Surety Bond News

Every now and then I get a call from a new client asking how much of a discount they will receive for obtaining multiple bonds. I immediately know the conversation will take a bit longer than usual, as I will have to explain what surety bonds are in order for them to understand why they will not obtain a discount for placing multiple bonds.

Surety bonds are not an investment bond, rather they are a three party (principal, obligee, and surety) guarantee. We will use an example (using mortgage brokers) to make it easier to understand. The state (obligee) the mortgage broker is operating in requires that a surety bond be filed to guarantee the mortgage broker’s performance per the states rules and regulations on the industry. The mortgage broker (principal) goes to a bond producer to write a bond backed by a Federally approved bonding company (surety). If the broker triggers a claim the surety will pay the claim to the state department handling the brokers license. The bonding company will then look to the mortgage broker for repayment of the claim and expenses incurred.

As you can see from our example above, a surety bond should be thought of as a type of credit. The principal pays a service charge (premium) to the surety for their financial backing. Traditional surety underwriting will not approve a bond for a client that does not financially qualify for it on paper. Since suretyship is truly another form a credit, risk increases as the principal’s credit gets maxed out. Therefore, a bonding company may increase rates as the principal maxes out their surety credit. New companies or companies with poor business financial statements will have less surety credit available to them.

I do not want to give the wrong impression that bonding companies never give special treatment or lower rates to larger accounts. If a surety feels that a principal is a very low risk, the underwriter may write a bond he/she normally would not (i.e. bond form with risky language) so they can write all of the principal’s bonds. However, this is usually only done for very financially strong principals. Contract bond rates can be reduced for large accounts that bid and are awarded jobs often. The same can not be said for commercial surety.

A good bond producer will have a variety of surety markets to place all of your bonding needs. A diversity of markets allows the producer to place bonds with bonding companies that prefer a specific line of business or even specific bond form.

If you are a principal calling a bond producer, don’t ask how much of a discount there is for multiple bonds. Ask approximately how much surety credit you qualify for, as rates will only increase as you reach your surety credit limitations.

In the first part of this article, we reviewed what bonding companies typically look at when reviewing an applicant. In this installment, we will talk about what you can do to better your situation to become less of a risk and in turn lower your bond premium.

General Bond Application: For the most part, there is little you can do to lower your rate or increase your chances of approval when it comes to the bond application. You will want to complete this form as completely and accurately as possible. If any information is left blank, the approval will be delayed.

Business Financial Statement: Your business financial statements are usually the most heavily weighted item when a surety underwrites a bond. There are a number of things you can do when preparing your year end business financial statement to make it the most attractive to a surety company. For one thing, utilizing the services of a Certified Public Accountant will give your financials more credibility (In-house financials are accepted for smaller bond amounts, but may not get you the lowest rate). Often, the figures on your balance sheet are only as strong as the individual that prepares them. You want a very clean and clear presentation of your business and it’s financial picture. Bonding companies prefer statements prepared on an accrual basis, with full notes and disclosures. The accrual method gives the underwriter the best picture of your company’s financial strength.

There are several important elements a surety will want to review within your business financial statement. These elements all should be maximized as much as possible to ensure the greatest amount of suretyship allowed to you and your company:

1) Working Capital: This is the quick equation of all of the current assets subtracted by all the current Liabilities. This gives a rough working capital position which indicates the business’s ability to pay bills and shows a snapshot of the liquidity of the entity. This is where most companies struggle, and is also where most sureties will look for a weak spot. You can keep your working capital strong by staying on top of your accounts receivable, thus making them cash. In addition, making sure that payables are taken care of and most importantly that there are not any unnecessary inter-company loans.

2) Limiting Shareholder/Employee Loans: This seems like a nice way to lend either yourself money, or employees in some instances however, what you do not know is that surety companies look very unfavorably upon these receivables. If an underwriter sees an account receivable in the amount of $XX,XXX – that figure is immediately discounted in it’s entirety. The reason for this is quite obvious, the company may never see that receivable back from the officer, in fact many times it simply keep growing. Thus making an unrealistic account receivable account.

