Red Flags Are Flying
October 17, 2023
Seemingly against the odds, the surety industry continues to experience fairly low losses in 2023. While the overall frequency of construction bonding losses is low, their severity is up, significantly. So what’s responsible for the spike? Merchants’ Vice President – Claims Jay Farley points out some operational red flags – practices he sees contributing to the severity of contractors’ claims and losses.
5 Operational Practices Impacting Loss Severity
· Underbidding sometimes reveals itself early relative to other bids, which increases the importance of conducting a thorough review of bid tabulations and estimates/proposals. Underbidding in relation to actual expenses is a reflection of contractors failing to control or properly account for – contractually, financially, or otherwise – price increases in overhead, labor, and materials over the course of a project. From a loss perspective, it places the surety in a hole because the contract amount is low relative to the cost to complete remaining work.
· Overbilling can be the result of underbidding a project in the first place, because billings are too low to generate sufficient cash flow to cover job costs. Overbilling in relation to actual work in place – for example, billing 75 percent of the contract amount when 50 percent of the work is complete – serves to increase the loss further because the contract balance is not enough to cover the cost of the remaining scope of work (even at original contract pricing).
· Defective work increases the loss in a number of ways: 1) defective work can necessitate investigation and testing; 2) repair work increases the completion scope of work; 3) the scope of repair can be difficult to ascertain with certainty, which results in contingencies and higher pricing; and, 4) repair work extends the time necessary to complete the remaining work, which increases general conditions and the likelihood of delay damages.
· While past-due payables often result in payment bond claims that can serve as an early indicator of a contractor’s financial strain, that is not always the case. Sureties are encountering high 90+ day old balances, often without any prior notice or claim, which leads to strained or ruined vendor relationships, charges and penalties, and additional losses.
· Delays in projects. This can result in supplementation costs and delay damages, including liquated damages, which reduce the contract balance and ultimately increases the loss.
Contractors should be mindful of these issues, in assessing their own operations as well as those of subcontractors and suppliers. They should also partner with a surety that demonstrates a proactive approach to claims. The right surety partner will seek to bring value to the relationship by working with contractors to avoid claims, and if the situation is unavoidable, to mitigate the severity of it.