In March 2020, AM Best downgraded the U.S. Surety Industry from “Stable” to “Negative,” in consideration of COVID-19 related shutdowns across the country. The driving factors behind this Market Segment Outlook downgrade for the US Surety market was twofold. First, for contract surety, the uncertainty in how impactful the COVID-19 pandemic would be on construction and its supply chain. The rating agency anticipated a domino effect from COVID-19 protocols and shutdowns that could negatively impact the ability to complete projects. In turn, that would drive up default situations and increase the likelihood of claims to be paid by the sureties. Next, for commercial surety, the rating agencies, like S&P and Moody’s, have put out an increased number of credit downgrades across multiple sectors, particularly in areas of hospitality and energy. Another result of anticipated higher than typical loss rates could drive up reinsurance costs to the sureties, which could have an impact on both underwriting protocols and pricing.

 The uncertainty that caused a downgrade does not necessarily mean that all within the industry will suffer. We have been in an incredibly soft surety market in recent years, driven largely by multiple new entrants to surety where competition had driven pricing down and loosened underwriting guidelines as markets were aggressive to acquire new accounts, or retain their existing. A natural, and prudent, reaction to 2020 is to see sureties tighten their underwriting guidelines and increase pricing. Similar to companies who require surety credit, to endure an economic crisis, sureties need be responsible in their operating activities (underwriting), as well as have strong assets that are able to withstand the hard time, should it mean a reduction in revenue stream or increase in loss activity.

The impact of 2020 varies greatly across all industries utilizing surety, particularly those that have been most affected by the tumultuous environment this year. Possibly hardest hit in the commercial surety space are those companies in hospitality and in energy. Volatility in those industries, between the COVID-19 shutdowns, limited travel, to the oil pricing trade wars and a dramatic decline in demand for both travel accommodations and oil/gas, many sureties tightened their underwriting guidelines specifically in these areas. Some have ceased accepting submissions to consider extending credit for these industries at all. In the construction surety space, you will likely see more intense underwriting driven by cash flow analysis; the farther down in the chain of payments, the more intense the underwriting. Cash flow is always important, but even more so this year. PPP loans were utilized by many, which was impactful to balance sheets and another line item to scrutinize in underwriting, determining what portions will be forgivable, when they will be forgiven, and if they will be subject to audit.

All that considered, 2020 has certainly served as a test of the surety marketplace. Since the AM Best forecast in March 2020, most sureties anticipate fewer claims in the immediate. However, in varying degrees across the sureties, most top line revenue figures will show a decline this year. As underwriting guidelines see a bit of tightening, sureties show concern for the next couple years. Topics often focused on now are based on adaptability: how accounts will rebound from 2020, what budgets will be available for upcoming work, if backlogs are profitable, if cost adjustments are adequately made to accommodate for revenue changes, how the market reacts to election results. These factors, and how surety accounts and their surety partners handle them, will dictate if the claims predicted in March will come to fruition in the years to come.

AM Best was clear, “A Negative market segment outlook indicates that A M Best expects market trends to have a negative influence on companies operating in the market over the next 12 months. However, a Negative outlook for a particular market segment does not mean that the outlook for all the companies operating in that market segment will be Negative.” As a consumer of surety products, it is critical to be aware of which markets are most impacted, the individual surety’s commitment to remaining in the bond-writing business, and their ability to ride out the storm.