Surety bonds 101: The basics and what you need to know
Here are the surety bond basics to make sure your clients have the coverage they need.
Surety bonds can present stressful challenges to agents, account managers and customer service representatives who do not regularly handle bonds.
Consider this scenario: An important insurance client calls at 4 p.m. The client needs a surety bond, and if they do not get it immediately, part of their business operation will be forced to a halt.
The problem is that you are given few details relative to the exact bond that is needed. This is often because the client (the bond principal) has not encountered a bond need recently, and is not an expert on what is required. It also is common for the entity requiring the bond (the bond obligee) to provide few details, perhaps because the obligee lacks knowledge about bonds. (They often just know that they need to require one based on a code or a statute).
Additionally, the universe of potential bonds needed is immense. Obligations, even among similar types of bonds, can vary significantly locally, regionally and at the state level.
Overriding all of this is the fact that the client expects you to provide the bond quickly, or you risk losing the business to another agent, which can precipitate the client opting to move their entire account during the next renewal cycle.
Four steps to get started
The good news is that you do not need to be a surety expert yourself to successfully handle the situation.
There are actions you can take to quickly reduce or even eliminate the anxiety that the immediate bond needs.
Here’s what you can do to get the bond into your client’s hands as quickly and efficiently as possible:
- Ask your client exactly who is requiring the bond, what activity they are performing that gave rise to the bond requirement, and what the amount (penal sum) of the bond is required to be. Also, forward any documentation the client has that states the bond requirement.
- Ask your client to forward a copy of the bond form, if one was provided to them. Bond obligees will often provide a specific bond form that they require to be used, or they may accept a surety company’s generic bond form.
- Search the internet, including the website of the obligee. This can be hit or miss, but sometimes you can find helpful information on the bond requirement and/or a copy of the bond form.
- Call your surety underwriter. Most are very happy to help you navigate the bond need maze that you are in. Convey the details that you have acquired and often your underwriter will know exactly what you need, or if they don’t, they will provide advice on where to go next and what to ask.
Underwriting expectations
Once the exact bond obligation is identified, your underwriter will inform you of the underwriting information that is required to qualify for the bond, which may include financial statements and related schedules, copies of contracts or other legal documents, authorization to pull a consumer credit report, and an indemnity agreement signed by the bond applicant.
The exact underwriting information required varies depending on the type and penal sum of the bond. Many smaller bonds are “instant issue” and require no underwriting information at all.
Here’s a hint: Communicating to your underwriter the extent to which you know and recommend the applicant’s character based on your agency’s past experiences with this client can be extremely helpful in achieving a quicker approval.
Different bond obligations pose varying levels of risks of loss to the surety. The greater the risk of loss (based on the bond obligations) and the greater the penal sum of the bond, the more underwriting information will be required by the underwriter.
In addition to the need for additional underwriting information, the bond applicant will need to have optimal financial, credit and character standing.
Surety bonds vs. insurance
Unlike an insurance policy, in which there are two parties to the agreement — the insurer and the insured — a surety bond is a three-party agreement consisting of the principal (the party whose obligations are being guaranteed by the surety), the obligee (the party requiring the bond and who is the beneficiary of the bond), and the surety company.
A surety obligation has more similarities to an extension of credit by a bank as the borrower’s (or principal’s) obligations under a loan are being guaranteed by a co-signor (or the surety) to the benefit of the bank (the obligee).
It is important that your client understands that the principal on a surety bond receives no payment benefits under the bond. Any and all payments inure to the obligee, or to the obligee’s designee, as stated in the bond form.
Client conversations
It is important to make sure that your client understands that a surety bond is not insurance. It is a guarantee that the principal will perform the obligations detailed in the bond form and in any other documents incorporated by reference, such as a statute or a construction contract. Failure to completely perform all of the obligations guaranteed by the bond could result in a claim being made by the bond obligee for default.
In the event a claim is filed on the bond, the surety will begin an investigation. It is important to understand that the principal is legally obligated to reimburse (indemnify) the surety for any and all loss incurred by the surety under the bond. Such loss could include other expenses such as attorney fees.
Before signing the bond, the principal should fully understand and be comfortable with the reimbursement risk, as well as with all of the other obligations covered by the bond.
Following this approach can help you solve your client’s bond need quickly and efficiently, and in doing so, will help solidify your client’s loyalty to your agency.
Mike Sanders, AFSB, (mtsanders@orsurety.com) is senior vice president of Underwriting at the Old Republic Surety Company, which is part of the Old Republic Insurance Group.
See also: