management system.

After consolidating insurance policies, Bellone achieved $893,000 in synergies.

In each of these cases, and in more on the following pages, we see examples of risk managers who weren’t just knocking on the door; they were owning the room. &

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Risk All Stars stand out from their peers by overcoming challenges through exceptional problem solving, creativity, clarity of vision and passion.

See the complete list of 2018 Risk All Stars.

Dan Reynolds is editor-in-chief of Risk & Insurance. He can be reached at [email protected]