Subject: the role of sureties
You Can’t be a Surety
So Learn to Act Like One
Thirty years of accumulated study as a contractor, work-out specialist, consultant, and research professor have verified the following realities about risk in the construction industry:
- Construction is basically risk assumption.
- Risk-taking is embedded in a contractor’s DNA.
- When a contractor signs a new contract, it’s like the contractor’s first day in business.
- Every time a contractor starts a new project, the contractor voluntarily assumes risks that are not fully defined.
The construction industry has not always demonstrated proficiency at recognizing, managing and mitigating hidden risks. This compounds problems and escalates the potential for business and project failures, making the third-party screening and financial protection of surety bonds more critical than ever.
The Surety’s Role
Sureties have an important role to play in the construction process and bring a unique perspective to contractor and subcontractor screening through the underwriting process, along with financial capability when there is a problem. They have extensive experience and data having pre-qualified firms in all types of construction, in various locations, in up and down markets.
Owners and Bankers Mitigate Risk
Owners have the easiest mitigation route, when they bond around their construction exposures by having a knowledgeable surety do the critical pre-qualification process, screening out ill- equipped enterprises, and covering the costs if things do not work out. Bankers have the same protection by requiring payment and performance bonds on the projects they finance.
Historically, contractors considered risk assessment and management a private underwriting skill developed by sureties to produce rational financial products that could protect owners and bankers against contractor failure. Contractors were not offered the opportunity to bond around themselves, and it seems to have never occurred to very many to utilize the same techniques the sureties were using to mitigate their own risk.
The Secret is Out
Risk management is no secret. Sureties follow a logical process that contractors should copy to mitigate their own risk.
- Recognize and identify specific risks in advance
- Assess and quantify their importance and the exposure
- Mitigate and manage their impact and cost.
For example: Construction business risks and project risks are often not apparent and may be disguised in many forms. Such as, top-line growth may appear to be an avenue to success but can also lead to failure.
For example: More tightly drawn contracts pushing any-and-all risk to contractors may appear to be needed protection for owners but can create more problems than they solve.
For example: An expanding market looks like an opportunity but can also be a mine field. The hidden risks in market expansion such as skilled labor shortage, limited access to capital, and the ability of management to keep up with a rapidly changing business environment must be assessed separately to understand their individual impacts while operating in an expansive construction market.
Act Like a Surety
Consider risk at the pricing stage. We need to elevate risk management within our organizations and embrace formal risk management processes which, fortunately, are becoming the construction industry’s newest discipline. You will find extensive research on risk management and contractor failure here on the site.
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