Risk Managers, How Will You Run into the Surety World?

By: | March 7, 2022

Rick Morgan is the vice president of contract surety at Philadelphia Insurance Companies. He can be reached at [email protected]

As a risk manager, you have many responsibilities when it comes to protecting your company. There are many types of insurance you are most likely well-versed in and understand completely.

You know the limits you need. You know the exclusions that exist. You understand what types of insurance you need for your company and for your employees.

And lastly, you probably already have an experienced insurance agent you have worked with for years who can guide you through any of your insurance needs. In short, you have an incredibly important job to protect your firm, but you have the experience, the tools and the outside professionals to help your cause.

But what happens when you run into the surety world?

Do you know what a bond is? Do you know if and when you should require a bond of those with whom you do business? How do you obtain a bond and what information do you need to provide? What guarantees will need to be provided to the surety, and just what is ‘indemnity’ anyways?

The following will help you answer all these questions and get you started protecting your company by understanding the surety world.

What Is a Surety Bond?

A surety is a person or organization that assumes responsibility of putting up money in case a debtor defaults.

Contract surety bonds are issued by the surety to guarantee the performance of a contractor (debtor) for the completion of a construction contract, in this case through a performance bond.

The surety can also guarantee that the subcontractors and suppliers associated with a project are paid through a payment bond. The payment bond protects the project owner from an unpaid subcontractor or supplier filing liens on the project’s property.

Commercial surety bonds are required by governmental entities.

The surety guarantees your business conforms to local, state and federal regulations at risk of financial penalty. These bonds exist for almost every industry and run to municipalities all over the country.

A Risk Manager Needs a Bond for Protection—What Are the Next Steps?

As a risk manager, you can request a bond of anybody with whom you enter a contract.

Ultimately, the bond provides you the protection of the contract being completed. It also provides you with an extra prequalification process performed by an independent third party (the surety).

Before you even start to negotiate a contract with your business partner, you can ask them to provide a prequalification letter from their surety. This letter will state the surety believes the contractor can perform a contract of the type and size you require.

While given relatively freely by sureties, this letter can be a critical step in eliminating a truly unqualified contractor bidding on your project and wasting your time and resources.

  • Check the AM Best rating of the surety providing the letter.
  • Check the surety’s Treasury listing.
  • Check the SFAA Rankings as to the size of the surety.
  • Ask your insurance professional what they know about the surety company providing the letter.
  • Verify the authenticity of any bond you receive by checking with the surety that it was properly approved and issued.

Your Company Needs to Provide a BondWhat Are the Next Steps?

Find a knowledgeable agent that can place your bond.

  • Does your insurance agency have a bond specialist? If not, you need to find one!
  • Look at the National Association of Surety Bond Producers (NASBP).
  • Look at the local Surety Association of America (SAA).
  • A simple search for surety bond professional agents in your area will provide several leads to call.
  • Not all agents handle all types of bonds or have the right surety market for you. Don’t hesitate to approach more than one until you find the right agent for your bond.

Be Prepared to Provide the Following Information

  • Reason for the bond
  • Type and amount of the bond
  • Bond form required. Is it an owner or a statute requiring the bond?
  • Your relative experience as compared to the bond need
  • Location of the bond need
  • Who within your company has the authority to sign the bond/indemnity?
  • Financial statements (fiscal year end and current)
  • Ownership and management structure of your company
  • The personal financials of the owners of your company depending on the financial strength of your company as compared size of the bond need

Understand your obligations regardless of which side of the surety transaction you find yourself.

If Your Company Is Requiring the Bond of Others

Follow the provisions of the contract exactly.

If you do not, you may provide the principal (contractor) and the surety defenses not to honor the bond.

If Your Company Is Providing the Bond

You must complete your end of the contract according to the specifications of the project. The following apply:

  • You must pay any subcontractor or supplier that provides services for your project
  • You must follow all the provisions of the contract.
  • You must document every change or dispute in the contract
  • You must follow the regulations and codes that are attached to the bond requirement.

Be prepared to indemnify the surety for any loss caused by your company.

It is important to understand that the surety providing a bond for your company will require the company and any private owners to sign an indemnity agreement. This agreement states that you (the principal of the bond) will reimburse the surety for any loss caused by your company that must be paid in the process of settling a claim on the bond. 

And Finally, What About an Irrevocable Letter of Credit?

If your company has posted any other sort of collateral as financial security for an obligation, like an irrevocable letter of credit (ILOC) or cash collateral, then ask the requiring party if they would accept a bond instead. The advantages are:

  • A bond does not tie up your liquid capital
  • You gain a partner (the surety) in defending yourself from an illegitimate claim on the bond
  • The bond may be cancellable where you can control that process as opposed to the owner of the ILOC releasing it
  • The bond may even be cheaper

Choosing the Right Surety Provider

There are several factors to consider when choosing a surety provider, from financials to size to service.

The surety’s AM Best rating indicates financial strength. Like insurance, surety bonds are a promise, so it’s important to work with a company that you can trust will meet its financial obligations.

The Treasury listing and SFAA Ranking indicate the surety’s size. Larger companies will be able to write bonds for larger projects.

Service is also important to consider, because it can save you valuable time. A customer-focused company will offer quick and easy access to surety experts to answer your questions when needed.

For example, Philadelphia Insurance Companies checks the box on financials, size. and service. Check us out for yourself. &

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