Surety Bond Authority Weblog

Whether it be local, state, or federal government, it seems as if they all are extremely interested in the surety bond industry. The bottom line is that government entities require various forms of surety bonds by companies hired to work for them because the government needs to ensure that the money they are paying on behalf of U.S. taxpayers is guaranteed, and not wasted. Because the government is spending money on behalf of U.S. citizens, they are obligated to ensure that companies given government contracts do what they say they’re going to do, and follow through with their promises.

Requiring contracted companies to get bonded, via the many different types of surety bonds, provides government entities with peace of mind that if the work does not get done according to the terms of a contract, the deep-pocketed bonding companies will step in to remedy the situation.

State governments frequently require surety bonds, often in relation to transportation departments. State courts also require countless court bonds each calendar year, such as probate bonds, guardianship bonds as well as appeal bonds.

The federal government is perhaps one of the biggest generators of surety bond business around, due in large part to the extremely expensive contracts they have. For an example, you don’t have to look further than some of the current Department of Defense (DoD) contracts awarded to civilian contractors such as Halliburton, Blackwater, General Dynamics, etc. Additionally, like state courts, federal courts require countless court bonds as well.

Government interest in the surety bond industry is not going anywhere, which should come as no surprise. Taxpayers should know that their government is taking action, many times in the form of surety bonds, to ensure government funds aren’t lost in the event of a contractor defaulting, or failing to follow through with their promises.

If you don’t know what to look for, purchasing a surety bond can appear to be a challenging process. There are numerous surety bond companies and bond agents around the country to choose from, so I have provided four things for customers to consider that will help them find the bond that is right for them.

Total Cost of the Bond
The annual total cost of the surety bond to the customer is a very significant factor to look at when shopping for a bond. While this is definitely not the only element that should be considered, it is typically the first place most people look. This should include premium rates from the surety bond companies as well as the bond agents you purchase them through. All else being equal, customers should look to buy bonds that take the least amount of their hard-earned money as possible. However, as you’ll see below, when it comes to the surety bond industry, all is else is not always equal. Bond companies as well as agencies that represent them can vary greatly.

Quality Customer Service
The level and quality of customer service provided by a bond agent is of particular importance and should not be overlooked, particularly for customers that plan on renewing their bonds. You want to look for skilled agents that can quickly turn bonds and get them to the customers that need them in a timely, efficient manner.  Turnaround time is especially important for customers attempting to purchase contract bonds. The most successful agents are those that truly lookout for the best interests of their customers and work to develop lasting business relationships. Such a relationship with a trusted, knowledgeable agent will benefit both parties and can provide principals (customers) with valuable business advice.

Conduct Background Checks
While bond companies and agents will conduct financial/credit checks on you, the customer, you too have the ability to conduct background checks on prospective sureties. You can do so by looking up the company on a database known as the Federal Treasury List. All sureties are given annual ratings by a number of organizations. Based on the documents they are required to submit, the sureties are assigned a letter grade. This letter grade is updated annually, and should be easily accessible to all who would like to find it. It should be attainable from surety bond agents, because they represent the sureties to prospective customers. Additionally, customers may want to consider how much experience a prospective agency has in the industry in which their specific bond type falls under, because it can possibly expedite the process and help you get exactly what you need.

Ease of Renewal Process
Another factor that may not jump out at customers at the beginning of the surety bond purchasing process is the ease of the renewal process. It goes without saying that this should be of significant importance for customers that know they’ll need to renew their bonds in the coming years. Requirements for the renewal of a bond may vary between different companies and agencies. Customers may want to find out how often they will be required to provide updated financial statements to their agents, such as balance sheets, income statements, statements of cash flow, as well as credit reports. Requirements established in writing by sureties and agents must be met by principals in order to prevent termination of a needed surety bond. 

For more information on the surety bond renewal process click here. 

While the aforementioned factors are not the only things to consider when shopping for a surety bond, they will definitely help steer you in the right direction, and should help customers find the right bond from the right company and agency.

Today, a majority of surety bonds are purchased by principals through surety bond producers, also referred to as surety bond agents. This does not only pertain to contract bonds, but all other surety bonds to include the numerous commercial bonds available, as well as court bonds.  Surety bond producers serve as middlemen between those in need of bonds, and the deep-pocketed surety bond companies. These agents are knowledgeable about the surety bond industry, and the industries in which they provide bond service, such as the construction industry. They work as part of bond agencies that focus on suretyship, but can also be a part of certain insurance agencies that have surety departments. The best, most professional surety bond producers have well-established relationships with multiple surety bond companies. This allows the agents to help find their customers (principals) the surety company that is the best fit for their particular needs.

