As 2019 comes to a close, the overall economy remains positive and continues to grow. Though at a slower pace than experienced in 2018 and early 2019, 2020 should continue to show slow to moderate growth as the forecasts of many economists shift gears to a more cautious outlook.

Although continued optimism may be declining for some, the surety and construction industry remains very fruitful. The surety industry is reporting another record year in direct premium written and overall capacity, and the availability of credit is at an all-time high. Contractors’ backlogs are strong and profit margins appear to show signs of not only stabilization, but also slight increases in some trades.

In 2018, The Surety and Fidelity Association of America (SFAA) reported overall direct premium written of $6.6 billion, up from $6.2 billion in 2017. The SFAA anticipates similar growth results for 2019 and likely 2020, with relatively low losses across the board.

Parallel with the surety industry’s results, non-residential public construction spending remains up nearly 6.4% from this time a year ago. With an election year on the horizon, and increasing infrastructure needs, non-residential spending should continue to grow in 2020.

The availability of credit is in abundance for both small (under $10 million), medium ($10 - $100 million) and large ($100 - $250 million) size contractors. Because of the appearance of an endless surplus of work, many contractors are pushing their aggregate programs and continuing to show healthy backlogs going into 2020. The excessive amount of credit in the small-to-large markets has led many surety companies to soften their underwriting guidelines in an effort to obtain additional market share. This has been great for the surety consumer, but will likely have a detrimental long-term impact on inevitable future surety industry loss results.

Another interesting trend in 2019 is resurgence of subcontractor default insurance (SDI) in the market. SDI is an alternate product to bonding and, over the past 5-10 years, has experienced sizeable losses due to poor management of aggregate exposures. However, recent guideline changes and market conditions have given SDI new life and this has attracted a number of new players to the SDI marketplace.

Although margins are good and backlogs are increasing, contractors are still facing a wide range of challenges similar to the past few years, including labor shortages, rising material costs and the uncertainty of fiscal and government policy.

Even with the small-to-large markets having such strong results in 2018, not all is smooth sailing, notably in the megaproject arena (greater than $250M) where the surety industry has experienced sizable losses and some significant contractor failures. These large losses may be isolated but, once fully realized, could have a significant impact on the overall construction and Surety industries. This will eventually lead to a correction in these markets.
This begs the question, “Are you prepared for the next downturn?”

Be Prepared

It’s easy for business owners to fall victim to the trap of maintaining the status quo, especially during times of prosperity. Most contractors simply lack the focus or do not see the value in assessing their operational procedures and committing to improving on them until forced by a market shift or project failure.

However, “best-in-class” business owners understand that now, during prosperous times, is the right time to perform an internal audit of their company’s capacities to capitalize on opportunities and guarantee both short- and long-term success. An operational audit should focus on improving deficiencies and strengthening efficiency in standard operating procedures, internal controls and the successful execution of the overall business plan.

Those waiting for the market to dictate their actions will not only miss valuable opportunities, but may find themselves in a distressed position when the next recession occurs. Here are a few areas that all contractors should be focusing on:

• Human Resources/Risk Control. How a company attracts, trains and retains great people has a dramatic impact on its success. Consider including a Growth and Development Advisor (GDA) to the management team to drive a strategic approach and attack the ongoing labor challenges that have plagued the construction industry. Building a best-in-class culture and onboarding process will pay dividends many times over.
• Project Controls. Adopting and integrating advanced communication and technology into all phases of the business will have a significant impact on morale, productivity and overall profitability. Rapid developments in artificial intelligence, robotics and industry specific automation and data management tools are creating competitive advantages for early adaptors. From estimating and material and equipment procurement to subcontract management and project execution, the opportunities are endless for improving efficiencies.
• Financial Controls. Much like project controls, updating the accounting software to ensure the business is utilizing the right accounting system is a crucial component to driving success. The process should begin with evaluating the market options and discussing company needs with the accounting team and trusted advisors. Whether it’s a fully integrated or standalone product, regularly updating the accounting system and controls will produce more efficiency and, as a result, increase bottom-line success.
• Contract Procurement and Management. Understanding and knowing the best procurement methods for the company and project team are critical in today’s contracting environment. Those firms that don’t properly manage the risks associated with hybrid delivery models -- including P3, IPD, CM/GC, MP, DBB and even some Design/Build obligations with erroneous efficiency guarantees -- could find themselves in a vicious financial trap with unsophisticated owners, design professionals and/or subcontractors.
• Succession/Continuity. Succession planning is a topic most owners avoid. For many, it signifies the culmination of a life’s work and it’s easier to ignore and put it off until it’s absolutely necessary. However, failing to effectively develop a detailed plan can have grave consequences, not only for the company but for business owners and their families. Work with advisors to develop a well thought-out and comprehensive succession plan. The process may take years, but if done right, it can ensure the continued success and legacy of the business.
• Pay Off Debt. To manage swelling backlogs, some contractors have been increasingly dependent on their bank lines of credit or other debt facilities to help bolster cashflow. The challenge this presents is that, once the economy enters the next recession and companies experience reduced revenue and backlogs, contractors might find it increasingly difficult to service outstanding debt obligations. To ease this potential burden, business owners should now look to proactively service debt loads when unearned profits in backlogs are strong.

In lieu of significant labor shortages, rising material costs and uncertain political policies, both domestic and international signs indicate that 2020 will be another profitable year for the surety industry. Direct premium written and construction revenues should be up, contractor failures should remain relatively low, margins should continue to rise and, for most, backlogs should remain strong.

While there is an overall positive forecast for next year, there are some contractors who are experiencing growing pains and having a difficult time managing increased backlogs. But those that are thriving in the current market should not neglect the importance of taking the time to reflect on their strengths and focus on improvements for short- and long-term success.

Conclusion

While it is important that contractors have a basic understanding of the economics of the insurance industry and how this can affect their business, there is nothing they can do about it. The market is the market. What contractors can control is how their company manages risk. Risk management is “market agnostic.” It needs to be front and center all the time.

In the long run, the only way to reduce the cost of risk is to reduce the frequency and severity of claims that drive the cost. An effective risk management program coupled with a proactive risk management-oriented insurance brokerage and the right insurance company is the key to lowering the total cost of risk. Investment in risk management will produce great returns and directly impact the bottom line.