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  • Workers Compensation: Fall 2013 State of the Market [ Whitepaper]

    Despite improvement in insurer underwriting results in 2012, the workers compensation market continues to be challenging to both employers and insurance carriers alike. To gain a broader sense of this situation, review the Gallagher Workers Compensation — Fall 2013 State of the Market whitepaper.

By law, most publicly-funded entities are required to protect the financial interests of the public by requiring some form of "guarantee" from the other party when executing a contract for services. This "guarantee" is most commonly met by providing a Performance & Payment Bond, which provides the promise of a trusted third-party to step in and complete the obligation without adverse financial impact to the public.

Private entities also find it to their advantage to specify a Performance and Payment Bond on their projects. They often find that by doing, it allows them to safely entertain proposals from a far broader base of bidders and respondents that otherwise would not be possible. What follows are answers to some commonly asked questions regarding Surety Bonding. Of course, our licensed representatives are available to answer any other specific questions you may have.

What is a Surety Versus a Surety Bond?

A Surety is a very specialized line of insurance that is created whenever one party guarantees performance of an obligation by another party. There are generally 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. A Surety Bond is a written agreement that usually provides for monetary compensation in case the principal fails to perform the acts as promised. There are many different types of Surety Bonds, but the two general categories are Contract and Commercial Surety Bonds.

Is a Surety Bond the Same Thing as an Irrevocable Letter of Credit (ILOC)?

Not really. In the case of the Irrevocable Letter of Credit (ILOC), the obligee may draw the funds provided in the ILOC in the event of default or other failure to perform, but you could still be left with a challenging project-completion effort. In the case of a Surety Bond, the surety company has a clear financial incentive to minimize their exposure and loss. In most cases, these interests are best served by working closely with the obligee to most expeditiously complete the project.

What Characteristics of Suretyship are More Common Forms of Insurance?

  • They are both risk transfer mechanisms.
  • State insurance commissioners regulate them both.
  • They both provide coverage for financial loss.

How is Suretyship different from more common lines of insurance? In traditional insurance, the risk is transferred to the insurance company. The insurance company takes into consideration that a certain amount of the premium for the policy will be paid out in losses. . In underwriting traditional insurance products, the goal is to minimize the "spread of risk." In Suretyship, the risk remains with the principal, and the protection of the bond is for the obligee. The premiums paid are "service fees" charged for the use of the surety company’s financial backing and guarantee. Plus, surety professionals view their underwriting as a form of credit, so the emphasis is on prequalification and selection.

How Does a Surety Company Underwrite the Bonds?

Each surety company has its own guidelines and underwriting criteria. However, the following basic factors will be taken into consideration in some respect. Does the applicant have the capacity, 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 show him or her to be of good character and likely to perform the obligation he or she assumes?

What is Personal Indemnity?

It is common for a surety to request the indemnity of the owners of a closely held corporation. Typically, the spouse’s indemnity also is required because personal assets are jointly owned. The two main reasons for this requirement are that the surety company requires all personal assets to be available to back the guarantee. Then, there is lower potential for a principal to discount his or her responsibilities if personal assets are at stake.

Why is There Such an Emphasis on "Related Entities"?

Related entities can include other businesses or proprietorships owned, operated or controlled by the primary firm or its owners. Where such related entities exist, the surety company typically underwrites the bond based on the overall reputation and financial strength and performance of the extended family. The surety entity may also request that cross-entity transactions be consolidated or eliminated, and potentially that there be subordination or indemnification from or by the related entities.

How Does Collateral Security Relate to a Surety Bond?

If an underwriter is unable to approve a bond request based on the qualifications given by the principal, the company may suggest depositing some form of collateral as an inducement to write the bond. In practice, many bonds are written on this basis, particularly ones that are considered financial guarantees. A Financial guarantee bond obligates the surety organization to pay a certain amount of money if the principal does not perform its obligation. Examples include tax bonds and Medicare and Medicaid Bonds. These bonds are extremely risky and very carefully underwritten.