Surety Bonds: Stability through economic turmoil

Just as the construction market thought that 2022 would mark a return to normality, the Office for National Statistics (ONS) Statistics warned that consumer price inflation hit 9 per cent in the year to April. The Bank of England also warned that the cost of living is expected to rise further this year. Sterling Advisory’s insolvency practitioner, Emily Ball, predicted that the construction industry could continue seeing a higher number of insolvencies over the next six to nine months. They added that fixed-price contracts would likely continue to plague the industry in a climate of rising material costs.  

The current economic situation has created challenging conditions for the surety market. The impact of firms taking on additional debt to deal with pandemic-related losses has put undue pressure on cash flows, and underwriters are paying close attention when deciding on bond capacity. After many years of relative stability in the supply of labour and materials, construction costs have experienced dramatic increases. This prolonged period of economic turmoil exacerbated by global issues such as the Ukraine war has slowed down economic recovery from Covid.  

The latest ONS data shows a drop in construction growth, and an index published by the government indicates that bills for building materials rose 11 of the 12 months during 2021. With the consultancy arm of contractor Mace warning in March that bid values could surge by more than 5 per cent this year, 2022 will be another financially challenging year for the construction industry.

Adapting to change  

For most construction firms, preparing and adapting their business model to cope with these challenging market conditions will be crucial to their survival.   

Firms are dealing with covid loans in addition to contracts that have either become under-priced or delayed due to supply chain problems. The problems around fixed-price contracts have been reported widely in the media, and many firms are finding that this is no longer an option. The construction sector has worked under fixed-price contracts with no provision for price increases. Standard contracts have optional clauses such as the JCT fluctuations clause, which is rarely used. 

A plan for the sector 

The Construction Leadership Council (CLC) has set out a five-point plan to help firms mitigate the impacts of steep inflation hitting the sector. These proposals include:  

• Developing market intelligence about risk hotspots;  
• Publishing guidance on price inflation indexation and commercial issues;  

• Preparing case studies on good practice in response to current inflation;  
• Running industry briefings on conflict avoidance; and  
• Researching long-term capacity loss from Ukraine, Russia, and Belarus and the impact on the sector.  

CLC member and Mace Group Chairman and Chief Executive Mark Reynolds said:

“Across our industry, we are seeing businesses facing real challenges with inflation that are well above those seen in the sector for many years. No one party can tackle this issue alone, and we can’t pass the problem on to others to solve. We all must work collaboratively – clients, contractors, and everyone in our supply chain – to provide support where possible to limit the impact on firms nationwide.” 

In Ireland, the same issues have led to a more collaborative approach to public sector projects. The Irish minister for public expenditure and reform, Michael McGrath, introduced the Inflation Cooperation Framework for parties engaged under a public works contract. The framework lays out the approaches and parameters companies working for the state can use to calculate additional costs attributable to material and fuel-price fluctuations. The government has agreed to bear up to 70 per cent of the extra costs as part of this process. This scheme boosts cooperation and prevents costly disputes caused by inflation. 

Bonds – a financial safety net  

Demand for surety bonds has grown exponentially during this period of economic instability. Performance bonds are a type of surety bond that protects the beneficiary against financial loss due to a contractor’s failure to complete a project or failure to meet contract specifications. A surety bond broker can provide professional advice, source bespoke bonding, and guarantee solutions to suit the needs of each business. They are experts in their field and have developed long-standing relationships with regulated surety underwriters. A broker can access competitive terms and premiums for a one-off bond, a new bonding facility, or to arrange additional capacity if required.   

Ben Milan, Surety Manager, Kerry London, said:

“We’re advising our clients to seek flexibility in their contracts and negotiate favourable payment terms from their supply chain. Insurers like firms to factor in all the risks. They focus on their clients’ profitability and stability rather than growth and turnover. Fixed-price contracts are becoming more challenging to bond, and underwriters look for clients with good supply chain management. We encourage clients to work with a broader range of trusted suppliers to minimise the disruption caused by supply chain failure and material shortages.”  

Using a bond specialist will ensure that your business is presented in the best way to insurance underwriters. They will generally require two years of audited accounts (consolidated in the case of a group of companies) and up-to-date management accounts for the current trading year.

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Kerry London is authorised and regulated by the Financial Conduct Authority. The company is a leading UK independent and Lloyd’s accredited broker, which means that we work with a wide range of niche and major insurers.

This note is not intended to give legal or financial advice, and, accordingly, it should not be relied upon for such or regarded as a comprehensive statement of the law and/or market practice in this area. In preparing this note, we have relied on information sourced from third parties, and we make no claims as to the completeness or accuracy of the information contained herein. You should not act upon information in this bulletin nor determine not to act without first seeking specific legal and/or specialist advice. We and our officers, employees or agents shall not be responsible for any loss whatsoever arising from the recipient’s reliance upon any information we provide herein and exclude liability for the content to the fullest extent permitted by law.

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