The surety industry is still thriving in spite of a decrease in federal construction projects that require bonding. Though all seems well with the industry, more losses are expected in the next couple years.

“Government spending is down fairly significantly this year,” said Roland Richter, marketing VP for Liberty Mutual Insurance Group. He added, “If they’re not building, the contractors aren’t working and fewer bonds are being written.”

Being that the majority of the surety industry’s revenue is from government construction contracts, when federal construction jobs diminish so does the surety industry. As of now underwriter loss ratios have been promising according to the Surety and Fidelity Association of America (SFAA) stating that as of June 30, 2011, the loss ratio remained at 11.8%; this is down from 13.2% in 2010 (for the top 100 surety writers).

One should keep in mind that there is usually a lag before negative effects of a recession are experienced. Tax revenues running to state and local governments have about a 12 month period before they feel the negative impact on their revenue. Generally the surety industry has moved through a constant, predictable cycle which is a helpful.

“The way we look at it, the surety industry is a cyclical business,” said Drew Brach, Marsh USA Inc.’s U.S. surety practice. He said the cycle historically goes through four stages: crisis, recovery, boom and worsening.

“Right now, we are in the worsening stage, which typically leads to an increase in construction defaults,” he said. “While we haven’t seen significant increases in defaults yet, we’re seeing some early warning signs. There’s a tremendous amount of stress on financial statements, less work, and many contractors haven’t reduced their overhead enough to compensate for the changes.”

“When that happens, they have losses and they have cash flow issues,” said Mr. Brach. He said the surety industry is bracing for losses in 2012 and 2013.

If one had to guess, the predicted loss ratio for the surety industry will be around an even 16% for the 2012 year but only time will tell.

With loss ratio’s low and profits high, things look good for the surety world. Those who have been around for a while are familiar with the cyclical pattern and expect to feel the negatives in the coming years. The famous quote describes the surety industry pretty well, “the night is darkest just before the dawn.”

 Fortunately, government regulations are on the side of smart consumers. By applying what you know about surety bonds in the real estate industry, you can find your dream home and know your assets are secure.

An Overview of Surety Bonds

In many industries, government agencies help protect consumers by mandating the purchase of surety bonds by certain professionals – namely, those who have access to others’ finances and property. A surety bond provides consumers with compensation in case of a professional’s misconduct.

For example, to keep his or her license, a building contractor must purchase a surety bond. This provides consumers with protection in case the contractor should skip town with their cash or otherwise fail to meet professional guidelines. If the contractor doesn’t make good on promises, then their surety bond company will help rectify matters for customers.

Similarly, brokers and others in the financial industry are required to buy protective surety bonds in order to remain licensed.

How Surety Bonds Work

Surety bonds are a contractual agreement between three parties: a surety, a principal (the person acquiring the bond) and an obligee, the entity that is requiring the bond; in this instance, it’s the government. Although surety bonds are often confused with insurance policies, they serve different purposes. Insurance policies are purchased under the assumption something may go wrong, and protection will be needed. Surety bonds are more of a preventative measurement, which help encourage principals to make appropriate, professional decisions. Ultimately, the principal will be responsible to repay any damages should a claim be filed against them; therefore it is in their best interest to act ethically.

 Also, surety agencies will not provide bonds for individuals or companies they feel are at high risk. Detailed investigations are performed regarding a company’s past history, their financial history and whether they have applied for bonding prior to selling a bond to organizations. Typically, surety agencies avoid putting themselves at risk by working exclusively with financially-sound clients.

Choose a Bonded Financial Adviser

Bonds are required for a variety of financial advisors: bankers, lenders, and real estate brokers are just a few professions required to hold surety bonds. Bonding requirements do vary by state, therefore individuals should research their local legislations prior to inquiring whether their financial advisor has obtained one.