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Financial Perspective – March 2016

Financial conditions for contractors continued to improve in 2015, making the year another healthy and profitable one for the surety industry; however, some significant individual losses, coupled with significant changes among the insurers is making the outlook for 2016 more dynamic than in recent years. Even with public construction making a comeback from almost a decade of underinvestment, buyers of surety bonds will be in the driver’s seat. That’s good news for contractors looking to add capacity or improve conditions but it’s worth noting that the construction industry has rarely benefitted from a soft surety market in the long run.

Based on premiums and losses recorded through September 30, 2015, the total loss ratio for all surety companies is forecast to be around 17.5 percent for the full year. That’s the seventh year in the past ten that the industry’s loss ratio was below 20 percent. The benchmark for profitability is 25 percent so sureties should have prospered again in 2015.

“In January my partners and I jump on a plane or hop in a car and visit every one of the insurers we represent. We go see the decision-makers, the policy-makers, even though they may have an office in Pittsburgh,” notes Brian Jeffe, managing partner of surety bonds for agent Seubert Inc. “For the third year in a row the surety industry did well in 2015. [Surety] mirrors the construction industry. 2014 was better than 2015 and 2016 should be better than 2015. Losses are still well below 25 percent.”

Much of the credit for the strong loss ratio performance goes to simple market improvements over the past five years. As volume has returned, contractors were able to land profitable work that enabled them to work through any weak projects with fewer defaults. Surety underwriters obviously deserve a share of the credit. Proactive during the wrenching downturn in 2009 and 2010, sureties avoided repeating many of the mistakes that plagued the industry during the 2002-2004 recovery. It also helped the insurance business in general that the years since the Great Recession have seen far fewer major disasters like those that occurred between 2001 and 2005.

The need to recover from losses like 9/11 and Hurricane Katrina pushed sales ahead of prudence. That was reflected in high premium growth, which spilled over into surety premiums and surety underwriting standards. By comparison, 2015 premiums were roughly $4.5 billion, down almost 20 percent from the heyday, and up about two percent from 2014. That means there is still plenty of excess capacity and room for growing premiums. Conditions in the general property and casualty insurance market are even softer, with even more appetite for premiums. That has made for a buyer’s market.

“I’ve seen a couple of deals come through that surprised me in terms of rate and capacity, especially capacity,” observes Jeff Ream, executive vice president for Willis of Pennsylvania. “The property and casualty market is relatively soft.”

Still, few surety agents expect to see pressure for revenue impact underwriting. More to the point, the expected conditions for contractors should allow for growth even with the same underwriting standards.

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