Category Archives: Bond Issues

Another look at the difference between insurance and surety

Clients are often confused about surety bonds and insurance and how they differ. Very simply, the difference is that you must qualify for a bond, and you must purchase insurance. This is why the surety or bond company will ask so many financial questions and will require financial statements and verifications of funds shown on those statements. Bonding is very much like getting a loan from a bank.

An insurance policy is a way to transfer the risk to the insurance company. The insurance company considers the risk and recognizes that a certain percentage of claims will occur. The premium you pay for the policy is partially based on the occurrence of those claims or losses and they charge accordingly.

In bonding, there are 3 parties involved: the Principal, the Obligee and the Surety. The Principal or contractor doing the work retains the risk. The bonds provide protection for the Owner of the project, or the Obligee, that the contract will be completed. The premiums paid for bonds are actually “fees” to use the insurance companies financial assets to back your job. The bonds state that the contract will be completed and that the subs and materials used on the job will be paid. In the event they are not, the bond company may step in and take over the completion of the contract up to the amount of the bonds.

Not everyone will qualify for surety. Lately it is becoming more and more difficult because of the stricter requirements being placed by the sureties due to recent losses. Every claim on a surety bond has an impact on the industry since no losses are assumed in surety. Premiums paid are not based on the losses occurring in the industry, but rather, they are a “fee” to be charged for having the surety back you financially on your project.

When you are asking for a bond you should expect to supply the following and any other pertinent information that may apply to your specific situation: CPA Prepared Fiscal Year End Financial Statements on your Business, Personal Year End Financial Statements, Copy of a Bank Line of Credit, Current Work on Hand Report, Contractor’s Questionnaire giving information about your company, and a copy of the Contract to be bonded.

You, as owner of your company, will be required to personally sign an Indemnity Agreement to set up your bonding. This means that in the event of a claim, you personally will repay or make the bond company whole. This is very different than insurance where claims are not repaid.

We have professionals trained to handle all your bonding needs. If you have questions or would like to be set up for Contract Bonding we will be happy to assist you. Call us at (800) 921 1008 or (212) 566 1881.

Are letters of credit a suitable substitute for surety bonds?

The direct answer is No! Surety bonds offer the best way to guarantee a contractor’s performance. Surety bonds differ considerably from letters of credit even though they are both types of guarantees. In the case of default, the surety bond company has duties and responsibilities to both the contractor and the project owner based on the underlying contract. The surety bond company strives to be equitable to all parties to successfully ensure the completion of projects. This role contrasts sharply with a letter of credit whereby the bank simply pays over a sum of money on demand to the project owner. The bank assumes no role in arranging for completion of the work, and the letter of credit is usually for a smaller amount which is often insufficient to cover all of the project owner’s additional costs in the event of contractor default.

What are surety bonds used for?

Different surety needs are met by different types of surety bonds. Surety bonds are a risk transfer mechanism whereby the risk of non-performance by the principal is shifted from the obligee to the surety company. Federal, provincial and local governments often require surety bonds to guarantee that business owners and individuals will comply with various laws protecting public funds. Contract bonds protect taxpayers and private construction owners by guaranteeing that projects will be completed properly, on time and without liens. Many commercial surety bonds protect and secure public funds and private interests.

There is a need to protect taxpayer dollars and private owners’ investment capital. Construction is a very risky business. Many contractors fail every year, leaving behind unfinished private and public construction projects – and billions of dollars in losses. Surety bonds offer the best way to protect against the risk of contractor failure. Essentially, they guarantee a contractor’s performance, assuring that construction projects will be built on time and that certain material suppliers and subcontractors will be paid.

What is the role of the Surety Agent?

The role of the Surety Agent is to assist the Surety in writing profitable surety business. Typically, the agent maintains the direct contact with the contractor and serves as an intermediary between the contractor and the Surety. The agent usually handles all bid and final bond requests from the contractor and gathers miscellaneous information as requested by the Surety for underwriting purposes. Furthermore, the agent is typically responsible for the processing and delivery of all bid and final bonds.

What does it take to get set up with a surety company?

Ideally, the Surety Company wants to see three years of Reviewed, CPA prepared business financial statements along with Work in Progress Schedules, Accounts Payable and Accounts Receivable Schedules, Company & Contractor Histories, Bank References and thoroughly completed questionnaire (often, surety support is established with less). The Surety Agent’s job is to retrieve this information from the contractor, verify its completeness, evaluate the provided information and submit it to the Surety Company that will best match up with the contractor’s needs and capabilities. As indicated above, a few sureties have a simple single page application for contracts around $100,000 or less. Surety for these small contracts is based solely on the established credit of the applicant.

What is a Bid Bond?

A Bid Bond is issued by the Surety to the owner of the project in lieu of a required cash deposit. The cash deposit (usually 10% of the bid amount) is subject to full or partial forfeiture if the contractor is the low bidder and fails to either execute the contract or provide the required Performance and/or Payment Bonds. In other words, the bid bond assures and guarantees that should the bidder offer the low bid, the bidder will execute the contract and provide the required surety bonds.

What does “bondable” mean?

Template-05Bondable does not mean that the contractor has a license bond. All Licensed Contractors are Required to post a license bond in order to be Licensed. Bondable Actually means that the Contractor’s capital, character & capacity have been analyzed by a Surety Underwriter. The Surety Underwriter has then determined that the Contractor can perform certain types of work within established parameters. Based upon that determination, the Surety Company will issue Surety Bonds guaranteeing the Contractors performance and/or payments within the resolved guidelines.

Can a “start-up” company qualify for bonding?

It is more difficult, but not impossible, for new companies to secure bonding . In addition to pro forma financial statements, the surety would require personal indemnity of owners and spouses along with some form of collateral. This can be in the form of a certificate of deposit or letter of credit, obtained from your bank, which is held by the surety as security for your bond(s). Once the job is completed and the Owner releases the bond requirement, your collateral can be returned to you from the Surety company.

How can small businesses benefit from Surety Bonds?

Bonds provide small contractors with numerous benefits. The surety bond provides protection against contractor default. The surety company helps the contractor avoid costly delays and contract disputes, by intervening before it’s too late. When a project is bonded, there’s also an added layer of payment protection for workers and suppliers of the contractor. Surety bonds help level the playing field, and allow a small contractor to compete in the free market, leading to lucrative contracting opportunities.

What happens if a surety has to pay a claim?

A Principal is legally obligated to reimburse the Surety Company for any loss and expense incurred by the Surety. The Principal’s obligation to the Surety can, therefore, be greater than the original obligation to the obligee. The Surety has the same recourse against the Principal as any other creditor would have in recovering their loss. This is the primary difference between a surety bond and insurance.

The Surety’s claim department will conduct an investigation as quickly as possible to avoid any further damages and mitigate their exposure. It is important to note as the Principal under a bond, that a pending claim does not necessarily mean there will be a financial loss incurred since the dispute may not even be legitimate. If the Surety does determine through their examination that the claim is valid, the Principal will be reminded of their obligations under the indemnity agreement and given the opportunity to satisfy the claim first. If the Principal fails to respond, the Surety will arrange settlement with the Obligee, and implement collection proceedings against the Principal.