3) Owners Equity Draws: The biggest evil is the fiscal year end owner draw of capital. This needs to be balanced out delicately. If your company is thriving and you are able to pull sums of money for yourself at year end, you need to ask yourself, “How can this affect my surety bond(s)?”. It is always wise to speak to your bond agent about equity draws at year end as many bonding companies require a minimum about of equity in your company depending on how much bonded liability you have. In a perfect world, a surety would like to see a customer add to his corporate balance sheet year after year. Even if it is small gains year after year.

In short, there are many other items that can affect your companies eligibility for bonds and suretyship. These tricks to the trade mentioned above are a great start to keeping you and your company on track in the strange world of surety bonds.

Resume: If the surety is requiring a resume of the owner(s), be sure to make it as professional looking as possible. Do not submit a hand written fax that has limited information. The more confidant you can make the underwriter, the more likely you will obtain an approval at a lower rate.

Personal Financial Statement: Just like everything else on your bond applications, the personal financial statement should be accurate. Do not inflate numbers, as bonding companies will verify information from time to time. If they find any inaccurate or false information they will more than likely decline you for lack of trust. Keep in mind the surety is being paid to guarantee the performance of your business, so they need to feel confidant in doing so. Bonding companies are always more comfortable writing bonds for principals with home ownership. If you have the money are currently renting, your bond premium is another good reason to own a home rather than rent.

Personal Credit: Credit report flaws are the most common culprit for a principal being put into a high risk program. Fortunately, many of the problems can be resolved rather quickly. However, for some issues only time or new ownership can alleviate the situation.

1) Bankruptcy: A principal is stuck in a high risk program if a bankruptcy is not discharged for 7 years or more. The only way to lower the rate is to either wait it out or change the ownership of the company. Just be sure the new owner has a flawless credit report if you go through all of the trouble of changing the ownership.

2) Tax Lien: An unpaid tax lien is just about as bad as a bankruptcy. If the tax lien is paid over 3 years ago a few sureties will consider you for a standard program. Most will consider an applicant for a standard program after the lien is 7 years old (if paid). Once again to get out of a high risk program, the only options will be to wait for time to pass or change the ownership.

3) Civil Judgment: If the judgment is not satisfied, a surety will place the applicant in the same program that someone with a bankruptcy would be in. A principal with a satisfied civil judgment will still be written in a standard market by some bonding companies, depending on the circumstances. If you know you have a judgment on your credit report, include a description of what happened; it could keep you in a standard market.

4) Unpaid Collection: An unpaid collection could put an applicant in the same high risk program someone with a bankruptcy would fall under. Fortunately, if a collection is paid the principal is in good shape again. Most bonding companies will except a letter stating the collection is satisfied from the collection agency or entity the money is owed to. If you have an unpaid collection, pay it, it could save you thousands on your bond premium.

5) Late Child Support: Without a doubt, late child support is the worst item a surety can see on a credit report. High risk programs won’t even touch these applicants. Bonding companies do not want to guarantee businesses if the owner(s) refuse to or can not support their own children. There is little one can do in this situation short of resolving the child support issues and moving on from there.

Credit scores can be raised rather quickly for some. Your score will be lowered if your available credit is low, meaning you are making use of your credit. Paying off credit cards and other forms of credit can quickly raise a score a great amount. Credit inquires should be kept to a minimum, as too many can also lower a score. Most bonding companies want to see scores over 650, with lower rates that go down as scores increase. Therefore, you will want to do everything you can to get your score as high as possible.

Bond Form: Unfortunately, there is a little one can do to resolve the problem of a risky bond form (See part 1 of 2 of this article for what makes a risky bond form). Obligees will rarely allow any changes to their forms. However, obligees will revise their bond forms from time to time and have language added that is agreeable to sureties. If you are required to obtain a bond with risky language, you should complain to the obligee, as your bond is probably costing you more than it should.

An applicant must meet all of the above criteria in order to obtain the lowest rate. An applicant may fall into a high risk program if any single owner of a company does not meet the underwriting guidelines as described above. Do what you can to become less of a risk, as the commercial surety bond market does not have much of a middle ground when it comes to rates; applicants are generally either in the 1-3% category or 15%, quite a large difference.

The conservative underwriting guidelines of the current surety bond market are causing many people to be dropped, even after a principal is with the same surety for years. Many are baffled as to why a bonding company would not want to write their commercial bond(s) after so many claim free years.

