I had the opportunity to contribute an article to the September 2020 edition of the Austin Construction News publication. You can find the article here.
Common Risk Factors in Surety Underwriting
Eric Schmalz, Principal, Schmalz & Associates Surety Bonding
When I began my surety underwriting career in 2002 as a trainee, one of the foundational books I was given to read was “Construction Contractors’ Survival Guide” by Dr. Thomas C. Schleifer. The book was written for construction contractors to learn from, but the parallels to surety underwriting make it a tremendous asset in learning about elements of contractor failure that remain unchanged over time. The underlying theme Thomas points out across the various risk factors is that the project will likely get done, but will it get done profitably? This is a very important question. I will focus on two of the most common risk factors outlined in this book and I highly recommend visiting Thomas’ website letstalkbusiness.net for many more helpful resources.
Increase in Project Size
Most contractors can build a project that is two, three, or even four times their largest project to date. But it is easy to underestimate the strain a very large project puts on the companies’ resources. A contractors’ balance sheet that is set up to handle their normal project size and backlogs, can be strained significantly if slow pay occurs on a much larger project. This project is often longer in duration, which creates a heavier impact on cash-flow from retention held and is more complex to finalize. A large project requires greater management supervision and likely requires an increase in oversight from owners, engineers, and architects. The last point I’ll note is the opportunity cost – the very large project will require dedicated management from key people who could have otherwise managed a couple of smaller projects, and your bonding company may be fairly conservative in supporting additional projects of size until the large project is complete. The best advice is to take measured, incremental increases in project size while expanding your company resources to meet those demands.
Change in Geographic Location
A change in geographic work location can change many risk variables for a contractor. Travel, housing, site conditions and weather are just a few factors that add cost, risk, and require a well thought out plan. Finding local subcontractors, labor, equipment, and material supply can all present challenges not dealt with in your normal operating territory. At a minimum you may not receive the best pricing quotes available and less than optimal service. Bidding and winning a project in a small town that is new to you can also present political and bureaucratic challenges. You are not around to hear how the local government and residents view the project. There may be some unfair treatment by locals who do not like or want the project built. The regulatory oversight and inspection process can be very different than with owners you are used to working with. A prudent course of action to expand geographic footprint would be to operate on the fringes of current territory and branch out further in a measured fashion.
In the surety industry we have experienced contractor failures as a result of a contractor taking on a job with one of these two risk factors, amongst other reasons. If you are exploring a job that will require a surety bond and the job is significantly larger than anything you’ve completed previously or in a new geographic location, you can expect questions to be raised. These issues can be overcome with proper planning and good communication with your surety agent and surety company.
Dr. Thomas C. Schleifer has vast experience in the construction industry and serves as a turnaround expert for sureties and contractors. He has written extensively on a variety of construction related issues. I would highly recommend picking up one of his books or reading some of his articles.
Schmalz & Associates is an agency exclusively supporting contractor’s bonding needs. Eric Schmalz was an underwriter and manager for over 15 years working for Top 10 surety companies and now helps his contractor clients establish and maximize their surety bonding. Please call 512-640-6444, email eric@schmalzsurety.com or visit the website at www.schmalzsurety.com
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