Surety Bond News

People often mistake surety bonds for just another type of insurance. There are numerous differences separating the two. First, we will go over what they actually guarantee. Next, we will go over how they work. You will have a better idea of what they are after knowing what they do and how they function. The concept of surety bonding was created thousands of years ago, which has remained the same ever since.

Contrasting insurance and surety bonds

Parties Involved: Insurance only involves two parties, the insurance carrier and the principal. Suretyship involves three parties. The principal is the person or entity required to obtain a bond. The obligee is who is requiring the bond of the principal, they are also the beneficiary in the event of a claim. The surety is the bonding company backing the bond. To sum it up, the obligee requires a bond of the principal who obtains it from the surety.

Risk: With insurance, the risk is with the insurance company. In traditional surety underwriting the risk is with principal. In other words, the surety guarantees the principal’s performance to the obligee. However, the surety will look to the principal for payment if a claim arises. Many ask, if the surety has no risk than what is the principal paying for? While it is ideal that the surety has no risk, this is not the case. Companies and their owners could declare bankruptcy or refuse to pay a surety when a claim arises. The surety’s premium can be thought of as a service charge for their financial backing. When you look at the alternative of a letter of credit, suretyship looks like a great deal! With a letter of credit the principal would be required to put up the cash for the full amount of the guarantee and would be required to pay their banks service charges (which are usually comparable surety service charges).

Payment: Payment for bonds are usually paid in annual lump sums. One must be careful when obtaining a bond, as most bonding companies have premiums fully earned for the first years premium. This means that if a principal cancels a bond mid-term the surety will not return premium. A responsible bond agent will always make that clear to the principal when giving them a quote.

How do surety bonds work? The obligee requires that the principal obtain financial backing to guarantee their work. The principal looks to the surety for their guarantee their work. In exchange for the guarantee the surety charges the principal a fee. If the obligee files a claim, the surety will be required to take action on the guarantee they made. The surety will then look to the principal for payment of the claim. If the principal fails to reimburse the bonding company they will certainly see them in court.

The above should give you a good idea of what a surety bond is and how they work. If you are unclear on anything in this article, you can feel free to post a comment or start a dialog in our online forums.

Surety bonds are often misunderstood. For many, all they know about them is that they are an expense required to legally operate their business. There are many common misconceptions when it comes to suretyship, but lets review what a surety bond is prior to going over bond falsities.

A surety bond is a three party guarantee. The three parties are the principal (the person or entity required to obtain the bond), the obligee (whoever is requiring the bond of the principal), and the surety (the carrier backing the bond). A bond should be thought of as credit, not an insurance product for the principal. In the event of a valid claim, the surety will pay the obligee a specified amount and look to the principal for compensation for the claim. The principal pays an annual premium for the financial strength of the surety to write the guarantee rather than obtaining a letter of credit and tying up capital. You can read more about surety bonding in our Bond Information Section.

Now that we have an idea of what a surety bond is, lets begin with our myths of suretyship!

1) “I have never had a claim, I should get a bond at a great rate.” While the surety will be happy to hear you have never had a claim, it is not a selling point. Bonds are underwritten quite differently than regular insurance. When it comes to insurance, losses are expected. However, bonds are underwritten with the expectation of no losses. Therefore, if you ever trigger a claim, it is likely you will never obtain bonding again.

2) Premium will be reduced the longer a principal stays with a bonding company. False, surety bond rates rarely change unless the principal’s situation changes. Bonding companies have to file underwriting guidelines to each state they do business in so they can not discriminate. The rate filings are tedious and costly job and do not change often. Therefore, unless the principal’s situation changes (ie business financials, owner(s) personal credit, etc.), the rate will not change often.

3) You need to pay the full amount of the bond. Wrong again. Some people assume that surety bonds must be paid in full in order to obtain a bond, which is simply not true. While some bonds will require 100% collateral for higher risk cases, most will simply pay an annual premium which is a percentage of the total bond amount.

4) The principal is the beneficiary in the event of a claim. Sorry, but this could not be farther from the truth. As we learned earlier, the obligee is the beneficiary and the principal will have to pay the surety any funds paid out plus attorney fees.

5) “That’s too much! A $50,000 auto dealer bond only costs $250 year.” Anyone that has been in the surety bond industry for a couple years knows that rates have drastically changed due to historic surety losses around the turn of the millennium. Bonding companies have since changed their underwriting guidelines and have become much more conservative. The soft bond market is a thing of the past and so are ridiculously low rates.

There many other surety bond myths out there. Above are the misconceptions our agency most commonly hears. We do our best to educate our clients so they can feel more confident with the process of obtaining a bond. Feel free to post a comment if you have any questions or would like to add a common myth to our list.

Personal credit is not the only factor used for surety bond underwriting. However, red flags on a credit report can make a rate sky rocket or in severe cases cause a declination. Red flags consist of bankruptcies, tax liens, collections, civil judgments, and low credit scores. The scoring system used by the credit bureau are complex algorithms that determine a persons individual score.

Having your credit pulled can lower your score. A credit inquiry that will lower a score is called a “hard credit report”, which can lower a score as much as 5 points per inquiry. A “soft credit report” does not count as inquiry and does not lower credit scores. Insurance related businesses, such as bonding companies and bond agencies are permitted make use of soft credit inquiries.

In my last article, “What Makes A Good Surety Bond Producer?”, I discussed how a good bond producer will be mindful of the principal’s personal credit. A great way to do so is by making use of soft credit inquires so credit is not negatively affected. A bond producer that shotguns applications to every bonding company and broker they know could drastically lower the principal’s personal credit.

