Updated: May 23, 2018
Hello everyone! Welcome to the first edition of Ben’s Bond Blog presented by Construction Underwriters, LLC. This blog will be a regular dose of the information needed to understand the world of surety. We will go over all of the basics up through more detailed topics and get into the reasoning for how and why the bonding process works the way it does. We will also touch on important industry changes and updates as they happen.
The goal of these posts are to inform you, the readers, whether you are a general contractor, service contractor, subcontractor, bond/insurance agent (or anyone else who is interested in surety for that matter) and provide the base knowledge necessary to navigate through this sometimes tricky and overwhelming industry. I hope that these posts will cover most everything you would need to know, however I am sure that along the way this information will lead to questions I did not even consider. When that inevitably happens, I encourage you to reach out to me as I would be more than happy to help cover anything I may have missed. My contact information is below:
Direct: (410) 910-0204
First things first, let’s start by discussing what a bond is, why they are so important, and make sure we are all on the same page with all of the confusing terms I am going to start throwing around.
What is a bond?
During my time in the surety world, I have learned that when you tell someone that you work in the bond business, their first thought is bail bonds. These are just one type of bond in the whole spectrum. More broadly, a bond is a product that guarantees something will happen. This guarantee can be the completion of a construction contract, guidelines for a specific type of license or permit, or the performance of a financial obligation. These are just a few examples – there are bonds out there for just about anything you can imagine.
Once I am able to explain to people that I don’t spend my days tracking down criminals, they then assume that a bond is an insurance product. Now this idea isn’t totally far-fetched, but technically is not correct. Insurance is a two party agreement where there is a transfer of risk from the insured to the insurance company and a loss is expected. Bonds differ in the fact that they are a three party agreement where the risk is retained by the principal (often a contractor), but a surety makes a guarantee to the obligee (owner) on their behalf and a loss is not expected.
The other main difference between bonds and insurance is that the principal can’t make claims on the bond, only the obligee and various other associated parties (which we will get into in a future post). Whereas with an insurance product, the party acquiring the policy has the ability to make a claim.
What’s the point?
So now that we’re clear on exactly what a bond is and who all is involved, you’re probably thinking that the principal/contractor is getting the short end of the stick. Obviously, there is a benefit to the obligee/owner in the fact that if something goes wrong, they can make a claim on the bond and the surety is obligated to make sure the work gets completed. However, bonding benefits the contractor in several ways, such as:
Showing that they are capable of handling the project: A financial institution (the surety) has underwritten the contractor and specific job and determined that they are capable of completing it. Not only are they just saying this, but they are putting their money on the line and guaranteeing that the contractor will finish successfully.
Providing additional guidance: The agent and surety company are available to provide technical, financial and management insight. This increases the chances that they will successfully finish the job at hand, as well as being set up for future, long-term growth.
Expanding the field of available work: Many jobs will require bid bonds and final (payment and performance) bonds, if you can’t get them, you can’t get the job!
No tangible security is required: The bond premium is paid by the owner and allows the contractor to use their assets for growth and improves cash flow, as opposed to putting up some form of collateral as a guarantee.
Subcontractors are also in a better position when the general contractor is bonded. If something were to go wrong, the bond would ensure that they get paid and are able to continue their work instead of being left high and dry. Recently, in the United Kingdom, an extremely large general contractor named Carillion has run into financial troubles. Because Carillion was not required to post 100% payment and performance bonds, as is typical in the U.K., the subs are not being paid and a snowball effect is taking place with major repercussions for the entire industry.
Terms and Definitions:
Below are definitions for some terms mentioned above, as well as some basic bond types that we will be discussing in posts in the near future:
Obligee: Also known as the owner, this is the party that the guarantee is being made to.
Principal: This is the party that is acquiring the bond and is getting the surety support. Often times this is a contractor, but as mentioned above, various types of principals require bonds.
Surety: This is the party that is guaranteeing that something will happen to protect the obligee. A surety is a large financial institution that collects bond premium on the assumption that they will have no losses. Sureties are also called “carriers.”
Agent: This is the person that helps to facilitate the surety/principals relationship and processes the surety transactions such as completing bond forms and collecting premiums.
Underwriter: This is an employee of the surety, they are doing the due diligence and determining whether the surety feels comfortable supporting the principal.
Bid Bond: This is a bond that guarantees a bidder will either accept the project at hand if they are awarded OR pay the difference between their bid and the next lowest (up to the maximum value of the bid bond, usually a percentage of the bid)
Performance Bond: This is a bond that guarantees, you’ll never guess this one, performance of a contract in accordance with all written aspects.
Payment Bond: Also known as a “labor and materials bond”, this guarantees that suppliers, laborers and subcontractors will be paid under the contract terms.
Maintenance Bond: These typically follow a performance bond – they guarantee that the work performed will hold up for a period of time pre-determined in the contract. One year is included in the premium for a performance bond, additional terms are calculated based on a reduced rate.
Subdivision Bond: This type of bond is used to guarantee that improvements being made in connection with individual or commercial projects meet existing codes and will be completed and turned over to the governing entity without liens.