Bonds: A Return to Disciplined Underwriting

Writing surety bonds is a niche that perfectly illustrates why specialization is so important in the insurance industry. Bond underwriters need to exercise the utmost caution when issuing bonds, and they need to make sure they have done thorough background checks on their clients to avoid hazardous claims.

The bond marketplace, like the rest of the insurance marketplace, is certainly seeing their fair share of hard times, marked by numerous carrier withdrawals and insolvencies. Among the most notable, Reliance (insolvent), Amwest (insolvent), Fireman’s Fund (withdrew), and Kemper (insolvent), not to mention a number of smaller carriers that have pulled out as well.

But while the past couple of years have been marked by insolvencies and withdrawals, the industry has also seen a good number of new writers enter the arena.

“There has been a tremendous amount of change in the landscape of active surety companies over the past several years,” said Bob Thomas, CEO of Los Angeles-based American Contractors Indemnity Company. “The industry has witnessed a number of withdrawals, consolidations and start ups.

“In the wake of the withdrawals, there have been new entrants into the market that are looking to replace the missing capacity,” he continued. “The evolution of the companies available to agents suggests that there continues to be interest by sureties to write bonds. It may not seem to be the case to some agents and principals but deserving risks will be bonded.”

Bond underwriters agreed that the market is hard across the country, not just in the Western states. They are seeing a return to stricter underwriting in response to the hard market.

“From my standpoint it’s not really a problem, it’s kind of a return to rational underwriting,” said Michael Burns, vice president of marketing at Seattle-based Contractors Bonding and Insurance Company (CBIC).

“We’ve really seen it start hardening up for us within the last year to year and a half. Prior to that, from my standpoint, our premium was somewhat flat because we didn’t get into a lot of these off-the-wall underwriting schemes. We kind of held back because it was our position that even though they were small or medium-sized products, we were going to still underwrite them because we were concerned about our bottom line. There were a lot of companies out there that were just issuing things without any real underwriting or without really understanding what it was that they were issuing. A lot of that stuff has gone into claims and caused a lot of real problems.”

“I think we have a good solid group of quality surety companies operating throughout the United States,” said Harry Crowell, chairman and president of Irvine, Calif.-based Insco/Dico Group. “There are just probably not as many as there used to be because all of the companies had a surety division but a lot of the big companies have discontinued surety as we know it. As far as the normal, smaller average-sized business, there’s not as many companies writing that as there used to be.”

Claims are up
While the types of claims have varied, there has been a significant increase in claims in the bond marketplace over the past several years.

“If you look at the claims rates for all surety it’s been up substantially from anything prior, all throughout the industry,” Crowell said. “Claims rates are running from 45 percent-70 percent on different companies and surety is designed to be a zero claims rate. Where you’re looking for it to be reasonably acceptable is 15 percent-20 percent, the high end. Claims have been substantially over that all over the place.”

The increase in claims is likely due to poor underwriting and the issuing of bonds that probably should not have been issued in the first place. The terrorist attacks of Sept. 11 only further aggravated the bonds market, as it did the industry.

“The forces that led to the current market conditions were poor underwriting and risk selection,” Thomas said. “The industry got very aggressive in the late 1990s that led to extension of credit beyond what risks deserved (underwriting) and the bonding of risks that should not have been considered (selection). The effects of these two fundamental breakdowns were being felt in the surety industry in late 2000 and 2001, only to be exacerbated by 9/11.

“While the surety industry didn’t record losses specifically related to the events of 9/11, many sureties’ sources of capital became strained as a result of those events. Simultaneous with 9/11 events were unrelated large surety losses that prompted many writers to pull back and re-underwrite their business plans.”

“There was a period in which there were a lot of things being written that just should not have been written and a lot of people were ignoring underwriting to some degree, especially on smaller to mid-size items,” Burns opined. “And then on larger items, there were some things being written for companies that should not have been written.

“We’re still seeing some business kind of still being dumped on the streets,” he added. “When you talk about the market hardening up and companies [going insolvent], there are a lot of things that should just not have been written. It’s questionable whether [the client] should have received surety credit to begin with. Not all of it, but a fair amount of it.”

For example, Burns said, a motor vehicle dealer may apply for a surety bond, and some underwriters might just issue the bond without running credit reports or checking financial statements.

“You’re seeing companies that are tightening up their underwriting, you’re seeing other companies wondering whether or not they really need to have surety or have surety on the level that they had it before, they’re either pulling back or upping requirements as to what they’ll take a look at.”

“It’s difficult to get people to understand that surety is not general insurance like auto insurance,” Crowell said. “This is something to help resolve an issue between two parties. Surety is there to protect both parties, not either one, so you have to stand in the middle and collect everybody’s money and try to solve the problem. The surety job is not just to write a check like you would when you have a car accident. The insurance company doesn’t care whose fault it is, they have a guarantee to get it repaired, but with surety you want to make sure, you have to find out all of the reasons for it and there are normally numerous parties involved in any claim so it’s a whole different type of claims handling than any other insurance is in.”

Looking into the future
The bond marketplace is cyclical, as is the rest of the insurance industry. And just as other lines are still reeling from the effects of the hard market, the old adage “What goes up must come down,” rings quite true for bond underwriters. While companies are tightening their belts in terms of underwriting, sooner or later the market will ease up and competition will increase.

Thomas sees a more disciplined approach to underwriting as the forecast for the future of the bonds marketplace, but then a return to a competitive market as the cycle continues.

“After 12-24 months of ‘quiet,’ I predict we will see more competitive behavior return to the market. Notwithstanding, sureties will be challenged by economic conditions putting pressure on its customer base; less government spending and rising interest rates. I anticipate there will be less deviation from sensible underwriting practices than what occurred in the late ’90s.”

Topics Claims Underwriting Market