The best example of the devastating effects of hard credit reports can be seen on mortgage brokers’ credit reports. They often have a long list of inquiries, which can make even the highest of scores plummet. What can be done to fix this problem? Unfortunately, not much since the brokers need the banks to run their business. However, I do have some good news for the brokers out there. A window is created, in which additional inquires do not count for 14 days when a hard credit report is pulled. The only thing that can be done is to try to time the credit pulls of the banks at the same time so you do not get too many hard credit report inquires that effect credit. Try setting up all of your banks at the same time rather than stringing them out over time.

Our agency always does anything possible to keep the credit scores of our clients up! The majority of our applications are done on soft credit reports only, and therefore credit is not effected whatsoever. A bond producer that does not know their markets could drastically effect the personal credit of all owners. Be careful with your credit, the time spent planning will save you hand over fist in the long end.

The difference between bond producers can be night and day. A good producer knows the surety industry and the construction industry (for contract bond producers). For contractors, a bond producer is a key to the door of suretyship. The differences in contract producers could be the difference of approval and declination, bond line size, collateral requirements versus no collateral, etc. A good bond producer can make all of the difference in the world to an active contractor. A good bond producer can also make a difference when it comes to commercial surety. A good commercial producer will be mindful of the owner(s) personal credit, obtain the best rate possible, and be able to offer a variety of solutions when necessary.

A contract bond producer should have an interest in seeing his/her accounts grow. The producer will give the contractor the best advice possible and should be seen as part of the company. A contractor should look for a new producer if they feel the current bond producer cares more about booking premium than the contractor’s future. Make sure the producer has a genuine desire for the contractor to be successful. Contract bond producers need to have intimate knowledge of inter workings of the construction industry. A producer will not be very effective in contract surety without knowledge of both suretyship and the construction industry. The producer will need to possess knowledge of contracts and construction law. A good producer will also be aware of local and national construction markets.

Suretyship is an industry built on relationships; commercial and contract bond producers must have good relationships with their principals and their underwriters. Underwriters will likely be more open to new ideas and various risks of a producer that they respect and are friendly with. Whether people like it or not, a producer that has good relationships with his/her underwriters are more likely to obtain approvals and or lower rates. Principals should expect honest evaluations from their producers, not empty promises of what can be done in an attempt to keep business. It is obviously time to look for a new surety source if a producer is consistently failing to provide what is discussed.

The most important capability any producer can possess is proficiency in accounting and finance. A producer that can adequately evaluate an account prior to sending to his/her underwriters is worth their weight in gold. If a producer does not know how to interpret the information at hand, the application will more than likely be submitted to every resource available. One might think it is a good idea to do this, as this will give the principal a better shot at a reduced rate. Unfortunately, that is not the case. Underwriters are going to be more favorable to agents that consistently send them accounts they feel comfortable writing. A good producer knows their markets and what they are willing to write. Therefore, a professional producer will not waste their time or their underwriters by submitting applications that are destine for declination. What is the harm in a surety declination? Well, there are multiple problems. For one, numerous submissions will also generate numerous credit pulls, lowering the owner(s) credit scores. A bigger problem is that once a surety has declined a bond, they will not review it again. Some sureties will decline a bond just because they have received an application more than once. They feel that the principal is shopping around a lot and therefore, in a desperate situation. A paper pushing bond producer is not a good route for any intelligent principal.

The most professional bond producers have networked throughout the surety and construction industries, creating lasting relationships that will assist them. A good bond producer is also proficient when it comes to reviewing financial statements and other bond application requirements. The producer will think about the best solution for an account rather than simply submitting it to every market they are appointed with. A bond producer can make a huge difference when it comes to the future of a business. Choose your producer wisely, and bring them on board to your company for years of success to come.

Bonding companies look at far more than just owners’ personal credit when it comes to contract surety over $250,000. A surety wants to have confidence in their bonded contractors prior to approval. There are numerous different actions a contractor can take to instill confidence in a bonding company. A contractor must be organized and practice restraint when necessary to gain the trust of an underwriter.

For most, the best way to run a company in an organized fashion is to hire professionals they can count on to assist in decision making. A bond producer well versed in contract bonding should be a top priority. If your agent is not knowledgeable enough or does not have the markets to fit your company’s needs, then there is little they can do to help with your bonding needs. An experienced bond producer is a must to ensure you are competitive in your bids and to allow for a bond line size that suits the needs of the contractor. An accountant that understands construction is a must. The business financial statements are the highest weighted item for underwriting a contractor. You can think of them as the underwriter’s window into your company. A contractor must walk away if their accountant does not know how to complete financial statements on a percentage of completion basis. A good relationship with a banker is a rather obvious need for any business that relies heavily on loans to operate. There are numerous other professionals that one could utilize such as a good controller and legal counsel, but we will stop our list here so it still applies to most contractors.

Surety underwriters will want to periodically meet with their medium to larger sized contractors. The underwriter will want to see that the contractor knows their cash flow and their receivables that are over 90 days. The underwriter will also want to see that the contractor can answer all other questions regarding their company. In other words, the underwriter will want to leave feeling confident that the contractor knows their industry and the specifics on their company.

Earlier, I mentioned that a contractor must practice restraint when necessary. By restraint, I mean that they can not be blinded by profits and take risks above and beyond their ordinary work. A surety will not be comfortable approving a bond twice the size of any previously bonded work for a new company. A red flag is raised for any contractor that wants to do work outside of their niche and or territory. If an underwriter is not comfortable with the contract for any reason, they will decline the contractor.

A contractor must keep in mind that they are essentially obtaining surety credit. Underwriters must use the financial documentation provided and personal relationships to decide the risk on a particular account. A contractor that is well organized with a team of professionals to assist them will create a great deal of confidence in a surety’s underwriters.