Canadian Underwriter

Some increased risks developing in surety space, but these can be managed: panel

November 14, 2016   by Angela Stelmakowich

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The outlook for surety in Canada is healthy, but a number of developments are introducing increased risk that need to be taken into account and properly managed, speakers suggested during the Toronto Risk and Insurance Education Forum last week in downtown Toronto.

Likely, “80% or so of the bonds issued are these approved (by Canadian Construction Document Committee, CCDC) forms of bonds,” said James MacLellan, a partner with Borden Ladner Gervais LLP in Toronto.

MacLellan noted there are three main types of bonds: bid bonds, which guarantees the contractor who submits a bid will enter into a final contract; performance bonds, which can guarantee any underlying contractual obligation and are likely the most common bonds; and labour and material payment bonds, which guarantee that sub-trades and suppliers will be paid.

Despite the vast majority of bonds being CCDC-approved, “more and more, owners are drafting their own forms of bonds and imposing them on sureties,” MacLellan, part of the Technical Review and Risk Allocation panel, reported to attendees.

Related: Surety Association seeks changes to Ontario bill to prevent ‘rash of claims’ on performance bonds

“These bonds are designed to download risks onto sureties that sureties typically don’t accept and typically don’t cover,” he explained. “So more and more, your sophisticated owners are creating their own bond form, which significantly expands the risk profile for a surety.”

Surety bonds are “an on-default instrument; it is not an on-demand instrument,” said Stuart Detsky, assistant vice president of surety and warranty claims for Trisura Guarantee Insurance Company.

However, “there is a push from certain owners to make certain parts of bonds on-demand,” Detsky noted. “I think we’ll see this change over the next five to 10 years as more and more companies from outside of Canada come into Canada to do contracting,” he explained.

The push will not be so much from the United States – which has a very established surety history and where most states require bonding for public projects – but more so from Europe and other parts of the world, Detsky said.

It is from Europe and other areas “where you’re seeing contractors, especially larger contractors, come into Canada,” he said. Not used to the surety manner of risk mitigation used in Canada, instead, they usually use “guarantees, letters of credit, those types of things,” he reported.

“So I think we’ll see a shift to bonds that are a little bit more partially on-demand, but that remains to be seen,” Detsky predicted.

Of course, others in the construction chain are also taking on increased risk in the wake of the changing environment.

In the public-private partnerships (P3) space, for example, “it’s very prominent that the contractors take on a tremendous amount of risk compared to what would have happened 20 years ago,” said Devon Maltby, field vice president of surety for Travelers Canada.

But the development need not be a problem. “They just have to be very good and adept at managing that risk. It’s not necessarily a bad thing,” Maltby emphasized.

Typically in Canada, surety buyers are public entities such as municipalities, provincial bodies and the federal government, said Dan Calderhead, managing director and branch manger of the construction division at Jardine Lloyd Thompson Canada.

“They request about 80% of the bonds in Canada,” Calderhead noted, with the remaining approximately 20% being private owners.

Here, again, some changes are under way.

Since a private owner will often need to borrow money for the project from finance company, the finance company will likely require the contractor to be bonded to offer protection should a job go sideways, Calderhead said.

While those trying to get a bond are often contractors, sub-contractors and road builders, anyone who qualifies for a bond can get one, he explained.

Consider a guy and his pick-up truck. “In the old days, he would have a hard time getting a bond, but these days, the thresholds have come down a bit. I think it’s not a bad thing because these guys need a chance to start off their companies.”

Bonding companies “have made it easier these days to set up bond facilities for the smaller operator,” Calderhead noted. “The thresholds are quite low these days. That’s not a bad thing as long as it’s handled responsibly,” he said.

With contract forms – much like the bond forms – “if you look at the U.S. marketplace 10 or 15 years ago, it was extremely aggressive,” Maltby said, noting firms in Canada may not have considered bonding some such projects.

“It’s becoming more and more commonplace here. So, again, a downloading of risk,” he explained.

“Risk is fine. I think the contractors have to be adept at understanding it, pricing it, and I think that’s where you can find problems these days is where people are assuming risks that they didn’t necessarily understand,” he cautioned.

Citing numbers from the Surety Association of Canada, Maltby reported that over the last six years, surety “has been growing and we expect it to continue to grow. Construction, for Canada, is an extremely important part of our GDP (gross domestic product).”

Estimating “the average surety expense ratio could be in the mid-40s, a bit higher for some,” he pointed out that this is attracting capital and new entrants.

“At the primary level, we’re seeing a tremendous amount of support from the reinsurance community,” Maltby said, adding that the number of surety players in the space has grown to about 40.

“That has increased the availability of capacity and is leading to what, I think, many folks believe is probably one of the most aggressive surety markets in history,” he told attendees.

On the flip side, however, increased capacity is one possible determinant “that can cause the next loss. Excess surety capacity can trigger a higher level of defaults going forward,” Maltby cautioned.

“The underlying assumption is that we underwrite to a 0% loss ratio,” Maltby told attendees. “I think relative to the premium that we’re able to charge increasingly in this aggressive marketplace, those losses are big. So it’s a bit more like a catastrophic scenario compared to say a lot of lines of insurance,” he said.

One of the differences between insurance and surety is that there is no annual renewal with the former, Calderhead noted, likening it to a rolling relationship.

“It’s not so much price-sensitive. Bonding companies historically don’t compete on price in a large way,” he explained. And even though things are “becoming a bit more competitive,” Calderhead said, “for the most part, (price is) not an issue.”