New to Surety?
The following links will help to familiarize with you with the surety bond process.
What is Surety?
Ten Things You Should Know About Surety
Common Types of Bonds
Surety Bonds - A Historical Perspective
Contractors - Your First Bond
Agents, contractors and developers, find your local Insco Dico Branch.
What is Surety?
A three party contract whereby the surety company provides assurance for the faithful performance of its principal.
Who are the Parties to a Surety Bond?
There are three parties to a surety bond: the surety, the principal and the obligee. The surety guarantees that the obligations of the principal to the obligee will be faithfully performed in accordance with a contract, statute or regulations.
What is the Bond Penalty?
The amount of the bond is called a "penalty". The penalty is the maximum amount the surety is obligated to pay if there is a default by the principal.
Ten Things You Should Know About Surety
A surety bond is an instrument under which one party guarantees to another that a third will perform a contract. Surety bonds used in construction are called contract bonds.
There are three types of bonds used in construction. The bid bond protects the owner by guaranteeing that the contractor will enter into the contract at the determined price. The performance bond guarantees the performance of the work on schedule and according to the plans and specifications. The payment bond guarantees that certain workers, subcontractors, and suppliers will be paid.
Construction is a very risky business. More than 10,800 contractors failed in 1997 - an increase of 11% from 1996. These failures caused more than $2 billion in liabilities. (SOURCE: Dun & Bradstreet Business Failure Record). Since 1985, surety companies have paid $7.2 billion because of contractor failures on bonded projects. Without bonding, these costs would have been borne by the owners of the projects.
Federal law (The Miller Act) mandates surety bonds for all public works contracts in excess of $100,000. Federal procurement officials may, at their discretion, require bonds on projects below that amount. All states have laws requiring bonds on public works (known as Little Miller Acts). Owners of private construction projects are recognizing the wisdom of requiring surety bonds to protect their company and shareholders from the enormous costs of contractor failure.
Although surety bonding is considered a line of insurance, it has many characteristics of bank credit. The surety does not lend the contractor money, but it does allow the surety's financial resources to be used to back the commitment of the contractor, thus enabling the contractor to acquire a contract with an owner. The owner receives guarantees from a financially responsible surety company licensed to transact suretyship.
Surety bonds, through the surety companies' prequalification of contractors, protect the owner and offer assurance to the lender, architect, and everyone else involved with the project that the contractor is able to translate the project's plans into a finished projects. Before issuing a bond the surety needs to be fully satisfied, among other criteria, that the contractor is:
of good character;
has experience matching the requirements of the contract;
has or can obtain the equipment necessary to do the work;
has the financial strength to support the desired work program;
has an excellent credit history; and
has established a banking relationship and a line of credit
Contract surety bonds:
guarantee the project will be completed;
guarantee that certain laborers, suppliers, and subcontractors will be paid;
relieve the owner from the risk of financial loss arising from liens filed by unpaid laborers, suppliers, and subcontractors;
smooth the transitions from construction to permanent financing by eliminating liens reduce the possibility of a contractor diverting funds from the project; and
lower the cost of construction in some cases by facilitating the use of competitive bids.
With a surety bond, the owner can be satisfied that a risk transfer mechanism is in place. The risks of construction are shifted away from the owner to the surety. If the contractor defaults, the surety may pay for a replacement contractor, finance the existing contractor, or provide technical and/or financial assistance.
The costs for bonds vary, but generally are one to three percent of the contract amount. On very large projects, the cost may be less than one percent.
To bond a project, the owner merely includes the bonding requirement in the plans and specifications of the project. Obtaining bonds and delivering them to the owner is the responsibility of the contractor who will consult with an independent bond agency.
Surety Bonds - A Historical Perspective
Surety bonds have been around since 2750 BC, when historian Herodotus told of contracts of suretyship. The year 670 BC marked the execution of the oldest surviving surety contract, a contract of financial guarantee.
While suretyship is an ancient practice, it wasn't until the latter part of the 19th century that the writing of surety bonds by corporations came into being. Since 1893, the U.S. Government has required contractors undertaking federal public work contracts to post surety bonds guaranteeing that they will perform such contracts and pay certain labor and material bills.
