2020 was supposed to be a year of moderate growth for the construction industry. In December of 2019, The American Institute of Architects projected a 1.5% increase in spending across non-residential projects. That figure has since been revised to a decrease of 11%.

The U.S. construction industry has been hit hard by the economic shutdowns ordered to slow the spread of the novel coronavirus, and the recovery is expected to be steady but slow. Surety underwriters are paying close attention and preparing for a tough 2021.

“I’m anticipating a 5 to 10% drop-off at least in surety premiums across the industry,” said Kevin McCann, Vice President, Chief Contract Officer Surety Division at Philadelphia Insurance Companies. “The work will come back, but it’s going to take discipline from both contractors and surety providers to manage through the losses and maintain a steady pace of recovery and growth.”

That pace depends on a number of variables, from the impact of vaccines on economic activity, to the availability of public funding and courtroom determinations of liability for project delays. Here are a few of the factors to watch in 2021 that will shape the overall health of the construction industry and how surety providers respond to support contractors in the future:

1) Availability and Application of PPP Funds

Kevin McCann, Vice President, Chief Contract Officer Surety Division at Philadelphia Insurance Companies

While some projects stalled for just a few weeks in the spring, others were scrapped altogether given the climate of economic uncertainty. Projects reliant on public funding were hit hardest, as those dollars were reallocated toward pandemic response.

Fortunately, many contractors were able to take advantage of Paycheck Protection Program (PPP) loans to stay afloat. Any portion of these loans used for eligible expenses — including payroll costs, payments on business mortgage interest payments, rent, or utilities — can be forgiven.

“For contractors in states less affected by shutdowns, these loans were instant equity. Among those that accepted the loans, around 75% to 80% will qualify for forgiveness,” McCann said. “The program has been a huge help in carrying contractors through that initial slowdown of work.”

Interest rates can vary and the repayment timelines can go from 2 to 5 years. The way that contractors account for this debt will have a meaningful impact on their balance sheet strength, and thus their competitiveness on future bids.

“Contractors’ end-of-year financial statements will be coming out in the spring — when the true impact of COVID will be known,” McCann said. “As a surety company, we’ll be looking to see how those PPP funds were applied. CPAs have been advising their clients with proper guidance on how to treat the potential short and long-term liability of these loan repayments. This guidance will have a significant impact on their balance sheets, given the anticipated repayment terms on these loans.”

“We’ll be examining those statements carefully, deciphering the CPAs’ footnotes to ensure contractors used and documented their loans correctly, and to determine how their overall financial health was affected by the pandemic.”

2) Determinations of Liability for Project Delays

Contractors have an obligation to deliver projects on time and on budget. State-mandated shutdowns ordered in March and April made that impossible, but the delays stretched on even as projects restarted due to the need to enforce extra safety precautions. To ensure appropriate distancing, subcontractors in many cases had to be staggered to limit the total number of people on site.

Though these delays were not the fault of contractors, the fact remains that contractual obligations were broken, and some project owners may seek compensation for the extra expenses incurred due to missed deadlines. Determinations of liability for those expenses will be made in courtrooms next year, but surety underwriters should be taking into account all the project factors on a case-by-case basis to assess for any potential delay exposure.

“It will be interesting to see how the courts interpret the delays on these projects, but we’re learning from what we’ve already seen in this pandemic. We’re incorporating language into our contracts and our bonds going forward to address force majeure or ‘Act of God’ shutdowns that would otherwise not be included,” McCann said.

He also encourages contractors to examine new contracts with project owners for similar language and argue for terms that excuse them from liability associated with delays beyond their control.

“Our surety underwriters can help with that. They will review contracts on behalf of our clients to pull out the hot points that affect us and them, such as cure provisions, default provisions, and damage provisions,” McCann said.

3) Fragile Resurgence of New Projects

An uptick in publicly funded projects will depend heavily on assistance from the federal government. The new stimulus package will take time to work its way through state administrations and trickle down to municipalities.

“The fact is the money for public projects just isn’t there and may not be until late spring or early summer. I’m not expecting to see a meaningful increase until June, with activity slowly returning to pre-pandemic levels in 2022,” McCann said.

New activity will also be influenced by the population’s acceptance of vaccines.  In the best-case scenario, a high enough percentage of citizens become inoculated against COVID-19 to drive down case counts and justify broader economic reopening.

Private projects will also be on hold as investors and developers wait to see whether the influx of new stimulus dollars and vaccine doses make a material impact on economic recovery. Big projects require a certain significant degree of confidence, and currently reasons for confidence remain tenuous.

In the meantime, McCann advises contractors to maintain discipline and stay selective about the projects, even under financial pressure.

“Don’t bid on projects outside your wheelhouse just because they are available or bid too low in an attempt to win more jobs. Do what you’re good at and don’t undervalue yourself. The current challenging environment will eventually end, and your business will be better off in the long term by focusing on quality first,” he said.

He also recommends verifying project owners’ financing whenever possible. This may be a bit more difficult when the owner is a public entity, but it is important to understand whether the budget is dedicated or allocated, and the likelihood that it could dry up or be directed elsewhere.

The Best Surety Is More than a Last Line of Defense

Typically, sureties are only called upon once a project has gone off the rails. But the best surety companies are much more than a last line of defense; they are advisors and partners in risk management.

To offer sureties with confidence, underwriters need broad expertise in the construction industry and specific knowledge of a contractor’s business. They can leverage that knowledge to offer guidance through difficult downturns like this one.

“Philadelphia’s surety underwriters have an average 20 years of experience and, while none have lived through a pandemic, they are familiar with market downturns and understand the discipline it takes to not just survive, but thrive over the long term,” McCann said.

Philadelphia also invests in its future through a training program established in 2013, which gives new grads the opportunity to work with and learn from industry veterans. A generation of underwriters may be nearing retirement, but their knowledge and insights won’t be going with them. Their well-trained successors will ensure a consistently high level of service for years to come.

“The strength of our company really is due to the strength of our people, all the way from senior management to our trainees,” McCann said. “We have a very flat structure, which allows for more seamless communication, and I think that matters now more than ever. We’re all going through this unprecedented period of difficulty for the first time together, so we have to make sure we’re on the same page with each other, and with our clients.

“Our goal is to communicate on the same wavelength, understand the same problems, and make sure that no one feels that they’re on an island with any problem.”

To learn more about Philadelphia Insurance’s surety business, visit https://www.phly.com/surety/.

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.