What are Surety Bonds?
Contracts of suretyship are known as surety bonds. Suretyship is an ancient concept that has played a significant role in the functioning of civilizations. Suretyship generally may be defined as when one party guarantees performance by another party of an obligation or undertaking. The party whose obligation is guaranteed is called the principal; the party who guarantees that the undertaking or obligation will be performed is called the surety; and the party in whose favor the guarantee is given is called the obligee. Many obligations are guaranteed through surety bonds. Common types of surety bonds include commercial surety bonds and contract surety bonds.
Public and private construction projects often require that contractors furnish contract surety bonds. There are three basic types of contract surety bonds, which are the following:
The bid bond assures that the bid is submitted in good faith and that the contractor will enter into the contract at the price bid and will provide the required performance and payment bonds.
The performance bond protects the owner from financial loss should the contractor fail to perform the contract in accordance with its terms and conditions.
The payment bond assures that the contractor will pay specified subcontractors, laborers, and materials suppliers associated with the project.
Most surety bonds in the United States are underwritten by subsidiaries or divisions of insurance companies, and both surety bonds and traditional insurance policies are risk transfer mechanisms regulated by state insurance departments. However, traditional insurance is designed to compensate the insured against unforeseen adverse events. The policy premium is actuarially determined based on aggregate premiums earned versus expected losses. Surety companies operate on a different business model. Surety is designed to prevent a loss. The surety views its underwriting as a form of credit, much like a lending arrangement, and places its emphasis on the qualifications of the prime contractor or subcontractor to fulfill its obligations successfully, examining in-depth the contractor’s or subcontractor’s credit history and financial strength, experience, equipment, work in progress and management capability. After the surety assesses such factors, it makes a determination as to the appropriateness and the amount, if any, of surety credit.
Who are Producers and What Role Do They Play in Suretyship?
Obtaining surety credit starts with professional bond producers. Arranging bonds and a line of credit with a surety company requires extensive, detailed work for every bid that a contractor or subcontractor submits. Each surety company has its own unique underwriting standards and practices, and the prequalification process to obtain surety credit can be a difficult experience if not handled by a surety bond specialist. Surety bond producers are licensed business professionals who have specialized knowledge of surety products, the surety market, and the business strategies and underwriting differences among sureties. A bond producer can serve as an objective, external resource for evaluating a construction firm's capabilities and, where necessary, can suggest improvements to help the construction firm meet a surety company's underwriting requirements. A bond producer also can introduce the construction firm to other helpful professionals and consultants, such as certified public accountants and attorneys, when appropriate. Finding the right fit in bond producer and surety relationships can be quite beneficial for the growth and development of a construction firm.
In choosing a bond producer, construction firms should consider the following information in their selection process. Please note that the following questions or points are not exhaustive and are intended merely to provide examples of possible questions to ask and factors to consider when assessing whether a particular bond producer might be a good fit for your company’s needs.
- Is the producer licensed in your jurisdiction and that of the project?
- What is the reputation of the bond producer? Does he or she have a reputation for integrity and respect in the industry?
- What percentage of his or her overall business are construction clients?
- Does he or she have an understanding of the construction industry and of the construction process, particularly the management and administration of construction contracts?
- Does he or she possess knowledge of construction accounting procedures, especially an ability to analyze financial statements, work-in-progress, and cash flow?
- With how many sureties does the producer work?
- Is the producer specifically authorized to issue bonds on behalf of sureties?
- Has the producer developed solid relationships with surety underwriters?
- Has the producer developed solid relationships with other professional service providers, such as attorneys, CPAs and lenders?
- How aware and interested is the producer in local, regional and national construction markets?
- How active is the producer in local or national construction associations, such as the American Subcontractors Association, Associated Builders & Contractors, or Associated General Contractors of America, and in local or national surety industry associations, such as the National Association of Surety Bond Producers?
- Can the producer demonstrate a commitment to maintaining frequent client contact through newsletters, site visits, or visits to client offices?
- What other services does the producer provide clients to help them with their business needs?
Find a Producer in Your State
Click here to find a producer in your state. NASBP provides a complete listing of members located throughout the United States, as well as Canada, Mexico and Guam.