Surety Bond Insights and Articles from March 2019March 2019

Surety bonds are a fact of life in the construction industry. Construction projects can cost a great deal of money�taxpayers� money in the case of public works projects and investors� money in commercial projects. Many states and municipalities require a contractors� license bond, simply to operate legally as a contractor or subcontractor. The three other types of surety bonds most often associated with construction projects are bid bonds, performance bonds, and payment bonds. Learn more about each below, and request a quote from Single Source Insurance today!

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Contractor�s License Bonds

In some states, contractors are licensed at the state level. In other states, the only licensing requirement for contractors is at the municipal level. In nearly all jurisdictions where licensing is mandatory, obtaining a license bond is also mandatory. A contractor�s license bond protects the state or municipality, as well as the public, from financial loss due to the unlawful or unethical actions of the construction contractor.

A contractor�s license bond typically obligates the contractor to abide by all applicable laws and industry standards. Failure to do so can result in a claim on the bond.

The Miller Act

Performance bonds and payment bonds are both requirements stemming from the Miller Act�federal legislation that applies to public works construction, modification, or repair projects valued at $150,000 or more. The Miller Act requires the general contractor selected for such projects to obtain a performance bond to protect the federal government and a payment bond to protect suppliers and subcontractors. Many states have their own �Little Miller Act� legislation that provides similar protection for state entities sponsoring public works projects.

Performance Bonds

Performance bonds guarantee the satisfactory completion of a project in accordance with the terms of the bond. It’s not uncommon for a contractor to underestimate costs and become insolvent before completing a project. In such cases, the project owner often must hire another contractor to complete the job.

A performance bond also protects the project owner (and by extension, taxpayers or private investors) against financial loss due to any unlawful or unethical actions of the contractor.

The only party that is entitled to file a claim against a construction performance bond is the project owner�known as the obligee in the bond contract.

Payment Bonds

Payment bonds are used to ensure that suppliers, laborers, and subcontractors are paid properly and promptly. Without a payment bond, any party not paid according to the terms of the contract could file suit, and a lien could be placed on the property. Requiring the contractor to obtain a payment bond ensures that the property will be lien-free when the project is completed.

Bid Bonds

Bid bonds are not specifically mandated by the Miller Act, but they are commonly required by both public works and private project owners. A bid bond is the contractor’s pledge to accept the job if chosen as the winning bidder. This guarantee protects the project owner against having to go through the bid evaluation or contract negotiation process again with another contractor. A bid bond requirement is intended to discourage frivolous bidding.

How Do Construction Bonds Work?

When a claim is filed and proven to be valid, the surety typically pays the claim up front and then seeks reimbursement from the contractor. Surety bond contracts contain indemnity clauses that make the contractor legally responsible for repaying the surety.

How Much Do They Cost?

The cost of any bond is a small percentage of the required bond amount. While the bond amount is established by the obligee requiring the bond, the premium rate you will pay is determined by the surety�the company that underwrites and issues the bond. The exact percentage is based on an evaluation of such factors as the applicant�s personal credit, personal and business financial standing, and industry experience.

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If you are in need of a surety bond, it�s important to understand the steps required. Read on to learn more about the surety bond underwriting process, or request a quote today. At Single Source Insurance, we offer bonds nationwide, and our knowledgeable agents are ready to assist you with any questions you may have.

What Is Underwriting?

Underwriting is all about the assessment of risk, specifically financial risk. It�s the process through which an individual or institution decides to take on a given financial risk for a stated fee and under what circumstances. For example, if you�ve ever purchased life insurance, you may have had to undergo a physical exam. You were likely asked your age, your height and weight, and certain other key facts that the underwriters then used to determine your likely life expectancy, insurability, the terms and conditions of your policy, and the premium cost you would pay.

Surety bond underwriting is much the same. The underwriters� job is to determine the degree of risk involved in issuing a given type of bond to a given applicant and the premium cost to the applicant.

What Are the Risks?

Different types of surety bonds carry different risks in terms of the ways in which the bonded individual (the principal in the surety bond agreement) can incur a claim. But they all boil down to the principal committing a prohibited action or failing to perform a required one. In either case, the principal would be in violation of the terms and conditions of the surety bond, and the entity protected by the bond (the obligee) would be entitled to file a claim against the bond to recover any resulting financial loss.

The bond forms filled out by surety bond applicants spell out the principal�s obligations under the bond and reflect the governing regulations, statutes, and ordinances. The obligee that requires and is protected by the bond establishes the required bond amount, also known as the penal amount of the bond.

The underwriters need to learn enough about the applicant to determine:

1. The risk that the applicant will somehow violate the terms and conditions of the bond to the financial detriment of the obligee
2. The applicant�s ability to come up with the funds to pay any valid claim up to the full penal amount.

The Three C�s of Surety Underwriting

Surety underwriters examine certain facts to establish confidence in each applicant�s character, capacity, and capital. A principal with good character is less likely to engage in unlawful or unethical behaviors that could result in a claim against the bond. A principal with the capacity (skills, knowledge, and resources) to live up to the terms and conditions of the bond is also unlikely to incur claims. And capital enters into the picture because the principal is ultimately financially responsible for paying all valid claims.

What Do Surety Underwriters Consider?

One of the key factors that surety underwriters consider is the applicant�s credit score. A principal with good credit will pay a lower premium rate than one with poor credit, because a good credit score means that the principal should be able to borrow money if necessary to pay a claim.

This is important because surety bonds do not transfer the financial risk of paying claims to the surety company. Virtually all bonds contain indemnity clauses that provide financial protection for the surety. The surety typically will pay a claim as an interim measure, but the principal is then legally obligated to reimburse the surety. Therefore, an applicant�s ability to borrow is crucial to establishing the confidence of the underwriters.

In addition to an applicant�s credit score, surety underwriters will want to see personal and often business financial statements as proof of capital and financial stability. In some instances, underwriters will request resumes or other proof of expertise and experience. In fact, the underwriters my request any documentation they feel is necessary to evaluate the applicant�s character, capacity, and capital.

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Single Source Insurance offers a full range of bonds nationwide. To get started, simply fill out our online application form. Our knowledgeable agents are ready to answer any questions you may have about the underwriting process.