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: Dan Reynolds | August 30, 2018

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.

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.

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.

“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].

How a Carrier Partner Can Help Navigate a Challenging Management and Professional Liability Market

A combination of a choppy economy with increased claims frequency and severity could lead to rate increases in the Management & Professional Liability market.

By: Risk & Insurance | April 3, 2024

Rates in the management & professional liability (M&PL) markets were on the rise from 2020 to early 2023 and are now falling rapidly.

M&PL divisions manage a number of different insurance products including management liability (D&O), professional liability (E&O), employment practices liability (EPL), fiduciary liability policies, cyber, etc. In 2023 and into 2024, a big influence on the marketplace has been the extremely aggressive and softening public company D&O market.

Though these rates have been softening for management liability, that may change over the next few years as companies continue to adjust their business models motivated by economic uncertainty. Layoffs were up nearly 200% last year, Forbes reported, even as other recession indicators, like the inflation rate, improved. A recession could lead to an increased claim activity and force carriers to raise rates.

“Whenever there is a meaningful downturn in the economy, we tend to see claim frequency pop up,” said George Schalick, Jr., senior vice president of the Management and Professional Liability Division at Philadelphia Insurance Companies (PHLY).

With continued fiscal uncertainty, businesses potentially already burdened with pandemic-related claims should seek a carrier with a long history in M&PL products. They will provide much-needed risk management guidance and be better positioned to support their insureds during market fluctuations.

Why Insureds Might See an Uptick in M&PL Claims

George Schalick, Jr., Senior Vice President of the Management and Professional Liability Division, Philadelphia Insurance Companies

The current soft market might come as a bit of a surprise as it does not track with previous underwriting cycles and economic conditions. Afterall, many privately held and non-profit organizations struggled during the early days of the pandemic with shutdowns and rapidly declining revenues. But the Government assistance programs, like the Paycheck Protection Program loans, helped keep many afloat during the tough times.

“During COVID many organizations stopped doing business until they were able to sort out all of the health and safety challenges,” Schalick said. “They were forced to lock down, but then all the government assistance programs allowed them to keep people employed. The increased volume of claims we anticipated we would see coming from the lockdowns and restrictions that were imposed upon businesses in the U.S. didn’t manifest at first.”

“Just because there wasn’t an onslaught of reported claims at the beginning of the pandemic, doesn’t mean the circumstances that would give rise to a claim being reported didn’t occur. Courts and the judicial system were closed or slowed and now that they are back open, we’re starting to see the circumstances that occurred during the COVID lockdowns becoming claims today,” Schalick said. “Litigation is progressing.”

Added to the delayed pandemic litigation is a concern over newer claims that might be filed as the country inches toward an economic downturn. Though a recession was avoided in 2023, experts think a soft dip could occur in 2024, with 76% of economists saying there’s a 50% or less chance of an economic downturn this year — that almost always results in more management liability claims.

“During the Great Recession in 2008, we saw an almost immediate spike in claims because of the economic conditions and the pressure it placed on organizations. They were making personnel changes with significant belt tightening almost immediately.” Schalick said.

What’s in Store for M&PL Policy Rates in 2024?

Despite an uptick in claims and increased economic uncertainty, management liability rates haven’t increased, resulting in market-wide pricing levels that may not meet the increased pressure of rising settlements and jury verdicts.

“Rates are going the other direction and settlement values are not falling,” Schalick said.

The mismatch between rates, claim frequency and severity is, in part, because carriers experiencing the dramatic soft market in the public D&O market are seeking premium gain in the private and non-profit market.

“In the public company market, the rates have been decreasing significantly. The rates were increasing in the private, not-for-profit market, and rightfully so, but there’s a desire to supplement overall mid-size D&O for carriers who also write private not-for-profit, and they see that as an opportunity to aggregate premium,” Schalick said. “So the always competitive landscape in the private, not-for-profit market has dramatically increased in the last 18 to 24 months.”

Still, companies of all sizes and types should be concerned about management liability rates in the future. Legal system abuse is resulting in increases in both the amount of litigation and the size of verdicts plaintiffs are receiving.

Certain areas of the country are particularly vulnerable to this type of legal system abuse. As a result, insureds in these localities are likely to be vulnerable to rate increases.

“The environment is so positive for the plaintiff that forces premium increases so carriers are able to stay in that market long term,” Schalick said.

Why a Tenured Carrier Partner Can Help Insureds Navigate An Uncertain Market

It’s clear that insureds are facing an uncertain M&PL market over the next few years. Fortunately, carriers with a long history in the M&PL space will be there to offer stability.

Philadelphia Insurance Companies has been supporting this market for 35 years. PHLY is committed to offering long-term rate stability, even as economic and claims trends start to push premiums upwards. They have an appetite for all sorts of companies, large and small, for-profit and nonprofit alike.

“We’ve been at this game for a long time and are one of the most tenured underwriters in this space,” Schalick said. “We like to stay very consistent.”

PHLY has worked with both for-profit and non-profit on management liability policies. With dedicated M&PL teams throughout the company’s 13 regions, PHLY provides the support agents and brokers are looking for on behalf of their clients. The teams know their regions well and can respond to local trends. They’re also dedicated to making the renewal process as easy as possible for their partners and policyholders.

“We have real confidence in our results, so we focus a lot on making the renewal experience as painless as possible for all agents and insureds,” Schalick said.

The company is also investing in tools to help insureds avoid losses. Earlier this year, they launched a new online risk management platform, PHLYGateway, which offers resources for insureds on how to create an employee handbook and trainings on issues such as recognizing workplace sexual harassment and discrimination.

If insureds have questions, they can consult a Best Practices Help Line, provided via the platform. That way, they can get on the spot risk management guidance to help them prevent claims.

To learn more, visit: https://www.phly.com/mplDivision/managementLiability/default.aspx.

This article was produced by the R&I Brand Studio, a unit of the advertising department of Risk & Insurance, in collaboration with Philadelphia Insurance Companies. The editorial staff of Risk & Insurance had no role in its preparation.

Risk Focus: Surety