Surety bond underwriting is the pre-approval evaluation by the surety of both the bond performance requirements determined by the obligee and the principal’s current financial situation to assess the risk related to the performance criteria and the principal’s ability to reimburse the surety should a claim occur.
Bonds are financial guarantees of the principal’s performance to established criteria by the obligee. Bonds transfer the risk of the principal’s performance from the obligee to the surety. If the principal does what they say they will do, nothing happens with the bond. Unlike insurance, if a claim is made on a surety bond, the principal must pay back the surety.
An underwriter may be an employee of the surety carrier or an employee of your surety bond broker if that broker has in-house authority. Either way, they are licensed individuals trained to assess risk for a surety carrier. Second, being regular people, they all have their own insights, opinions and risk tolerances. This is why some underwriters will approve a bond when others will not. But there are basic guidelines they follow.
The riskier the bond type or principal, the more in-depth the underwriting will be. A bond type with more numerous and complicated performance criteria is riskier than a bond with simple, easy conditions. A bond for a new industry is more risky than a well established industry that’s existed for many years. A larger bond amount is more risky than a smaller one. A principal with limited financial resources is riskier than one with lots of cash, assets & profits.
There are thousands of different bond types and many different financial circumstances. So the number of different underwriting circumstances is nearly limitless. A risky bond type with a principal having enormous financial resources could be a less risky situation for the surety than a simple bond type for a principal with very little financial capabilities, and vice versa. The job of the underwriter is to determine if any given situation is a good risk for the surety. The primary questions underwriting is trying to answer are what is the likelihood this principal will have a claim on this bond and if that happens then will they be able to indemnify the surety. Not all bonds require the same amount of underwriting or information.
What are some of the things underwriters may look for in their evaluations?
In regards to bond type, this may include items such as:
- What is the bond amount being required
- Are the performance criteria clearly stated and defined
- How long will the surety need to stay on the bond
- What is the bond claim history with this type of bond
- When, or if, the surety can cancel the bond
In regard to the principal’s financial condition, this may include items such as:
- How long have they been in business
- What is their experience in this industry
- Credit score of the owner(s)
- Who will indemnify the bond (the business, the owners, spouses, etc)
- How much liquid assets does the business and/or owner(s) have (cash, investments, etc)
- What is the business’ working capital (current assets less current liabilities)
- What is the business’ total sales
- Are they profitable
Good underwriters look for a reason to say yes. They look at the overall picture as opposed to a hard “go, no go” with the above items. But in general they are looking for a proven track record of the principal doing what they said they would and if there’s a claim is there enough liquidity to indemnify the surety. For example, good credit is a sign that someone does what they say they’ll do. Someone extends another person credit then that person pays them back. Bankruptcies, past due bills, etc. are opposite signs. Cash in the bank, positive working capital and profitability show a principal is responsibly running the business. Being overly leveraged and taking every dollar out of the business signals something else. In the end the underwriter typically doesn’t know the principal personally so they have to use what financial information is available to ascertain if they are a good risk.
There are also different ways an underwriter can minimize the surety’s risk on a riskier bond and still approve it. For example if the situation is more risky then they may require collateral to approve it. Collateral can be in the form of cash, an irrevocable letter of credit from a bank or in some cases real property. The collateral amount depends on the situation and can range from a small percentage of the bond amount up to 100%. The collateral minimizes the surety’s risk since if there’s a bond claim that cannot be indemnified then the surety has something to cover, or at least minimize, their loss.
After the underwriting is done, the bond is either approved or not and the premium rate is set. A bond not being approved means the surety will not agree to issue the requested bond. If a bond is approved then the surety agrees to take on the risk of the bond in exchange for a premium. This premium is based on the risk identified from the underwriting.
We are here to answer any questions you may have about the underwriting of your bond(s). Feel free to call or email us any time and we’re happy to help, even if it’s not a bond you’re getting through us.