Suretyship - A Practical Guide to Surety Bonding

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SuretyshipA practical guide to Surety Bonding


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This publication furnished by CNA Surety,

Sioux Falls, South Dakota 57103.

http://www.cnasurety.com© Copyright WSCo. 2012. All rights Reserved.


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Although surety is an ancient concept, its primemission can be stated simply: performing a servicefor qualied individuals whose affairs require aguarantor.

In the United States, surety guarantees have beenissued by corporations for over a century. These cor-porate sureties are large nancial institutions. They

have the necessary capital to make numerous com-mitments in the form of surety bonds.

Because insurance companies issue many suretybonds, some people think that insurance and suretybonds are the same thing. While there aresimilarities, there are also major differences.

A bond guarantees the performance of a contractor other obligation. Bonds are three party instru- ments by which one party guarantees or promises asecond party the successful performance of a thirdparty.

The Surety--Is usually a corporation whichdetermines if an applicant (principal) is

qualied to be bonded for the performance of someact or service. If so, the surety issues the bond. Ifthe bonded individual does not perform as promised,the surety performs the obligation or pays for anydamages.

The Principal--Is an individual, partnership,

or corporation who offers an action or serviceand is required to post a bond. Once bonded, thesurety guarantees that he will perform as promised.

The Surety Bond:A Primer

What is aSurety Bond?

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The Obligee--Is an individual, partnership,

corporation, or a government entity whichrequires the guarantee that an action or service willbe performed. If not properly performed, the suretypays the obligee for any damages or fullls the obli-gation.

The example below illustrateshow a surety bond works:

Joe, the principal, has promised someone (the

obligee) that he will do something. If Joe fails toperform as he has promised, nancial loss couldresult to that person.

Consequently, the obligee says to Joe, “If youcan be bonded, I’ll accept your performance prom-ise.” Joe goes to a surety and asks to be bonded.

After the surety is satised that Joe is qualied

and will live up to his promise, it issues the bondand charges Joe a “premium” for putting its namebehind Joe’s promise.

Joe is still responsible to perform as promised. The surety is responsible only in the event that

Joe does not fulll his promises.

The purpose of a surety is to protect public and pri-vate interests against nancial loss.

Therefore, the surety bonding company must beprotable and must have a strong balance sheet. Noone is likely to accept the guarantee of a party with

a bad name or a weak balance sheet. The suretybonding company guarantees performance. Its goodname and its balance sheet back up that guarantee.

The Surety’s Job:Protection

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Three party agreement. Most surety bondsare three party agreements. The suretyguarantees the faithful performance of theprincipal to the obligee.

Losses not expected. Though some lossesdo occur, surety premiums do not containlarge provisions for loss payment. The suretytakes only those risks which its underwritingexperience indicates are safe. This service isfor qualied individuals or businesses whoseaffairs require a guarantor.

Losses recoverable. A bond resemblesa “loan”; the surety is “lending” its creditto the principal. After a claim is paid, thesurety expects to recoup its losses fromthe principal. Unfortunately, actualexperience shows few such recoveries.

Premiums cover expenses. A large portionof the surety bond premium is really a ser-

vice charge for weeding out unqualied candidates and for issuing the bond.

Sureties are selective. A surety agent isselective. Like a banker, he is trained notto make any bad loans.

SURETYSHIP vs. INSURANCETwo party agreement. Insurance is basi-cally a two party agreement whereby theinsurance company agrees to pay the in-sured directly for losses incurred.

Losses expected. Losses are expected. In-surance rates are adjusted to cover lossesand expenses as the law of averages uc-tuates.

Losses usually not recoverable. When aninsurance company pays a claim, it usuallydoesn’t expect to be repaid by the insured.

Premiums cover losses and expenses. In-surance premiums are collected to pay for

expected losses. If an insurance companycan get enough average risks of one class,it will always have enough money to paylosses and the expenses of doing business.

Insurors write most risks. The insuranceagent generally tries to write a policy onanything that comes along (at the appro-

priate premium rate) and allows for alarge volume to cover the risk.


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hen the surety company is called in, the prin-

cipal has usually paid as much of theloss as he is able. At this point, the surety companymust pay the difference. The surety then tries to re-claim its loss from any resources left to the principal.In some cases the surety recoups all of the money ithad to pay the obligee. In most cases, however, theprincipal either cannot be located or proves to be in-solvent.

