The surety underwriting process is often looked upon with disdain by insurance agents. It is frequently considered to be a futile exercise wrought with frustration, delays and non-responsive underwriters asking multiple questions and generating negative responses. Although it shouldn’t be this way it is important to remember that surety is different than insurance.
Surety claims are not caused by “accidents.” Surety bonds are three party agreements providing a guaranty to an obligee that the contractor principal will complete the project per the terms of the contract and pay their bills. Ultimately the customer of the surety bond is the obligee. The surety has a responsibility to the obligee to “prequalify” the contractor for the work.
Like insurance, the surety industry is cyclical. Also, there is a long-tail in the surety industry. In the mid-1990s the surety industry was very “soft.” There was little underwriting being performed. However, with a robust economy there was sufficient work, even for unqualified contractors. A combination of the slowing economy and the poor underwriting practices from earlier years caused the industry to suffer the first of five consecutive losing years in 2000. The industry loss ratio peaked at 82.5 percent in 2001. (This does not include the expense ratio estimated at 60 percent.) It is estimated that the industry lost about $3.9 billion over these five years. Preliminary results for 2005 indicate a return to profitability with a loss ratio of 39.8 percent.
The surety industry has a tendency to overreact and the losing years caused the market to turn from soft to hard almost overnight. Many primary and reinsurance companies exited the industry. Underwriting standards were tightened and prices increased substantially. Capacity quickly became an issue, especially at both the small and large ends of the spectrum. Small and emerging contractors were finding it difficult to obtain any bonding capacity and “jumbo” contractors were finding difficulty securing enough capacity.
Where do we stand today? It would appear that we are somewhere between the end of a hard market and the beginning of a soft market. There is sufficient capacity for contractors who are properly capitalized and well managed. There are also surety companies who are expanding their appetite for small and emerging contractors.
Details of submitting
When submitting an account to a surety company it is important to remember that surety is a form of credit. The underwriter is making a credit decision usually without having had the opportunity to meet the contractor. It is true that initially there can be a substantial amount of paperwork required, however, this should not be necessary with subsequent requests.
Since surety support is a form of credit, the surety is going to require substantial financial and background information on the contractor. The contractor’s ability to generate and maintain meaningful financial information is an integral part of the underwriting process.
The initial submission should be organized and clear. If possible it is best to have all of the information prepared and submitted to the surety together. This will help streamline the process.
An initial submission should include the following items:
- Three years of business financial statements. It is beneficial if this information is prepared by a CPA however it does not have to be audited. If three years are not available submit what you have. A current interim statement is also beneficial.
- Current personal statements on all owners. These do not have to be prepared by an accountant. Most surety companies and banks have forms that are acceptable. It is important that they are as accurate as possible and legible.
- Current questionnaire. Most surety companies have their own questionnaire form but will accept a questionnaire on any company’s form.
- Current bank reference letter.
- If you are requesting support of a specific project then you should include details on that project.
It is beneficial to include a brief narrative explaining the background of the account and your relationship to the contractor. Depending on what the contractor needs it may be necessary to include work on hand information.
After submitting an account to a surety what should you expect? The surety should keep you informed at all times what the status is of the underwriting process. The surety should try to find a way to support your request if at all possible. If they can’t then they should provide you with a prompt and detailed explanation as to why.
If there are any conditions required by the underwriter in order to support the account, these conditions should be clarified in writing. If a complete submission is made to the surety you should have an answer within 48 hours. It is essential for the agent to make sure that plans and expectations of the contractor and the surety are fully understood by both parties. It is beneficial to have the underwriter meet with the contractor on a regular basis so the contractor can explain their plans and goals.
Selecting a company
How do you find out if the surety company will be responsive to your needs? You can contact the department of insurance in your respective state, The Surety & Fidelity Association of America (www.surety.org) or a rating agency such as A.M. Best. It is important that you try to meet with the underwriter and get to know them. Try to find out as much as you can about the history of the company. Check out its Web site. Find out how the company handles their claims? Does it have full time claims representatives dedicated solely to surety claims? The surety underwriting process should not be painful. The more you get to know the company and the underwriter, the better off you will be.
Michael Foster, AFSB, executive vice president of underwriting for Merchants Bonding Company (Mutual), has over 25 years surety experience. Visit: www.merchantsbonding.com.
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