Some bonding companies review accounts every year and will require file updates in order to keep the bond in effect. If the updates do not meet the bonding companies guidelines they will drop the client for the renewal. Updates are typically credit reports and business financial statements. If a credit score drops or a flaw such as a tax lien pops up, the principal risks cancellation. The surety will look to see that the company made a profit on their business financial statement; a year showing a loss is bad and a surety may decide to no longer back the bonds.

Often, principals will argue they have never had a claim and should not be dropped. The fact is, never producing a claim is nothing to brag about, it is expected. Bonds are underwritten assuming there won’t be a claim. A principal with a previous claim will probably never be able to find bonding again. Therefore, thinking you are “bondable” just because you haven’t had a claim is comparable to saying you are a good person because you never robbed a bank. Obviously, this is not true, you are expected to no steal and not doing so does not automatically make you a good person.

Some bonding companies do not review accounts from year to year. In other words, the surety will continue to carry the bond until the principal no longer needs it, a claim is produced, or if they decide to stop writing that particular bond all together.

There is a great range in rates for commercial surety bonds these days. Principals can see premiums range from 1-15% of the amount of the bond. Even a small bond at 15% can be extremely costly. In part 1 of 2 of this article, we will review what bonding companies look at when deciding a rate. Part 2 of this article will discuss what you can do to better your situation to make sure you are at the bonding companies lowest tier rating.

Commercial bond underwriting takes more than just personal credit into consideration. In general, a commercial bond submission must include: a bond application with general information on the principal, business financial statements and or a resume on the owner(s), personal financial statements of the owner(s), personal credit of the owner(s) and possibly their spouse(s), and the bond form that must be used to create the original bond. There are specialty programs available for some classes of business that will require less information. However, these programs are far and few in between.

A principal must qualify on all surety items named above. A surety can decline a principal if they fail to meet any of the sureties underwriting guidelines. The best way to understand what the surety is looking for is to go through everything one item at a time in detail. Some of the items below can be fixed immediately, others can take years to correct.

General Bond Application: A bond application will help the surety to determine: the bond amount, who is requiring the bond of the principal (obligee), principal’s contact information, owner(s) contact and personal information, etc. A surety can decline an applicant if they find that any of the information is inaccurate. At times, a surety will not want to write bonds when certain obligees are involved.

Business Financial Statement: The business financial statement of the applicant is the bloodline of the company and is one of the most critical items reviewed by the surety when applying for a bond. The statement should be done in an orderly fashion. Handwritten & sloppy internal statements are not recommended in a submission. Instead, it would be wise to contact a CPA to complete at least a “Compilation‿ Financial Statement for your business. This statement should also be done on an accrual method of accounting. This is necessary as it shows a clearer financial picture of your business. The unacceptable method of, “cash basis‿ should be avoided as it does not include several items on the balance sheet making the financial picture “cloudy‿. The CPA business statement should always include full notes and disclosures. In-house financial statements can be used for bonds $100,000 and less, but CPA is still preferred.

Resume: A surety needs confidence in the principal when approving a bond, especially at a low rate. The bonding company wants to know the principal has experience in their field of expertise and they can successfully run a business without triggering a claim.

Personal Financial Statement: Bonding companies are going to want to see that the owner(s) have enough liquid assets. Real estate ownership is also a must for most bond types. Obviously, they will want to see that the net worth of the individual is strong. Items such as life insurance, personal property, automobiles are less valuable in comparison to liquid cash or real estate equity.

Personal Credit: Many have the misconception that score is all that matters on a credit report. There are several items that are just as if not more important in the eyes of a bonding company:

1) Bankruptcy: Declaring bankruptcy can negatively effect you for the rest of your life. Fortunately, most bonding companies will write an account 7 years after it has been discharged. If it is within 7 years, the principal is usually stuck in a high risk bond program.

2) Tax Lien: For the most part, tax liens are underwritten similar to bankruptcies. The majority of sureties like to see them 7 years old and paid. If they are not paid or not far enough in the past, the principal will most likely be in a high risk program.

3) Civil Judgment: Bonding companies vary greatly when it comes to civil judgments. Some bonding companies will never write an account that has had a judgment placed against them. Other bonding companies will write an account with a satisfied judgment and a brief explanation of it.

4) Unpaid Collection: A collection on a credit report is not a good thing, but can still be written in a standard market if the collection is paid. An unpaid collection will immediately put an applicant into a high risk bond program.

