Construction Surety UK
Market appetite remains strong
Insurers’ appetite for UK Construction Contract Surety is improving, but underwriters are still applying a great deal of caution as they want to ensure that the risk profile of the principal fits the underlying risk. This is predominantly due to the large levels of losses sustained over the past 24 months. There are many sureties wanting to issue bonds and the markets are very receptive to risks that fall into their risk appetite.
Appetite for commercial surety is strong although insurers are keen to ensure that the risk profile and the sureties’ security package is suitable to support the underlying risk. Ultimately, the appetite for surety bonds, contract and commercial, is good so long as the principal and wider group are strong enough, and the sureties’ security package is sufficient to support the underlying risks.
Underwriting changes
Two or three new sureties are expected to enter the surety market in London by the year’s end or the first quarter of 2025. Their focus has yet to be confirmed but we expect it to be a mixture of contract (construction) and commercial surety.
In June 2024, QBE exited the UK Construction Surety market on a direct basis. However, they are continuing to issue bonds up to GBP 2.5m in size in this sector via Evolution Insurance who acts as a managing general agent (MGA) for QBE. QBE is still present in the commercial surety space.
Notable claims
The last big insolvency was just over six months ago, since followed by several smaller insolvencies. Despite this, the number of contractor insolvencies is significantly reducing, suggesting that market conditions are improving. Claims into the market have also significantly reduced and pressures are starting to ease.
This being said, there are murmurs of a potential large loss on the horizon in the UK Construction Surety Market, which if it comes to fruition, could have a significant impact on sureties’ appetite in this sector.
Geographic/sector differences
While the appetite for commercial surety is strong the market is a bit more cautious with regards to contract surety.
Appetite for commercial surety is strong although insurers are keen to ensure that the risk profile and the sureties’ security package is suitable to support the underlying risk.
Outlook
Expected range in rate changes for the next 6 months for claims-free portfolios
Sureties are trying to increase rates across the whole UK construction sector. This is because they need to recoup significant losses from the past 24 months and rebuild their reserves to pay claims in the event of another catastrophic period of losses in the future. On average, rates are increasing around 10%, however, the market has arguably been under-pricing surety bonds for a long period now. Rates are unlikely to continue going up as the current increases are mainly adjusting the pricing to reflect the risk of the principals which have arguably been underpriced in the past. Equally, some principals may not face any increases because they have already been priced adequately.
Expected capacity change in the next 6 months for claims-free portfolios
Interest rates hit a 16-year high at 5.25% in August 2023 in the UK. This has added significant cash flow and profitability pressures to contractors and developers.
In August 2024 we have seen the first interest rate reduction since March 2020 from 5.25% to 5%, reducing the pressure for principals. In addition, most contractors have closed their loss-making/break-even contracts that were priced prior to the period of hyperinflation. These contracts have mostly been accounted for in full in prior years and will no longer impact balance sheet growth. Coupled with the above and inflation coming down, some contractors are starting to see buying gains on materials from contracts priced in the hyperinflation period.
Expected coverage change in the next 6 months for claims-free portfolios
Sureties will want to see a bit more of a reduction in inflation and interest rates and subsequently a period of growth for contractors prior to issuing bonds for principals that are a current concern. There are still a number of sizeable contractors who are of great concern to the market. If they were to fail, this would have a significant impact on the market and potentially undo the progress we’ve seen recently.
Reinvest profits into the balance sheet to increase the tangible net worth and concentrate on the bottom-line profit rather than top line turnover.
Emerging risks
A number of notable contractor insolvencies over the past 24 months affected contractors that have transferred into an Employee Ownership Trust (EOT). EOTs have created a significant risk and they have been a reoccurring theme in a significant number of losses to sureties. Where EOTs have been created, these are under considerable scrutiny and if the sureties aren't comfortable with the risk, they will not provide needed capacity.
Renewal recommendations
Reinvest profits into the balance sheet to increase the tangible net worth and concentrate on the bottom-line profit rather than top line turnover. Ensure retentions that are being held on completed contracts are recovered in good time. This will help to build cash (and cash reserves). Further, ensure that you demonstrate transparency when sureties request financial and company information as without this information, they cannot correctly assess the risk. In addition, businesses that are not transparent in providing the information that is sometimes requested from them can create red flags to the sureties who may suspect that this is intentional.
For further information, please visit the Lockton Surety page, or contact:
Ben Milan
Account Executive, Global Real Estate & Construction
E. ben.milan@lockton.com