Bond FAQ’s for Contractors
Shorewest Surety Services, Inc. has compiled a list of bond FAQ’s for contractors to clear up some misconceptions and answer questions about surety bonds.
What is a surety bond — just another type of insurance?
A surety bond is a three-party guarantee between the surety, the obligee (usually the project owner), and the contractor. The surety guarantees to the owner that the contractor will perform a contract in accordance with contract documents. Although surety bonding is considered a line of insurance, it has many characteristics of bank credit. The qualification process for the contractor is more like obtaining bank credit than purchasing insurance.
Do most sureties require audited financial statements from a CPA?
Not usually; CPA audited financial statements are generally required only for very large bonds. Many multi- million-dollar bonds are written with CPA reviewed financial statements. Bonds under $250,000 are often written with CPA compilation statements and some smaller bonds are written with in-house statements or statements from non-CPA accountants. Generally, the higher the quality of statement, the better the bonding terms.
Is it true that only the strongest contractors need apply for bonding?
While it is true that bonding is based on financial strength, there are many different surety markets. At Shorewest Surety Services, we represent over fifteen different surety markets, from familiar standard markets to alternative or substandard markets, and many in-between. We also bond contractors through the SBA bond guarantee program. These market alternatives enable us to help most contractors obtain bonding.
Do contractors have to be in business for a long time to be bonded?
Longevity and profitability certainly help a contractor obtain bonding with the best terms, but even new contractors can often be bonded with one of our markets. We have the expertise to help you get started with bonding, so you don’t pass up good contract opportunities, simply because bonding may be required.
I’ve heard that obtaining bonds through the SBA involves too much paperwork and is too difficult. Is that true?
The SBA offers the best opportunity for some contractors to obtain bonding. There are some additional forms required by the SBA, but we are able to simplify this for you through computer automation and familiarity with what is required. Should the SBA program be the best fit for your firm, we will handle all of the paperwork for you.
Why is collateral sometimes required for bonding?
Collateral is not an issue with the standard or secondary surety markets. In the alternative or substandard surety marketplace, collateral may be required when a bonding situation is viewed as hazardous, if the contractor is financially challenged, or because of the lack of credible financial information. Again, we have many surety alternatives and we access markets that may require collateral only when absolutely necessary. We also handle all of the paperwork to facilitate the use of collateral when it is necessary to obtain bonding.
Why is funds control sometimes required for bonding?
Like collateral, funds control is not normally utilized in the standard surety markets. In the alternative or substandard surety marketplace, funds control may be required when a bonding situation is viewed as hazardous, if the contractor is financially challenged, or because of the lack of credible financial information. Funds control may also be required when joint venture partners have not worked together previously. Funds control protects the surety by ensuring that project payouts are used exclusively to fund appropriate project expenses. Typically, there are fees associated with funds control programs.
My insurance agent tells us that our bond needs are too large for any of their insurance carriers to handle; can you help?
We have surety markets that can handle bonds of virtually any size, either directly or through reinsurance agreements. And, we can often point out actions that you and your firm can take to enlarge your bonding capacity, lower your rates, or both. Let us share some of our success stories with you.
How much does a performance bond cost and why are there so many different rates?
Very simply, the premium rate for a given type of contractor depends on the financial strength of the construction company. The financial strength and type of statements generally dictate what type of surety market is appropriate. The standard and secondary markets generally have lower rates than the alternative or substandard markets. Most general construction contractors have bond rates between 1% and 3%, but the stronger contractors can be lower. The type of construction contract also affects the rate, with lighter construction and supply rates being less. Each surety has rates filed with the state and underwriting criteria (relating to financial strength and quality of the financial information) that correspond to each rate filing. Certain sureties have a more aggressive underwriting style with relatively lower rates. Market pressures and changes in underwriting personnel can also affect underwriting styles. We have the expertise and volume of interaction with the sureties to be able to assess this for the benefit of our clients.
What is a General Indemnity Agreement (GIA) and why does it require personal indemnity in addition to corporate indemnity.
The GIA is an agreement whereby the contractor promises to indemnify the surety for any claims paid out on behalf of the contractor. By this agreement, the contractor allows the surety to recover any bond claims paid out by the surety. Bonding is a form of credit and not insurance per se. The surety will require personal indemnity of the owners, including spouses, in addition to corporate indemnity by the contractor’s company. This agreement provides assurance that the surety can recover bond claim losses first from the contractor’s company, then if necessary from his personal assets, while eliminating or minimizing legal challenges. In rare cases of significant personal net worth, portions or even all of the personal indemnity of the contractor is waived at the sole discretion of the surety.