Surety bond underwriting is a daunting task because there are many factors that influence the decision to issue a bond to a contractor. A surety bond is not a two-party insurance policy, which is underwritten on the basis of statistical models using historical loss data. Rather, it is a three-party instrument, underwritten on the evaluation of an individual contractor’s ability to perform the contract to be secured by the bond.

As part of the evaluation, the surety underwriter must now carefully consider pandemic-related risks, which are outside the contractor’s control and therefore difficult, if not impossible, to evaluate. Financial protection for a contractor’s inability to fulfill contractual obligations in the current marketplace carries far more risk than before the COVID-19 pandemic. What’s more, it is hard to predict how long the pandemic will last, making non-completion or delayed completion of work a near certainty.

The construction industry is fraught with risk and uncertainty even in good times, and the pandemic has significantly added to industry-wide risk and uncertainty. Many states have deemed construction non-essential, which has resulted in the complete shutdown of some construction activity, except for pandemic-related projects. Other states have designated construction as an essential business so that construction projects continue, although at a slower and more restrictive pace due to federal guidelines and state and local orders designed to protect the health and safety of those both on and off the job site.

The pandemic has resulted in shortages of both labor and material, further leading to uncertainty for underwriters. Due to the COVID-19 restrictions, many contractors have furloughed or laid off all or part of their workforce until the crisis abates. Both the Centers for Disease Control and the Occupational Safety and Health Administration recommend that employees stay home if they display symptoms or have household members with the disease. Further, social distancing requirements on job sites and pandemic-related absenteeism will cause a delay in completing construction tasks.

Material sources are threatened due to supply chain disruptions and the shifting of manufacturer’s priorities to products needed to combat the virus. Many construction material suppliers have reported that the outbreak is adversely affecting their businesses. Government-imposed restrictions on certain imports have also disrupted supply chains. In addition, COVID-19 spikes in geographic hot spots have caused state and local governments to partially or wholly reinstate stay at home orders, resulting in the complete or partial shutdown of construction. These are only a few of the many impacts on labor and material that either are occurring or are anticipated to occur due to COVID-19.

Most public works projects require bonding. But on private projects, the pandemic-induced economic shutdown/slowdown has resulted in renewed interest in surety bonds or similar forms of security at the general contractor and subcontractor level to provide a financial backstop to protect the owner’s investment.

When a surety issues a bond, it does not expect to incur a loss. The surety underwriting process is the rigorous evaluation of a contractor’s creditworthiness to satisfy the surety of said contractor’s ability to perform bonded work at no loss. Although every surety company has its own unique underwriting standards, requirements and processes, there are common fundamentals of underwriting, both objective and subjective.

Underwriters talk about these fundamentals as three Cs: Capital, Capacity and Character. The surety underwriter conducts a careful and thorough examination of the contractor’s financial condition (Capital), and the ability of the contractor to successfully complete contracts (Capacity), all of which involves the collection and verification of information from the contractor and third parties.

The underwriter must be satisfied that a contractor has the ability to meet current and future obligations, has a good reputation, has experience meeting the requirements of the projects to be undertaken, and has (or can readily obtain) the labor, material and equipment necessary to perform the work. The surety also looks for contractors who run a well-managed, profitable enterprise, keep promises, deal fairly, and perform obligations in a timely manner (Character).

In the post-pandemic construction world, the surety will be much more selective in approving a contractor’s bonding request. Character, more than all other criteria, will be critical to the surety underwriter’s decision to extend surety credit to a current or new account.

Given the risks posed by the pandemic, the underwriter will require more detailed information and documentation on the individual contracts it is asked to bond. Pre-pandemic, many underwriters were not overly concerned about the provisions in the individual contracts for which bonds were sought. Instead, the underwriter relied more on the contractor’s track record and financial strength to approve bonds.

However, the pandemic has prompted underwriters to pay greater attention to provisions in the proposed bonded contract relating to delays, extension of time and compensation for delays. The underwriter will surely want to know if the contract contains a force majeure clause or similar provision addressing relief from delays and disruptions caused by the pandemic. Force majeure clauses operate to excuse performance obligations or to extend time of performance on a contract when an event that is beyond the control of the contractor causes a project delay. Such provisions may list acts of God, acts of Governmental Entities, public health emergency, epidemics or terrorism among the delaying events.

These will entitle the contractor to an extension of time and, in some cases, additional compensation for costs and expenses caused by the delaying event. The underwriter will want to know about such provisions since they could provide the contractor with relief from time deadlines and compensation for the delay, thereby reducing the surety’s risk.

In addition, before signing off on a bond request the underwriter may want information concerning any federal, state and local COVID-19 laws, regulations and guidelines pertaining to the project. These can include PPE and social distancing requirements, virus testing, quarantining of workers, likelihood of work stoppages and possibility of site shutdown in the event workers contract COVID-19. Such requirements tend to impede the pace of work on a project. The surety underwriter will question whether the contract time specified is reasonable under current circumstances and will want the contractor to provide a plan for accomplishing the work within the time allotted in the contract given pandemic-related limitations and restrictions.

Such limitations and restrictions will put additional pressure on the contractor’s ability to perform and pay for the work. A contractor looking for surety credit must be prepared to clearly show the underwriter how it will navigate through the limitations and restrictions and successfully complete the contract to be bonded. A contractor should also be prepared to address the following with the surety underwriter:

• actions they are taking to mitigate pandemic related risks;
• identification of any contracts awarded to the contractor that may be or have been postponed or cancelled due to the pandemic;
• impact of the pandemic on subcontractors and their ability to work;
• delayed payments due to the pandemic;
• actions taken to reduce overhead;
• furloughs or layoffs due to the pandemic; and
• access to funds to pay for ongoing operations.

Being prepared to provide that information will assist the surety underwriter in understanding a contractor’s pandemic-related challenges and may help increase the likelihood of securing a bond.