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Geoff Delisio is a senior vice president at Berkshire Hathaway Specialty Insurance Co., where he heads the Boston-based insurer’s surety operations. An engineer by training, he has worked in the surety sector for nearly two decades. He recently spoke with Business Insurance Editor Gavin Souter about trends in the construction industry and the surety market.
Q: How are the general construction market conditions affecting the surety market?
A: From the surety standpoint, things that are good for our customers, the contractors, by extension are good for the surety.
In today’s market, while there seems to be a plethora of projects, the thing that we are talking with customers about a lot is the competitive pricing that they are facing seems to be rather steady. They are not seeing the ability to increase gross margin on their bids, which is a little atypical from where you would find the market at this point in the cycle. Normally at this point, work is fairy abundant, backlogs are healthy, you begin to get a little wage pressure, you potentially could get a little pressure on materials and supplies, which gives the general contractor the ability not only to raise gross profit but to add in some contingency for additional risk. Today, from our conversations with contractors, I don’t think that people see those opportunities yet. It’s still a pretty competitive landscape from the pricing structure.
Construction is a high-risk business when you consider the gross margins involved. A point or two increase in gross margins allows contractors to strengthen their balance sheets and provides a bit more cushion for a rainy day. From a surety perspective, any time we see margins rising, we see that in a very positive light. From the broadest perspective, raising margins increases our contractors’ financial standing; it directly reduces our risk.
Q: With project sizes growing, is there any pressure on capacity?
A: A $1 billion project or larger is no longer an outlier. Five or 10 years ago, a $250 million project was an outlier. We now have to be thoughtful about the levels of capacity that we want exposed on a single project. For the past two to four years, there’s been a significant amount of excess of capacity in the surety industry; but if I look into the crystal ball, I don’t know whether I see that same excess capacity in the next three to five years.
Q: How are the changes in the subcontracting environment affecting sureties?
A: As it relates to the large megaprojects, logically there are larger subcontracts. If you have $1 billion general building project, a $200 million electrical and a $200 million HVAC subcontract would not be out of line, so with the changes in the subcontractor default insurance phase, the options that a general contractor has for transferring that risk are less than they were a few years ago.
A contractor is left with the options of securing a subcontract bond for that subcontractor, potentially breaking up the contract between four or five subcontractors; but the ability via the insurance contract to transfer a risk that large does not appear to be available in the marketplace today, so it causes the construction community to be a bit more thoughtful around these risks.
Q: Is there a maximum that can be placed?
A: In the SDI space, $40 million to $50 million gets you toward the top of the exposures that they are willing to take in this space.
Q: We hear about the low unemployment rate putting pressure on labor markets. How is that affecting the surety sector?
A: We believe that the current lack of availability of labor increases our contractors’ risks and, by extension, our risk. But it’s two-fold: it’s not only the availability of that labor but it is also the productivity of that labor, as many of the tradespeople left the industry for other industries in the 2006-2010 time frame.
The level of productivity of the new people coming into the industry is markedly different. Not only does the construction community have to deal with finding people who want to make a career in the trades, it’s also, especially on firm fixed contracts, pricing the right productivity of those people into the marketplace. Both aspects are challenging, and both raise a contractor’s overall risk profile.