Spotlight: Surety Bonds - The importance of bonds and guarantees and their effect on the UK construction market

Surety bonds provide a guarantee to a third party that their counter party in a contract will deliver on their obligations.

David Chandler, underwriting manager – surety at Liberty Mutual Surety, says: “Our surety team support our clients with bond solutions that underpin their contractual obligations and in turn provide their clients with certainty.”

Bonds and guarantees play an increasingly important role at a time when there is mounting pressure on businesses and concerns over their ability to deliver on their contractual obligations. 

In January 2018, the collapse of Carillion sent a shockwave through the construction market, given the size of the business and the number of projects with which it was associated. There are also longstanding issues in the sector around skills shortages, labour availability and rising material costs. These issues have combined together to make it more difficult for construction companies to deliver.

Steven Lewis, joint practice leader – surety UK & Ireland at Marsh Specialty, says: “One of the main factors which determines the demand for surety bonds is economic uncertainty. When this increases, employers look to protect their projects from contractor insolvency. One method of doing this is to require the contractor to put in place a surety bond upon contract award.

“Within the construction sector there are a number of headwinds, such as the withdrawal of the various government Covid-19 support schemes, increasing inflation, supply chain issues and the conflict in Ukraine, all of which could detrimentally impact contractor cash flows.

“As a result, there is an increasing risk of contractor insolvency over the coming months; we expect there to be an increase in demand for surety bonds as employers look to protect themselves from this risk.”

Common construction bonds

The UK surety market is well established in the UK construction sector, predominantly supporting clients with performance bonds, which guarantees third parties that their client – the contractor – will meet their obligations as set out in the agreed contract. However, there are also several other bonds available in the market to help the construction sector.

Chandler explains: “We offer a number of different surety products including performance, advance payment and retention bonds, which support our clients throughout a construction project.”

He adds: “In sourcing a bond from a surety company such as Liberty, our clients are able to exhibit a level of stability in a market which currently has a number of different headwinds, including inflation, material availability and labour shortages. Our network of global offices and local underwriting expertise mean we can support our clients with UK and International requirements when required.”

Alternative options

One of the major competitors for the insurance-backed surety market is the bank market, although in recent years, banks have reduced their appetite for this business.

At a national level in the UK, this has been driven by the fallout from the failure of Carillion in 2018 as well as a rising number of insolvencies across the construction sector more generally. At an international level involving some of the biggest global construction projects, banks have also switched their focus to more local or regional projects.

James Souter, executive director at Howden, comments: “Some of the banks really want to focus on home territories and I think a number of banks have become less global. Where they are willing to support customers has become more regional and more local.”

For insurers supporting the surety market, a key underwriting consideration is the current and future financial performance of their clients. Underwriters need to be comfortable with the ability for their client to continue as a business and meet their contractual obligations. This feeds all the way down the sub-contracting chain.

Chandler says: “Bonds and guarantees flow throughout a construction chain from the ultimate employer down to the contractor and sub-contractors.”

Standard UK market performance bonds are 10% of the overall contract value and can cover some of the UK largest infrastructure projects down to a small regional contract.

Chandler says: “Liberty seeks to establish long-term relationships with clients, and offer a surety facility, which provides clients with a level of support in respect of their bond and guarantee requirements. Our clients then turn to Liberty with specific bond requirements with which Liberty can assist with contract negotiations and bond wording reviews.”

The UK market standard bond wordings are accredited by the Association of British Insurers, although Chandler says there is increasing input from legal representatives on behalf of an employer which require underwriters and client to be aware of the terms and conditions they are being asked to accept.

He comments: “A significant and important part of an underwriter’s job is to ensure that bond wordings issued cover obligations which are acceptable to both us and our client. It is important that we work with our clients to ensure that we – and, therefore, they – are not assuming additional contractual risks particularly during a period of enhanced uncertainty.”

Capacity levels

Despite the caution created by the ongoing pandemic, sureties have maintained capacity levels in the bond market and Lewis at Marsh Speciality expects this to continue in the short term.

He concludes: “While surety underwriters have been cautious over the last two years of the pandemic and have taken a more rigorous underwriting approach, capacity for surety bonds in the construction sector has on the whole been maintained.

“As contractors move out of the pandemic and deal with the current issues affecting the sector, it is important for them to work closely with underwriters and their specialist brokers. Regular communication and enhanced information flow is key to ensuring they have sufficient bond capacity arranged to deal with the expected increase in demand for surety bonds.”

Sponsored