David Hewett, head of Marsh’s U.S. surety practice, has had a 20-year-long career in surety that includes senior positions at XL Caitlin and Zurich. A graduate of Johns Hopkins’ Carey School of Business, Hewett also has held positions at USI Holdings and USF&G. He recently spoke with ENR Correspondent Scott Van Voorhis about how the hot market has caused trouble for some contractors, recent accounting rule changes and the rising costs to sureties of curing defaults.
ENR With the economy booming, what are the most common kinds of defaults you are seeing by contractors?
Hewett Even with the booming economy, we are still seeing defaults on a relatively limited basis. The loss ratio was 14.9% last year, resulting in another year of loss ratio below 20%. We are not seeing a whole lot of default activity. The default activity we are seeing are pretty typically and overextension of contractors in either one of two ways, operationally, and that certainly includes labor and their ability to get labor to perform, and second is financially in that a company or companies have taken on more work than they can finance or they have some sort of liquidity issue.
We've heard about the risks of labor shortages, but a recent default in Spokane is one of the few where there was talk specifically about that issue. Are we starting to see a trend emerge?
I don’t think anyone is seeing it [labor shortage-driven defaults’ as a trend. When you talk to sureties in the industry there is a bit of concern but it is probably a bigger concern to the contractors. When asking about their number one concern today, it is very rare that that [labor shortages] would not be one of the first issues. There are certainly geographies it the country that are facing some very acute labor issues, [such as] the metro Seattle area and more broadly the Northeast. You have some along the West Coast as you get into the tech sector and as you get out west into, say Denver.
What we have heard is that sureties are having a very difficult time getting replacement contractors. The cost of curing those defaults is going up. A default is a bad job. If they (contractors) have five other options, they will take the other five. Because contractors are so busy they are not really hungry to go out and get those bad, default jobs.
Are there any recent defaults or surety losses that are ominous or indicative of risks?
Carrillion, the second largest contractor in the U.K., has gone into liquidation. That is the largest contractor default we have seen in a long time. It’s [relevant] not because Carrillion had jobs in the U.S [but because] the surety that is dealing with Carrillion also has a big U.S. operation. I think the potential fallout could be likely a tightening of underwriting requirements around large international firms.
How will new revenue recognition rules, etc., help at all in assessing a contractor's true financial position?
In talking to leaders in the industry, I they believe it will but they are waiting to see. It will create general consistency between the U.S. and international standards. I don’t think we will know until some statements are issued in 2018.
Has Marsh been involved in creating any bonds with a liquid, fast-pay component? What is the future of such hybrid bonds? Has Marsh been involved in creating any bonds with a liquid, fast-pay component? What is the future of such hybrid bonds?
Marsh, as an insurance broker, gets involved in the public-private partnerships where we see greater use of these bonds. We are seeing more owners ask us about them but we are still not seeing them become standard.
Have there been new entries and exits to sureties, from off shore, from Europe, and what is your advice about changing sureties? Is there ever concern that ones that are in a strong market might not be around in a weaker one?
Virtually all of our clients are interested in maintaining long-term relationships. Most of the new entrants are coming in from overseas. Contractors must balance the relationship with their current surety with the aggressiveness of a new surety. There definitely is that concern that the market could go down and there could be a potential weeding out. Still most people [sureties] in the market will stay below 20% losses. Nobody is predicting we will see a 20% loss ratio go to 50%.
How do the sureties best compete, what should a major contractor expect?
We are mainly seeing competition around who can provide the best solutions, and our job is to get those solutions in front of clients. Construction delivery methods are more complicated and contractual issues are more complicated. The sureties that have the ability to help contractors understand mitigate those risks tend to be the most most successful. Prices have continued to go down but we have not seen any player come in and underprice the market to the point where they are capturing large amounts of market share. Competition now is based much more on service than on price.
Has the time involved in claims investigation and resolution improved and become shorter?
That is tough to tell with the limited amount of loss activity that is out there. Most of the major sureties are very responsive and provide great service. The quicker issues are dealt with the better costs are kept under control. Slow response to a default can cascade and impact other contractors on the project increasing costs.