Even though the surety industry is only a fraction of the total property/casualty marketplace, the importance of surety bonds to contractors and their impact on their relationship with insurance brokers is significant.
A surety bond line can be a critical component of a commercial contractor’s business plan. From the contractor’s perspective, the bond program is a priority compared to the property/casualty insurance program. Insurance agents who can provide surety support through their own markets or coordinate the bonding through a surety specialist can strengthen their relationships with their contractor clients and protect their accounts.
With that reality as a starting point, it’s always helpful for agents to refresh themselves on the basics and process of contract bonds. In addition to the basics, I’ll provide a quick overview of the SBA Surety Bond Guarantee Program that supports contractors who cannot qualify for bonds in the standard market.
What’s the difference between Bid Bonds, Performance Bonds and Payment Bonds?
Bid bonds are required for all public bids. These bonds are usually in the amount of 10 percent or more of the contractor’s bid price. Bid bonds guarantee the contractor will enter into a contract with the owner or forfeit the bid bond as compensation to the owner if the job must be rebid or awarded to the higher-priced second bidder
Performance bonds are required on public contracts in the amount of 100 percent of the contract price. The performance bond guarantees the contractor will fulfill the terms of his construction contract. This includes the basic contract but also the job’s plans and specifications. If the contractor cannot meet this obligation, the surety is required to complete the job per the contract using the balance of contract funds and paying for any shortfall a completion contractor will charge.
Payment bonds are required in conjunction with the performance bond. Payment bonds are typically in the amount of 100 percent of the contract price. They guarantee all direct job-related bills will be paid. If the contractor cannot meet this obligation, the surety is required to pay these bills under the payment bond. The payment bond covers subcontractors and suppliers who are second and third tier to the prime contractor.
Maintenance bonds are typically in the amount of 10 to 20 percent of the contract price. These bonds are issued when the job is 100 percent complete and run for one to two years from that date. They provide a guarantee to the owner that the contractor will address any construction issues that come up during that time frame.
All bonds are underwritten on a per-project basis in conjunction with the overall position of the account with their surety. The contract bond is a three-party agreement where the surety guarantees the project owner (obligee) that the contractor (principal) will perform in accordance with the contract documents and pay all legitimate bills on the project to subcontractors and suppliers. It’s important to note surety is an indemnity-based concept, similar to a banking relationship, rather than an insurance one. Any loss the surety sustains will trigger the indemnity agreement, whereby the contractor is obligated to reimburse the surety for these losses.
The Underwriting Process
The surety agent typically walks a contractor through the multiple steps of securing a bond or bond line and advises them on the specific issues and documents needed to accomplish this goal. Working with multiple sureties, the surety agent will match up the contractor’s needs with the program that fits. Currently the bond market is segregated into three levels:
Quick Application – Credit-Based Programs
- Single bonds up to $1 million/aggregate bonds up to $2 million
Standard Surety Programs
- Standard Underwriting Complete bond file needed to underwrite
- Single bonds from $1 million to billions
- Small Business Administration (SBA), funds control, seed money, collateral, deeds of trust, third-party indemnitors, teaming agreements
Each of these surety submarkets has specific underwriting requirements and analytics, but a similar process is followed:
Step One: Surety broker and insurance agent together meet with contractor.
Step Two: Surety agent gathers necessary information and submits to several key markets.
Step Three: Surety underwriter reviews paperwork and interviews contractor personally or via conference call.
Step Four: Bond line is established to support normal bid bond needs.
Step Five: Bond file is updated quarterly or semi-annually to support ongoing bond line.
In addition to the surety interview, the scope and analysis of the underwriting documents are critical to the decision-making process of the underwriter. Character assessment, corporate reputation, internal management systems, financial strength and past track record are explored in detail. The traditional keys of character, capacity and capital still represent the foundation of suretyship. A basic bond file will generally include:
- Past three-year fiscal financial statements (CPA compilation, review or audit);
- Current interim financial statements (Prepared internally or by CPA);
- Current personal financial statement on owners;
- Latest corporate tax return;
- Current work-in-process report;
- Copy of bank line of credit documents’
- Contractor surety questionnaire;
- References from past owners or architect’s/engineer’s;
- Financial statements or tax returns on affiliate companies;
- Resumes/organization chart
- Basic or extended business plan; and
- Company’s website.
These items will get the contractor and surety specialist established with a bond relationship, but active bidders need professional handling of their bid and performance bonds regularly.
SBA Surety Program
Insurance markets can be temperamental, and surety is no exception. Emerging contractors may not be able to secure sufficient bonding from the standard market, and troubled accounts may be asked to exit a standard program for a specialty one.
Many small contractors face difficulty securing their first bonds or establishing enough bond support to handle their growing business plans. As an insurance agent, you should know there are specialty bond programs available that require collateral, funds control or subcontract bonds to mitigate the underwriting risk to the surety.
A viable option to these onerous tools is the SBA Surety Bond Guarantee Program.
Started in 1972, the Small Business Administration’s mission is to help small accounts secure bonding levels they cannot get in the standard market. Providing up to a 90 percent guarantee to the surety, the SBA minimizes any loss exposure to the surety. Bonds are written by the surety, with the formal backup guarantee from the SBA working behind the scenes. Historically, this program was focused on federally certified contractors with 8(a), HUBZone, SDVOB and other disadvantaged credentials. However, the program is now open to any small business that meets the SBA’s requirements. General contractors with three-year average revenues of $36.5 million and trade contractors at $15 million qualify. Single bonds of $6.5 million are available under the program.
An important factor in the SBA Program is the allowance of available bank lines of credit being considered part of the working capital calculations.
The SBA just increased its own Quick App Program to $400,000 on a single bond.
This SBA credit-based program helps accounts with low credit scores that cannot qualify for the standard programs.
Over the years, surety bonding has fluctuated between liberal (easy to get) to conservative with a limited marketplace. Credit-based programs have worked well, and single-sized bonds under these programs have increased to over $1 million on a single project. Several standard sureties have established affiliated specialty programs to handle their challenging accounts, and the SBA is robust and competitive in both its pre-approval and preferred guarantee programs. Standard underwriting has moved toward a focused analytical process where the agent needs to understand accounting, finance, legal and operating issues for its accounts.
Surety specialists can prove to be a valuable partner to agents to protect accounts and better service contractor clients.
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