Suretyship is a very specialized line of insurance that is created whenever one party guarantees performance of an obligation by another party. There are three parties to the agreement. The principal is the party that undertakes the obligation. The surety guarantees the obligation will be performed. The obligee is the party who receives the benefit of the bond.
2. What is a Surety Bond?
Surety bonds are usually required of general contractors on public projects let by federal, state or local government agencies. But many subcontractors also find that they are being asked to provide bonds. And an increasing number of private project owners are requiring bonds as well. Simply stated, a surety bond is an agreement under which one party, the surety, guarantees to another, the owner or obligee, that a third party, the contractor or principal, will perform a contract in accordance with contract documents. In the case of a subcontract, the general contractor is the obligee, and the subcontractor is the principal.
There are three types of contract surety bonds. The first, the bid bond, provides financial assurance that the bid has been submitted in good faith and that the contractor intends to enter into the contract at the price bid and provide the required performance and payment bonds. The second, the performance bond, protects the obligee from financial loss should the contractor fail to perform the contract in accordance with the terms and conditions of the contract documents. The third kind of contract bond is the payment bond which guarantees that the contractor will pay certain subcontractor, labor and material bills associated with the project.
3. How to get Surety Bonds?
Since most companies issue surety bonds through producers, also called agents or brokers, your first step toward taking on bonded work is to discuss your plans with a professional surety bond producer. You will find that an agent who specializes in insurance and bonding for the construction industry is likely to be the most qualified to assist you. The surety bond producer will guide you through the bonding process and assist you in establishing a business relationship with a surety company.
Even though most surety companies are also large insurance companies, qualifying for bonds is more like obtaining bank credit than purchasing insurance. Like your bank, a surety company wants to know you well, before committing its assets. Most contractors find that it is necessary to spend a lot of time and effort establishing their first relationship with a surety company. Since the surety is guaranteeing your company's performance, it needs to gather and carefully analyze much information about you and your firm before it will agree to provide bonds.
The surety underwriting process is focused on prequalifying the contractor. It takes time to develop and present data, address questions the surety may have, and verify information. Before issuing a bond, the surety must be fully satisfied that the contractor is of good character, has the experience that matches the requirements of the projects to be undertaken, and has, or can obtain, the equipment necessary to perform the work. The surety also wants to make sure that the contractor has the financial strength to support the desired work program, and has a history of paying subcontractors and suppliers promptly. It will want to see that the contractor is in good standing with a bank and has established a line of credit. In short, the surety wants to be satisfied that the contractor is a well-managed, profitable enterprise that keeps promises, deals fairly and performs obligations in a timely manner. It is important to realize that each surety company has its own underwriting standards and requirements.
But there are fundamentals that are common to underwriting surety bonds, and understanding these fundamentals is helpful to a contractor seeking surety bonds for the first time. If you understand what's involved in getting bonds, you can weigh the time and expense of obtaining surety bonds against the benefits of being able to perform bonded projects. Your decision to seek surety bonds should be based on long-term considerations. To obtain bonds, even some changes in the way your firm does business may be necessary and these changes could have certain costs.
4. How does Surety Underwrite?
Each surety company has its own guidelines and underwriting criteria. However, the following basic factors will be taken into consideration in some format.
Does the applicant have the skill and ability to perform the obligation?
Does the financial condition of the applicant justify approval of the particular risk?
Does the applicant's record demonstrate good character and the likely ability to perform the obligation to be assumed?
5. What is the process to obtain a bond?
To start the process you need to apply then be given your premium cost and an agreement between you and the bonding company. The bond is then issued 1-2 business days from receipt of payment and the agreement (original agreement is often required).
6. How do surety bonds work?
The principal (you) pays a percentage of the bond amount called a bond premium. In return, the surety extends "surety credit" to make the required guarantee (the bond). A claim can arise when the principal does not abide by the terms of the bond. In the event of a claim, the surety will investigate to ensure it is valid. If the claim is valid, the surety will look to the principal for payment of the claim and any associated legal fees.
7. What good is a bond if I have to pay for claims?
A bond is not insurance, it is a form of credit where the principal (you) are responsible to pay any claims. The alternative to a bond is to post cash or a letter of credit. Surety bonds are advantageous, as they typically require no collateral, which frees up capital. Bond premiums are also similar to fees for letters of credit and are typically less than one would earn making conservative investments with the available capital.
8. How much do surety bonds cost?
Bond premiums vary greatly depending on the applicant, the bond type, surety, and the obligee. Just like other forms of credit, everyone does not receive the same rate. Surety rates are typically anywhere from 1-3%.The lesser the risk the lower the rate.
9. Why do I need a surety bond?
Simply because a government authority or private entity is requiring the bond in order for you to operate. The bond ensures you will follow their guidelines.
10. Who is the obligee?
The obligee is whoever is requiring the bond of you. You are not the obligee. For example, the obligee for a contractor would be whoever they are doing the work for. The obligee for a license bond (e.g. auto dealer or mortgage broker) would be whoever they are filing their license with.
11. What is a blank bond form and where do I get one?
It is a blank copy of the bond that you are required to post. It states exactly what the bond is guaranteeing. Your bond agency will use it to create the original bond by completing the blanks on the form, signing on behalf of the surety, and attaching a power of attorney. You need to obtain a blank copy of the bond form from the obligee.
12. What is the turnaround time?
Approval time varies depending on the type of bond and the program the applicant falls under. Some are approved immediately while others can take up to 1-4 business days. Bond issuance is typically 1-2 business days upon receipt of items required by surety for issuance of the bond.
13. Why does my spouse have to sign the indemnity agreement?
Bonding companies have several reasons why they would like your spouse to personally guarantee the bond. Keep in mind, a bond is a guarantee of something. The bonding company does the best they can to underwrite your policy, but have no way to gauge your character. A good way to do this is to have your spouse personally guarantee it, as they know you best. Spouses are also required to sign, as married couples have joint assets, which may have to be sought after in the event of a claim.