The Evolution of Bad Credit Surety Bond Programs

At the turn of the millennium, the surety bond industry experienced some major changes. Consecutive years of record breaking losses forced many bonding companies to close their doors. The sureties that weathered the storm of the “soft market” backlash has some serious changes to make in their underwriting guidelines. The industry as a whole became much more conservative, leaving many high risk applicants hanging out to dry.

A good portion of America has credit flaws. Therefore, there was a large section of the bond market that was considered “unbondable” in the conservative standard market programs. For the most part, the higher risk applicants could not obtain a bond without posting 100% collateral. Then the bad credit surety bond programs came about, which offered an alternative that went against traditional suretyship ideology. The surety would write high risk commercial bond applicants, but at a much higher rate. The solution may seem obvious from an outsiders perspective, but traditional surety underwriting is done with a 0% loss ratio. This means that, unlike insurance, there is no loss built into the premium, and only the cream of the crop should be approved.

Bonding companies that consider high risk applicants are few and far in between. However, there seems to be about one new company a year willing to write the applicants using the insurance based philosophy. A program that was once a monopoly, is now offered by a handful of sureties. The increased competition is good for the principal. Certain requirements of the program, such as cash collateral, are no longer. Classes of business that were previously excluded are now once again available.

So what is the future of the bond industry’s bad credit surety bond programs? We have already seen collateral requirements discarded. Will the premiums start to drop? Unfortunately, the answer can not be stated in a simple yes or no. We may see rates drop slightly due to increased competition, but don’t count on it being anything too significant, as losses are built into the premium. Currently, the bond market is very black and white. A principal is either in the standard market or the high risk market. We more than likely we will start to see a middle ground of bond rates begin to form. For instance, an applicant with some collections could be written at a 5-10% rate, rather than be lumped into the same rates as an applicant with a bankruptcy. However, creating a middle ground market will take time. Bonding companies are going to want to see concrete data that there is a way to underwrite these bonds without having losses too high.

The end of the “soft market” brought about the high risk programs. Over the years the high risk programs have seen slow change as additional bonding companies practice this new type of surety underwriting. Eventually the market should develop a grey area of middle-ground rates, rather than being so black in white. However, this will take years to come about, as bonding companies are conservative in nature and are not quick to change their policies.