For many years the surety industry has experienced considerable profitability due to the backing of a strong economy and a theoretical zero percent loss ratio business plan. This model for operations worked very well for many years, but also set the stage for a few years that hurt the surety industry on a whole, leading to much stricter underwriting guidelines and pricing.
Up until around 1989 the surety industry had experienced a fairly consistent low loss ratio, with moderate times of increasing and decreasing loss amounts, combined with considerable premiums being earned, newer players entered the market and began competing with previously existing players. This resulted in a much more lax standard on background checks for the principals applying for the bonds as well as driving costs down. It is widely noted that many bonds began to be written with little regard to risk consideration due to this more aggressive market with underwriters competing with each other. Around 2000 the economy experienced a faltering that resulted in principals getting into financial difficulties, requiring support of the surety bonds and ultimately the bond companies. The number of claims that were experienced between 2000 and 2002 were staggeringly high, resulting in a huge direct loss ratio that contradicted to original model of zero loss. Many carriers were forced to withdraw themselves from the market as others became insolvent.
While the terrorist attacks on September 11, 2001 did not directly affect surety companies in the same sense as careless underwriting did, there was an adverse effect that was experienced. The insurance companies that paid out money for property and casualty losses were in many cases the sureties’ parent companies as well as their affiliates. This caused the insurance companies to tighten up on requirements from the primary sureties that they owned, which in turn caused bond underwriters to make more disciplined decisions while trying to place their bonds. Around this same time period Enron filed for bankruptcy, which in turn had a negative impact on economy. Once again this created a difficult time for principals that were trying to maintain their bonds, relying on help once again from the surety bonds causing more claims.
All these events have led up to this current state of conservative guidelines for underwriters to consider while they issue the bonds, although this does have a positive consequence for all parties involved in the bonding relationship. The surety companies can avoid hazardous claims and work back closer to a zero loss ratio, stabilizing the bond market which will ease guidelines and pricing in the near future. Principals also benefit from this; companies that would have a difficult time meeting their requirements won’t get into any obligations that will hurt them financially in the long run during this unstable economy.