When it comes to the construction business, surety bond producers not only help contractors obtain their required surety bonds, but they also can provide additional business advice, technical expertise, and managerial consulting. A good surety bond producer can become part of a contractor’s business advisory group, similar to the contractor’s lawyer, accountant and financial advisor. Producers familiar with the construction industry, and the surety bonds pertaining to it, can utilize their experience and knowledge to assist their customers in preparing for the often rigorous prequalification process required by surety bond companies. Working with solid, reputable, reliable surety bond producers and bond companies can help contractors increase their surety capacity which will help them if they choose to grow their business in the future.

While most of the larger property and casualty insurance companies out there have their own surety departments, there are also some companies (surety companies) that focus most, if not all, of their business efforts on the surety bond industry. Regardless of whether it’s an insurance company with a surety department or a surety company, any company that wants to write surety bonds in the U.S. is required to be licensed in one or more states. Typically, surety companies must ensure they obtain a license from the state they in which they conduct business, or from the state where the bond guarantee is required.

Most surety companies become members of the Surety & Fidelity Association of America (SFAA). The SFAA is a non-profit organization based out of Washington DC that is officially licensed as a rating or advisory organization in all 50 states. Additionally, SFAA is designated by the insurance departments of all states (except for TX) as a statistical agent to deal with the reporting of surety experience. Perhaps SFAA’s most significant role is how it represents all of its member’s common interests before a variety of local, state and federal government agencies. They also post annual reports with news on state and federal legislation that has affected the surety and fidelity industries.

Retainage is a term that applies to the contracting business, and is therefore important to grasp when learning about contract bonds.  While it is not necessarily a part of the surety bond industry, it is related. 

Retainage is defined as the portion of a contractor’s payment that is withheld until a project is completely finished. In other words, the client won’t pay the contractor the retainage until all work has been completed, in order to provide the contractor with incentive to provide a quality product/work until the very end. Usually, the retainage amount will be negotiated before a contract has been agreed upon, and will be listed as a certain percentage of the project’s overall cost. Typical retainage percentages are around 10%. In some instances, where clients develop familiarity and confidence in a certain contractor, they may offer to forego the retainage requirement.

To illustrate the concept of retainage here is a simple example:

Lets say a customer (obligee) hires a contractor (principal) to do some construction work. The two go into contract for a $200,000 construction project to build some sort of structure. Using the average retainage percentage listed above, 10%, the customer puts into the contract that 10%, or in this case $20,000, will be withheld as retainage. Throughout the course of the construction project, the customer pays the contractor $180,000 for the work performed. Once all work is completed per the terms of the contract, and in a quality fashion, the final $20,000, the retainage amount, will be paid to the contractor.

At first glance, some people may assume that mortgage bonds (mortgage banker bonds, and mortgage broker bonds) are all the same. While there are some similarities between the two types of commercial bonds mentioned above, there are also some clear differences which this article will outline.

Mortgage Banker vs. Mortgage Broker: Most surety bond companies classify mortgage banker and mortgage broker bonds in a similar fashion, but there are some operational elements to each that differentiate the two. Mortgage brokers serve as a “middleman” by bringing principals together with banks that end up loaning qualified principals funds. Mortgage bankers (also referred to as mortgage lenders) are the entities that actually lend money to the principals, and they act as both the banker and broker for the loan. Understanding the difference between a mortgage broker and a mortgage banker (or lender) is the first step toward understanding similarities and differences between mortgage broker and banker bonds.

Bond Amounts: Perhaps the most obvious difference between the two types of bonds lies in the amounts in which they are commonly written for. Mortgage banker bonds are typically much larger, or written for much more money, than mortgage broker bonds are, and can be two to three times the size of mortgage broker bonds. Therefore, qualifying for mortgage banker bonds can be much more challenging for a prospective principal.

Bond Forms: Every state will have a separate bond form for mortgage banker and broker bonds, which will spell out exactly that the specific bond guarantees. The bond forms may differ depending on the language of each state. While any given state’s bond forms for each type may appear similar, it is important to carefully read the bond form, or work with a knowledgeable bond agent, to ensure you understand exactly what is being guaranteed.

