capacity

Secrets of Bonding #38: Capacity – How to Preserve It

For contractors, Bonding Capacity is a good as gold.  It enables the company to pursue new projects with the confidence that their surety will back the contracts when the need arises.  This is the source of increased revenues and greater profits!

How is available bonding capacity calculated? First a bonding line is determined, consisting of an Aggregate (total) amount and a Single per job limit.  The Aggregate is then decreased by different factors that consume the line. What can be done to minimize this effect so bonds remain available for the client? Let’s look at how the numbers are developed and how they can be appropriately managed.

Bonded and unbonded work is included in the analysis.  (*Why is Unbonded work included?)  Here’s the math:

Aggregate Capacity amount  Minus:

  1. Undecided bids (full contract amount)
  2. Low but unawarded bids (full contract amount)
  3. Projects that are awarded, signed or started (full contract amount)
  4. Remaining Costs to Complete on open contracts

Equals the Available Bonding Capacity.

So how can agents help their contractors preserve this vital asset?

1.  Prompt reporting of bid results – When bid bonds are issued, the entire estimated contract amount is deducted from available capacity, not the bid bond amount.  The capacity is not restored until the “not low” results reach the underwriter.

2.  Updated Work In Process (WIP) schedule:

  • Surety underwriters and accountants determine a contractor’s “current work load” based on the costs they must incur (such as labor and materials) to complete their open contracts.  When there are no remaining costs to incur on a project, by definition, it is considered completed.  The WIP schedule shows revised Costs Incurred to Date and Estimated Costs to Complete. Both increased costs incurred and decreased future costs improve available capacity.  Future costs may be reduced by progress on the contracts and also by greater labor efficiency, material cost savings, improved scheduling and other factors.
  • A reduction in the contract amount (by amendment) has the same effect because it reduces unincurred costs. Report such amendments immediately.

3.  Prompt reporting of completed or terminated work, including unbonded projects, removes them from the work load and therefore increases availability.

Note: Factors that can reduce available capacity include unincurred contract costs that increase for any reason and the addition of new unbonded projects.

*The aggregate capacity amount is based on all the contractor’s professional and financial capabilities. If unbonded projects are acquired, they consume resources (supervisory staff, equipment, etc.) and therefore must be recognized within the use of the bond line.

Available Bonding Capacity is a moving target subject to frequent revision.  To maximize availability, send us the right info and keep it current.


First Indemnity of America Insurance Company
2740 Rt. 10 West, Suite 205
Morris Plains, NJ 07950
Office: 973-541-3417

An “A Rated” Carrier

 

Secrets of Bonding #28: Size Does Matter

In the world of Bid and Performance Bonds, size matters.  Underwriters want to know about the contractor’s largest successfully completed project.  The agent and contractor ask about the single job limit (largest available bond size.) Size is a subject of constant interest.

So what do you do when an unusually large project comes along?  Let’s assume it is more than the single job limit.  For example, the surety set a bonding line of $1 million single (per project) and $2 million aggregate (the maximum one day total for incomplete bonded and unbonded work).  The new project is for $1.5 million.  Does the contractor pass up the opportunity to acquire a desirable project? Will the agent and surety risk losing a client because of their failure to deliver the bond?

There are three possible outcomes to this situation:

  1. Decline the bond
  2. Restructure the contract so it fits the existing bond line
  3. Grant an exception (a bond approval) to the line

Let’s look at each one in detail:

Decline

  • Contractor fails to obtain the project.  Agent and surety may lose the account.

Restructure – Reduce the risk, and the bond amount, by restructuring the contract into a dollar amount that falls the bond line.

  • A contract for multiple buildings can be broken into a smaller contract for each building.  The idea would be to NOT issue all the bonds at once.
  • The scope of work can be reduced (smaller bond) or broken into phases (bite sized pieces).
  • The obligee can purchase the materials directly, thus removing them from the contract price (smaller contract and bond).
  • Multiple primes: Instead of one General Construction contract and a big bond, individual smaller contracts are issued for each trade.

An Exception is granted – The bond is issued even though it is beyond the current line.  How do you get to that point?

  • The contractor may be uniquely well-suited for the project based on prior experience such as working for the obligee and / or architect before, done “the same job” previously or some other special advantage.  Examples of this would be a job the contractor helped design, a project located close to their office or maybe they have special equipment, materials or skills.
  • The project may be exceptionally low risk. Example: a project that is repetitive in nature (four identical buildings at the same site) or simple in design (a large building, only one story.)
  • Reduce the risk: Hire a major subcontractor and bond back the work.
  • Individuals in the construction company may personally have special skills or prior experience playing a key role on a similar project.
  • Mentoring – a larger more experienced firm may provide expertise to help the contractor through the project.

Teaming: This technique is in the same family as Mentoring and Subcontracting, but is different.  Structural arrangements in this area are more complicated than we can cover in this brief article.  Suffice to say, as a Surety, we have a great deal of experience in this area.  Despite operating in the “hard to place” niche, our outstanding underwriting results arise from knowing how to put these transactions together properly for our agents and contractors.

The following are incorrect solutions to the size problem:

  • Issue more than one bond on the contract. Unacceptable because reinsurance limitations require only one bond per contract.  This is referred to as “stacking.”
  • Breaking the contract in an unnatural manner.  For example a GC dividing the construction of a single building.
  • Stipulating a bond for less than 100% of the contract amount.  The surety bases the underwriting decision on the contractor’s obligation, which is the contract amount.
  • Issue a smaller contract (and bond), then follow it with a huge increase change order. This doesn’t work because the bond may say it does not automatically cover large increases in the contract amount.
  • Reduce or eliminate the contractor’s profit margin.

    Call us with you next Contract, Site or Subdivision Bond.

    FIA Surety / First Indemnity of America Insurance Company
    2740 Rt. 10 West, Suite 205
    Morris Plains, NJ 07950
    Office: 973-541-3417

    An “A Rated” Carrier

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