5) Late Child Support: With out a doubt, unpaid child support is the worst item an underwriter can see. If an owner has late child support showing on their report they might as well start looking for bond alternatives. Not even high risk bond programs will write a bond for someone with late child support.

Of course, credit scores still count as well. Most bonding companies will be looking for credit scores of 670 or higher. However, some sureties have more liberal underwriting guidelines for low risk classes of business. Some sureties will base their decision on the owner that is considered the highest risk, while other bonding companies will average the credit scores of the owners.

Bond Form: The bond form is exactly what it sounds like, a form used to create a bond. The bond form contains the specifics of what the bond is guaranteeing. Therefore, bonding companies are careful as to what they are willing to write. Some classes of business are considered riskier than others (i.e. ICC Freight Brokers, Wage & Welfare, etc.). Sometimes a line of business is considered less risky, but the bond forms language is considered a higher risk. There are two clauses bonding companies will typically look for:

1) Cancellation Clause: A cancellation clause allows the surety to cancel a bond. An example read as follows, “The surety may cancel this bond and be relieved of further liability hereunder by giving 30 days’ written notice to the principal and the [obligee]‿.

2) Aggregate Clause: This clause creates a cap to the aggregate amount of claims. In other words, a $50,000 bond can pay out no more than $50,000 on a single claim or multiple claims. Therefore, if the bond pays out $50,000 on a claim, then it is maxed out and will not pay out on any additional claims. An example of the clause would be, “In no event shall the aggregate liability of the surety exceed the penal sum specified herein.‿.

For most bonding companies, a bond form missing the proper language will result in an immediate declination regardless of who the applicant is.

As you can see, a bonding company reviews a multitude of information prior to approving a bond. A good agent knows not to quote or even give a ball park quote based on a credit score alone, as it will likely be very inaccurate. In the next installment of this two piece series we will go over what a principal can do to be considered less of a risk and obtain the lowest bond rate the bonding company has to offer.

License bonds are surety bonds filed with a license to help protect the public. All different types of businesses are required to file license bonds: mortgage brokers, car dealers, contractors, etc. The one thing that they all have in common is that they typically deal directly with the citizens the bond is in place to protect. As a bond producer, I know many of the requirements for a variety of different businesses. I also see first hand when the state fails to properly protect the public by not requiring a bond, or by not requiring large enough of a bond.

I am always pleased to see a government official take action to set a new bond requirement. My satisfaction does not only come from the potential to write more business, but because I know that it is for the public good. How many times have you heard about someone getting a raw deal when buying a car, a home, getting improvements made on a home, etc. It is the government’s job to help protect it’s citizens from harm, including financial loss. A bond guarantees the work of the licensee and will pay out to their clients in the event of a legitimate claim. If a state is going to issue a license to legally operate a business they better make sure there is some sort of financial guarantee to protect the public from fraudulent acts.

You can always visit the Surety Bond Forums: Surety News section for updates on bond requirements across the country. There are a few recent proposals to mention, hopefully other state representatives will follow their lead. Colorado is proposing a $100,000 license bond requirement for mortgage brokers operating in the state. Georgia is considering an increase from $25,000 to $50,000 for their current auto dealer bond requirement. Smaller towns are also taking action to protect their citizens. Asbury Park, NJ is proposing a surety bond to be filed with remodeling contractors licenses.

Many license bond requirements are just too small. As mentioned above, Georgia has recognized their small requirement and are trying to take action. If there is a fraudulent auto dealer, do you think he/she will be crooked on just one auto sale or multiple? How much do you think the average vehicle costs these days? There are many citizens getting hit with large financial losses with a bond requirement of only $25,000. Of coarse the people fighting the act would be the auto dealers. They complain the requirement would put many smaller shops out of business. However, I believe that a bond to protect the public is simply the cost of doing business in that state. If an increased bond amount is going to put you out of business, then you probably would not have been operating for much longer anyhow. Statistically, the business owners that are more financially desperate are also the ones more likely to trigger claims.

License surety bonds are a great instrument to help protect the public from fraud. Our representatives need to wake up and create the requirements where they are lacking and increase the requirements when too small. Their job is to protect the public and a bond requirement is the best way to go about doing so. There will be people opposing new requirements/increases, but that is a cost of business to operate. If you can’t afford to bond your clients, then perhaps you should no longer be in business.