As high energy costs hit hard, some businesses have turned to surety bonds as a way of providing cost-effective collateral to their energy supplier.
At a time when interest rates are rising and the cost of borrowing increases, many businesses are seeing pressure on their balance sheets and constraints on working capital. For those with significant energy usage – large manufacturers for example, or big retailers – an added problem is the high cost of energy triggered by the Ukraine conflict. Increasingly, energy suppliers – perhaps unable to secure trade credit cover due to constraints in the market – are asking for security from customers before they will commit to supply. For energy buyers that means providing bank guarantees or letters of credit, which can be expensive while also tying up working capital. An alternative and often cheaper and quicker solution however, is the option of a surety bond; an increasingly popular way for solvent, well capitalised organisations to provide collateral.
Guaranteeing Energy Payments
Take this example of a UK supermarket chain looking to agree a new energy contract. The normal route for the energy supplier wanting to protect itself against any possible client insolvency would be for them to seek credit insurance on the supermarket but, because of the existing level of exposure to the supermarket chain within the credit insurance market, capacity wasn’t available to the level required. As a result, the energy supplier asked the supermarket chain for an alternative form of security. The supermarket had two options: either a letter of credit, which would have been closer to the current base rate (currently at a 24 year high) - and would have tied up a significant level of working capital – or by turning to the insurance market for a surety bond.
Taking Advantage of a Surety Solution
Aon found a surety bond solution – effectively a contract guarantee supported by an insurer – for the supermarket chain which offered an alternative to funding a bank supplied letter of credit. Not only was it a win for the supermarket chain because of the money they saved without tying up working capital, but it also provided the energy supplier with a potential recovery of 100 percent of any loss on the energy contract – compared to a possible recovery of 90-95 percent under a trade credit arrangement, which can also take weeks or months to pay a claim compared to days under a surety bond. The energy supplier also saved the cost of buying trade credit, and while the supermarket chain has the cost of the surety bond, they can use it as useful leverage when negotiating pricing and payment terms with their supplier.
Effectively, the surety bond facilitated a deal that might not have happened due to the lack of available trade credit which is obviously beneficial to making sure the supermarket chain’s lights stay on, but also beneficial to the supplier who can look at taking on a client that they might otherwise have had to turn down.
Deal Size Grows
While there have been an increasing number of surety bonds entering the market – and capacity wise, Aon is seeing even bigger limits with one example worth over £2 billion – the underlying financial strength of the applicant is important; surety providers will not underwrite a bond if they think there is a chance that the buyer will become insolvent. It is though, very much a relationship driven business, and surety markets like to build long term partnerships with clients – often starting off with smaller bonds that will grow over time.
The likely trend is for surety to continue growing in popularity and complement the ways in which businesses can work with the insurance industry to find off-balance sheet solutions for demands for collateral, as well as in other funding needs such as helping to free up access to working capital.
If you would like to explore the benefits that a surety bond solution could bring to your organisation, please speak to your usual Aon contact, or visit