Similar Risk for Mortgage Bankers and Brokers: Contrary to popular belief mortgage banker and mortgage broker bonds both have very similar risk factors. Seeing that the bond amounts for mortgage banker bonds are on average significantly higher than those of mortgage broker bonds, most people would think that mortgage bankers face more risk, however that assumption is not necessarily accurate. While the nature of a mortgage banker’s job makes the risk they face obvious to most, the many challenges mortgage brokers face seem to level the playing field when it comes to risk. Recent studies have further proven that the claims ratios for both types of bonds are comparable.

While there are some similarities between Surety Bonds and an Irrevocable Line of Credit (ILOC), there are some significant differences that make surety bonds more cost-efficient and beneficial to prospective customers. This article will briefly explain surety bonds and ILOCs are, how they work, and what makes them different from one another. After reading this article, you will understand the benefits to posting a surety bond, and will be able to see how they can actually save you money.

What is a Surety Bond?

Surety Bonds (often misspelled as “surity bonds”) are three-party agreements involving the surety (bonding company), obligee and principal. (Note: Surety Bond Agents are also involved to facilitate the process.) Basically, an obligee is requiring a principal to purchase a surety bond in order to guarantee that they will perform per the terms of a contract or agreement. By paying a premium for a bond, which is typically 1-3% the bond amount, the principal purchases the financial backing from deep pockets of the surety bond company. Collateral is only required from the principal in unique, very high risk situations where the likelihood of a claim is increased. Even in these circumstances, the surety will often accept an increased premium over the need for collateral.

What is an Irrevocable Line of Credit (ILOC)?

An Irrevocable Line of Credit is also a guarantee of performance, but it is handled differently than a surety bond. An ILOC is a letter of credit issued to an obligee to guarantee that the principal will perform, but in creating this letter of credit, the bank freezes the principal’s liquid assets in the total amount of the ILOC. Since this amount of funds is frozen by the bank, the principal cannot access it until the bank releases the line of credit. If a claim arises, the obligee is able to use the letter of credit to access the funds held by the ILOC. Obtaining an ILOC can be tough for principals that truly value their liquidity.

Comparing the Costs

While at first glance, the premium rates and service fees for a surety bond may make it appear to be more expensive than an ILOC, potential customers look at the whole picture before coming to such a determination. When you consider the long run, surety bonds usually end up being less expensive than ILOCs and can help principals save money. While service fees for an ILOC (roughly 1% the amount of the ILOC) are typically lower than premiums bond rates for a surety bond (roughly 1-3% the bond amount), purchasers of an ILOC have a bank freeze cash assets for the total amount of the ILOC. Customers that purchase surety bonds typically do not have a collateral requirement, and experience much more liquidity. They are able to invest the freed up assets and make money by doing so. In a money market account, for example, the principal could earn 3-4% on dividends, vice having their cash made off-limits to them. This is a clear illustration of how surety bonds can save you money when compared to an ILOC.

Conclusion –>  Surety Bonds are Superior

For those who qualify, surety bonds are more often than not the best choice for prospective principals for numerous reasons. As you can see, in the long run they usually end up being cheaper than ILOCs. Not having to put down collateral for a bond allows customers to invest their capital, which would not be the case for those who purchase ILOCs. Being more liquid provides increased flexibility in day-to-day operations. Customers deciding between a surety bond and ILOC must make themselves informed of the different options available to them, and by doing their homework, and not just looking at premium rates and service fees, they will see that surety bonds can be much more beneficial to their company

Over the past decade, the surety bond industry has seen some significant changes that have changed the industry landscape, particularly when it comes to high risk bond programs. Companies that were dropped by their bond companies as a result of bad credit, etc, have been forced to find new bond agents in order to help them attain new surety bonds. This created a slew of challenges for agents, as they now have to find markets for these customers with credit problems, and will typically require significant collateral in order to write a bond for someone with bad credit. To serve these types of principals, Bad Credit Surety Bond Programs came into play.

High Risk = Higher Premium: Before there were high risk bond programs, underwriters of surety bonds would only write bonds for customers (or principals) that presented little to no risk of having a claim arise against them. In other words, they went after a “0% loss ratio”, and the bond companies were in a position to do so. With Bad Credit Surety Bond Programs, the underwriters of bonds are able and willing to write bonds for principals that are higher risk (of having a claim), and can do this by approving them at higher premiums. Similar to insurance companies, surety bond underwriters can approve a wider array of customers, but approval for those more likely of having a claim obviously comes at a cost to the principal… higher rates.

