What is a Surety Bond?
A Surety Bond is a financial guarantee that ensures that one party (usually a contractor) of a contract will fulfill the obligations they've agreed to. This provides security for the other party because the insurance company agrees to pay to cover losses should the bonded party fail to complete their obligations. An added benefit is that the insurance company takes care of the administration and application process effectively ensuring that the contractor is bondable and able to enter into the agreement in question.
The Pre-Qualification Process
Surety underwriters conduct a financial review of each risk. Only after review and analysis of the duly completed
- Contractors questionnaire (average of 10 pages)
- Copies of the last THREE (3) fiscal year end audited financial statement
- The most recent audited interim financials
- Purpose & description of operations of each of the related or privately owned companies (whether active or not - including a family tree showing share ownership).
- The most recent uncompleted work-on-hand schedule (data duly entered in the questionnaire -including job costs, date work began and estimated completion dates etc..
The underwriters are provided with information regarding the company's current work on-hand and their financial status. This is to ensure:
- The business being considered is not over-extended
- Their is no expectations of the company defaulting on a bid completing current and future projects
- The capacity to provide all necessary labor & materials required
Annual Premium + Charges For Each Bond Issued
Once bond facilities are in place, the owner pays an annual fee or premium for the privilege of having bond facilities in place. This is based on the size of the company, their gross receipts, and the estimated number of bonds they will require yearly. This fee is payable whether or not any bonds are issued by the surety. This cost is required to maintain your surety/bonding privileges in place.
There is then a charge with every single bond issued by the surety. Bid bonds are the least expensive, with performance bonds and L&M bonds costing the most - this being a specified dollar amount X the value of the contract. Depending on how large the company is and how active they are, their bond costs can add up.
With Insurance - Losses Are Anticipated And Expected
With insurance, you purchase certain coverage's as protection in event you (the insured) suffer loss or damage or are found negligent for damage caused to a third party. In such case, when it is an insured loss, you (the insured) are compensated for the loss sustained to you or to the third party, less any deductibles that apply.
With Surety - No Losses Are Anticipated
The underwriters review the risk from a primarily financial point of view taking into account:
- The financial status of the organization (current & prior 3 yrs)
- Any business loans
- Interest payments
- Investments and the financial growth of the company by means of earnings, savings and investments - over and above operating costs.
The surety underwriting review takes a minimum of 6 to 8 weeks to complete before the surety approves a new company for bonding facilities. With approval, the surety has pre-qualified the company. By initiating bond facilities the Surety provides a financial guarantee that the company is:
- Financially soluble
- Business operations are secure
- The company has steady work
- Work is completed according to specifications and in a timely fashion
- The company is not over-extended and is able to meet and complete all work they have contracted to do
- Surety is closer related to banking or other financial type industry than insurance. As surety evolved it rooted within the insurance markets, where that businesses supporting commercial property, liability, builders risks (COC's) and wrap-up liability was being underwritten.
Should a Surety Loss Occur: With insurance if you have an insurable loss you are compensated for your loss. Under surety, if you default on any of your surety bonds, you are responsible to make good the loss, (the surety does not cover the cost of your default or inability to perform).
