Demand for surety bonds is expected to rise as Inflation Reduction Act (IRA)-driven renewable energy and grid modernization projects get underway in the United States.
With interest rates remaining elevated this year, lending remains challenging. Businesses will seek alternative financing through surety bonds, and insurers are expected to step up capacity, according to Karl Choltus (pictured), national surety practice leader at Brown & Brown.
Speaking to Insurance Business about his outlook for the surety market in the year ahead, Choltus noted several factors leading to significant growth in direct written premium (DWP) in surety.
“The surety market has been very strong for many years, but the boost has come from the infrastructure package that came out in 2021,” said Choltus.
On an annual basis, the US surety market generated $8.6 billion in DWP in 2022, representing 15.7% growth compared to 2021, according to data from The Surety & Fidelity Association of America. Choltus expected 2023 growth to be similar.
“This is profitable growth. So, for insurance companies, surety is one of the most profitable lines of business,” he said.
Surety bonds are three-party agreements between the principal (the party obligated to perform), the obligee (the party who receives the bond’s protection), and the surety (the entity providing the financial guarantee). They provide financial protection against non-performance, default, or other breaches of contract.
In situations where the principal fails to fulfill their obligations, the surety steps in to compensate the obligee for any losses incurred up to the bond’s coverage amount. This protection helps mitigate financial risks and ensures that parties involved in transactions or projects aren’t left vulnerable.
The two most common forms are contract surety, used primarily in construction, and commercial surety, which satisfies the security requirements of public, legal and government entities and protects against financial risk.
IRA, President Biden’s infrastructure spending bill in 2021, injects some $550 billion in new investments for bridges, airports, waterways, and public transit across the US. This includes ambitious grid modernization initiatives under the Broadband Equity, Access, and Deployment (BEAD) Program, which are also expected to drive demand for surety bonds. The BEAD Program, a $42 billion package, aims to bring high-speed internet to communities across the US.
Choltus said: “A lot of insurers will be looking to deploy more capital into the surety space, whether they’re participating already or making further investments.
“There are insurers that are not in the surety space yet that we anticipate will bring capacity into the market over the next few years because it’s highly profitable.
“Additionally, we are seeing more and more the ability to utilize surety in lieu of letters of credit and that is highly valuable to companies across the United States and Canada.”
As an unsecured form of contingent liability, surety bonds can be advantageous to businesses lacking cash.
“For instance, a lease contract might have a requirement for a deposit or financial security. Typically, that might be a letter of credit or cash if you’ve posted those, and you can replace them with surety,” Choltus said.
“What that means to the entity providing that security is that they can get cash back on their balance sheet if they’ve given cash out. It simply comes back as cash that they can utilize.
“If it’s a letter of credit that is collateralized, then they can return the letter of credit and post a surety bond in lieu of that letter of credit. If the letter of credit is unsecured, it still can be viewed as a debt, whereas a surety is not a form of debt on the balance sheet.”
Surety is a highly valuable tool for renewable energy companies to meet obligations tied to decommissioning obligations, interconnection and power agreements. Real estate and private equity investment are also industries that stand to benefit from surety, Choltus added.
“If you, as a private equity investor, invest in an energy company, and after that investment, you’re able to utilize surety in lieu of having to utilize letters of credit, you’ve added value to your investment because you’ve either returned cash to the balance sheet, or you’ve added value by being able to use contingent forms of liability surety bonds,” said Choltus.
“Your investment can take on more projects, and they’re doing so without having to take on liability, which, if you’re a private equity investor, means a lot not only in the short term but in the long term in terms of the valuation of your investment.”
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