The federal law mandating surety bonds on federal public work is known as the Miller Act of 1935 (40 U.S.C. Section 270a-d). It requires performance and payment bonds for all excess of $100,000. Also, each of the 50 States, District of Columbia, Puerto Rico, and almost all local jurisdictions have enacted legislation requiring surety bonds on public works. These are referred to as "Little Miller Acts."
The Contract Bond Process
Today's construction industry is more competitive than ever, and more contractors are interested in projects that require surety bonds guaranteeing their performance of the contract. Surety bonds are usually required of general contractors on public projects by federal, state or local government agencies. Many subcontractors also find that they are being asked to provide bonds, and an increasing number of private project owners are requiring bonds.
Simply stated, a surety bond is an agreement under which one party, the surety, guarantees to another, the owner or obligee, that a third party, the contractor or principal, will perform a contract in accordance with contract documents. In the case of a subcontract, the general contractor is the obligee, and the subcontractor is the principal. There are three types of contract surety bonds. The first, the bid bond, provides financial assurance that the bid has been submitted in good faith and that the contractor intends to enter into the contract at the price bid and provide the required performance and payment bonds.
The second, the performance bond, protects the obligee from financial loss should the contractor fail to perform the contract in accordance with the terms and conditions of the contract documents.
The third kind of contract bond is the payment bond which guarantees that the contractor will pay certain subcontractor, labor and material bills associated with the project.
How to Get a Surety Bond
Since most companies that issue surety bonds work through agents and brokers, also called producers, your first step if you think you want to take on bonded work is to discuss your plans with one of these representatives. You will find that an agent who specializes in insurance and bonding for the construction industry will likely be best qualified to assist you.
The professional surety agent will guide you through the bonding process and assist you in establishing a business relationship with a surety company. Qualifying for bonds is more like obtaining bank credit than purchasing insurance. Like your bank, a surety company wants to know you well before committing its assets.
Most contractors find that it is necessary to spend a lot of time and effort establishing their first relationship with a surety company. Since the surety is guaranteeing your company's performance, it needs to gather and carefully analyze much information about you and your firm before it will agree to provide bonds.
The surety underwriting process is focused on prequalifying the contractor. It takes time - sometimes a lot of time - to develop and present data, address questions the surety may have, and verify information.
Before issuing a bond, the surety must be fully satisfied that the contractor is of good character, had the experience that matches the requirements of the projects to be undertaken, and has, or can obtain, the equipment necessary to perform the work.
The surety also wants to make sure the contractor has the financial strength to support the desired work program, and has a history of paying subcontractors and suppliers promptly. It will want to see that the contractor is in good standing with a bank and has established a line of credit.
In short, the surety wants to be satisfied that the contractor is a well-managed, profitable enterprise who keeps promises, deals fairly and performs obligations in a timely manner.
It is important to realize that each surety company has its own underwriting standards and requirements. But there are fundamentals that are common to underwriting surety bonds, and understanding these fundamentals is helpful to a contractor seeking surety bonds for the first time.
If you understand what's involved in getting bonds, you can weigh the time and expense of obtaining surety bonds against the benefits of being able to take bonded projects. Your decision to seek surety bonds should be based on long-term considerations. To obtain bonds, even some changes in the way your firm does business may be necessary and these changes could have certain costs.
The Contract Bond Process Here's What You Need
Let's take a look at the kind of information you may need to provide to your surety agent in order to prepare your case for bonds:
An organization chart that shows your key employees and their responsibilities;
Detailed resumes of yourself and your key people;
A business plan outlining the type of work you do, how you obtain your jobs, the geographic area in which you operate, and your growth and profit objectives;
A description of some of your largest completed jobs, including the name and address of the owner, the contract price, the date completed and the gross profit earned;
A plan outlining how the business will continue in the event of your death or disablement, or that of another key employee (your surety agent may suggest that your plan include life insurance on key people, with your company named as beneficiary);
Subcontractor and supplier references including names! addresses and telephone numbers of persons to contact (the surety will probably also order an independent credit report on your firm);
Evidence of a line of credit at your bank (sureties generally are looking for an unsecured line of credit that can be used when needed to meet short-term cash requirements; an additional secured line of credit obtained through the long-term financing of equipment or real estate may help to strengthen your case); and
Letters of recommendation from owners, architects and engineers.
SURETY BOND SITE LINKS:
New to Surety