Construction’s “Sports Book”
Sureties operate the “sports book” for the construction industry. They handicap risk by setting rates and issuing bonds. They “book” the contractor’s bet that he will complete a project as contracted. They “set the line”.
Growth Risk – Working Outside Normal Expertise
In our analysis of dangerous contractor risk during expanding construction markets, we identified “taking on new unfamiliar work” as risky conduct hidden in growth euphoria. To evaluate whether this risk element has materialized as we predicted, we asked sureties what they had to say about handicapping contractors who expand beyond their typical type, size or location–those that leave their area of expertise to find new work.
How The Surety Looks at Risk
“Great risks are inherent to the construction industry. How well these risks are managed will ultimately determine the success of a project. Old attitudes of avoiding any risk to the greatest extent possible by shifting it to others are giving way to concepts of risk sharing. Although construction risk tends to be perceived from a negative aspect, those that are successful in the industry also look upon it as an opportunity.”
Risk Factor: Moving Beyond Area of Expertise
Sureties site a variety of hidden risks that contractors are often unaware they are assuming when they take on projects outside their area of expertise.
Private to Public
“If you do electrical work and you’ve done housing your whole life, but now you’re doing hospitals, or you’re moving from the private to the public sector, contractors with experience in every field of construction are facing new challenges,”said David Finkelstein, executive vice president in the surety division of Philadelphia-based Arch Insurance Group Inc. “Today, more and more is being required of any contractor, because terms and conditions of construction and the processes that go into it are so much more complex.”
Residential to Commercial
“Contractors moving into the commercial world are going to find a much stronger focus on project schedule. If the predecessor contractor falls behind schedule, it puts pressure on the successor contractor to complete the job in less time than they negotiated on the front end. So, the contract should contain provisions to account for this possibility to cover the cost of additional manpower or man hours to complete the job in the compressed time frame,” according to Tom Miller, senior vice president at Kansas City, Mo. Based Lockton Cos, L.L.C.
“In such scenarios, there might be liquidated damages provisions or a requirement in the contract that the contractor responsible for the delay pay a specified dollar amount to the project owner,”he said. Additionally, “the contract might state that you’re on the hook to pay the general contractor for whatever period you delay the project,”he added.
“Many commercial projects require contractors to pay ‘liquidated damages,’ a form of financial penalty, if any of their activities result in the delay of a project’s promised completion date. Contractors basically put their corporate balance sheets at risk every time they sign a contract without the ability to transfer this risk,”said Tim McGinnis, Dallas-based senior vice president in the national construction practice of Willis North America.
Gray to Green
Mid-market contractors involved in “green” building projects are being asked to provide guarantees that the end product will meet a specified certification level under the Leadership in Energy and Environmental Design program of the U.S. Green Building Council. But most legal and risk management experts warn contractors against providing any such guarantees, as most professional liability insurers will void coverage if a policyholder offers a warranty of any kind.
Bid Build to Design Build
“Middle-market contractors increasingly are being asked to participate in public-private partnerships that require contractors to have “skin in the game” by helping to finance a construction project, said David Bowcott, senior vice president on Aon P.L.C.’s infrastructure solutions. “Owners are resigning themselves to the fact that they are not good at designing and building assets. They’re telling contractors to do it all and won’t pay until it’s up and running. The contractor’s inability to perform is a risk to the deal if the contractor enters into a design-build contract vs a bid-build contract, where the owner obtains the design.
“Construction organizations usually start out and remain with types of construction in which they have expertise…For a variety of reasons, however, contractors sometimes change from one type of construction to another or add a new type of work to their existing specialty…What is very often drastically underestimated is the entrance cost – the amount paid for the learning period during which an organization adjusts to performing a new type of work.” (Managing the Profitable Construction Business, Thomas C. Schleifer, Ph.D., Kenneth T. Sullivan, Ph.D., John M. Murdough, CPA, Wiley, 2014)