Collateral vs. Increased Premiums: Early on in the process, Bad Credit Surety Bond Programs brought about a need for bond companies to require collateral from principals. This tends to be a cumbersome, time-consuming process that involves a lot of administrative effort, and therefore many bond companies decided to avoid the collateral requirement by offering higher premium rates to their principals. Customer preference depended on the specific principal’s financial situation. Typically, however, the bond programs that offered higher premiums vice collateral were less expensive for the first year of the bond, but over time those that required collateral proved to be less expensive. This was due to the fact that the collateral would eventually be returned to the customer (roughly a year after the bond’s release) if no claims arose.

Knowing Your Options: It is important for principals with bad credit to understand what all of their options are. While many Bad Credit Surety Bond Programs are designed to meet the needs of customers with poor credit, and often times prove to be the most cost-effective option, they are not the only option available. For example, an Irrevocable Line of Credit (ILOC) is an alternative whereby the bank will freeze liquid assets of a principal in an amount equal to the total amount of the surety bond they would need to purchase. This would only be more preferable for principals with enough liquid assets to comfortably have the amount of the ILOC frozen by a bank. For customers that truly value their liquidity, and ability to quickly have cash on hand, an ILOC is probably not a viable option. While ILOCs have traditionally had service fees of around 1% the cost of the line of credit, the money market rate will have an impact on that as well, and can significantly raise the annual rate of the ILOC for the customer. For example, if the money market rate is 5%, and the service fee for the LOC is just 1%, the actual annual rate the principal pays for the ILOC is 6%. Customers must understand the choices available to them, and should choose the option that best fits their specific needs.

Outlook: High Risk Surety Bond Programs have been around for more than 5 years now, and it does not appear that they are going anywhere in the foreseeable future. More and more companies are willing to write surety bonds for principals with bad credits, and those that carry some sort of risk of having a claim arise. While increased premiums are part of what makes bonding companies willing to do this, the increasing number of bonding companies writing high risk has created competition. Competition is obviously a good thing for the customers, in this case the principals with bad credit, because it will eventually drive premium rates down, making Bad Credit Surety Bonds more affordable.

Like many industries in our economy, the U.S. construction market has taken a hit as a result of the recent credit crisis. Many constructions projects throughout the country have either stopped or been slowed down, and subsequently, the construction bond portion of the surety bond market has seen changes as well. Specifically, perhaps the greatest change to the construction bond market is the level with which underwriters of surety bonds scrutinize the cash flow, or financial health, of contractors seeking surety bonds for their businesses.

It’s important to understand why this additional scrutiny is being placed on the contractors’ cash flow by underwriters, because this is happening despite expectations by brokers that rates will be stable for the near future. However, the U.S. construction market’s recent decline forced related insurance rates (premiums) to fall during the second quarter of this year, which was the first quarterly drop in insurance premiums in the past few years. Additionally, the current market situation has caused a major increase in competition for construction jobs/projects nationwide. Construction companies are forced to lower their prices to get much needed jobs, and therefore their profits (profit margins) are naturally going to take a hit. This makes accurate, efficient management of companies’ financial statements essential to their financial well-being, and possibly to the survival of the business. In particular, proper management of the balance sheet, and the statement of cash flows (SCF) is crucial to a construction companies’ success, because often times they can work for up to a couple of months on a project before they begin receiving cash from customers. Construction expenses and payroll can add up quickly in this environment, and therefore cash flow is vital. Underwriters of surety bonds understand this, which is why they are taking a closer look at contractors’ cash flow when determining the level of risk associated with a bond and the premium rates.

On 1 July 2009, California State Assembly Bill 180 will become operative, and will set forth tighter laws governing the state’s Foreclosure Consultants.

AB 180 allows homeowners the right to cancel on a contract up to 5 business days, as opposed to 3 business days, as was previously the case, and also makes delivery of a cancellation notice easier than before. Furthermore, the bill prevents foreclosure consultants from getting a power of attorney from the homeowner, regardless of the purpose.

In July 2009, upon becoming operative, the bill will require all California foreclosure consultants to register with the Department of Justice, and also to purchase a $100,000 surety bond (commercial bond) in order to guarantee they all foreclosure consultants follow state law. The Department of Justice will then have proper oversight of the foreclosure consultants throughout the state of CA. The surety bond requirement was put in place to benefit/protect homeowners.