In reality, no obligee wants a claim against a suretybonding company. The obligee wants the principalto carry out his obligation. A surety bond is writtenbecause the obligee expects the surety company toweed out any applicant who cannot fulll his com-mitments.

The job of the surety bonding company has be-come as complex as the rest of our economic society.In an age of lawsuits, broken promises, bank-ruptcies, and a generally high level of nancial insta- bility, the surety company provides basic public pro-tection. To do this, the surety must responsibly de-termine the qualications of those who wish to bebonded.

A surety provides the best method for guarantee-ing performance and protecting public interests.Still, people tend to distrust business--even whenhistory proves that private enterprise has been theconsumer’s single most important benefactor.

The government has tried many programs to pro-vide surety guarantees for the public. None of themhave worked well.

“Risk pooling” and so-called “state funds” havebeen tried in all their various forms. Risk pooling is

Are therealternativesto Surety?

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a government program which “assigns” to surety

companies various applicants who are unable to ob-tain bonds elsewhere. State funds are nothing morethan state agencies which go into the bonding bus-iness. In almost every case, both concepts havefailed.

There are three important reasons for this failure:

Insolvency--In many cases, state funds have

been underfunded through an inadequatefee structure or too liberal in their claims paymentand have faced the risk of insolvency. Several havehad to restrict payment of claims or increase thefees charged to belong to the fund. A comprehensivestudy by the California Contractor State LicenseBoard (CSLB) stated that the apparent challenge ofa recovery fund is to remain solvent and function-ing in order to compensate the nancially damaged

consumer. The CSLB concluded, after evaluatingrecovery fund programs in California and otherstates, that consumers would not be better off witha contractor recovery fund. California currently usesa contractor’s license bond for consumer protection.(Analysis of State Recovery Funds by the CaliforniaContractor State License Board October 1, 2001).

Difcult Recovery--In other cases, the state

has tried to reduce losses by making it sotough for a consumer to get a claim paid that it’s notworth the effort. Many recovery funds require thatthe consumer obtain judgments and exhaust all civiland administrative remedies before they can submita claim against the fund.

By comparison, bonding companies are bound bylaws that require timely and proper claims handling

procedures. The surety always pays promptly uponbeing shown a minimum amount of proof of loss.

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Surety bonding does not depend upon the

law of averages. Losses cannot be expected tobe covered by “premiums”. Only through proper andexacting underwriting procedures can surety bond-ing be protable, reliable and valuable for public andprivate protection.

In short, corporate sureties have the necessaryknowledge, experience and expertise in the espe-cially crucial areas of underwriting and claims hand-

ling. State funds are not only lacking in these areas;they also frequently lack the proper stafng.

Public protection can only be maintained by an in-dependent party - the surety. In addition, by takingresponsibility for investigation, evaluation, and re-covery of loss, corporate sureties keeps thousands ofcases out of the legal system every year. The result isadditional public savings.

Fidelity Bonds There is always the possibility that anemployee will steal. Statistics show a shocking in-crease in employee theft. They also identify theft asthe leading cause of small business failure. The

only protections against this kind of loss are good in-ternal control, regular outside audits and a FidelityBond.

Fidelity Bonds are often referred to as “honesty in-surance.” They cover loss due to any dishonest act ofa bonded employee. The employee may steal alone orwith others. The loss my be money, merchandise orany other property, real or personal.

The Fidelity Bond is available in a group (blanket)or individual (schedule) form.

The sevenfamilies of

Surety Bonds

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Public Ofcial Bonds Public Ofcial Bonds guarantee taxpayersthat the ofcial will do what the law requires.

A public ofcial is expected to “faithfully perform”the duties of the ofce. For this reason, bondingpublic ofcials is highly important. It isn’t enoughto simply buy honesty insurance. “Faithful perfor-mance” is not synonymous with “honesty.” It may in-

clude honesty along with many other important fac-tors.

For instance, a county treasurer may have lostfunds through a failure of a bank he thought wassound. If the treasurer did not obtain proper deposi-tory security, he could be held liable for restitution.

The county treasurer could easily prove that he didnot act “dishonestly.” However, he would have dif-

culty proving that he “faithfully performed” his duty.

Public Employee Bonds are also available forbonding the subordinates of the public ofcial (those people who are not required by statute to be bonded).

Those subordinates need to be bonded for dishon-esty only.

Public Ofcial Bonds may be written for individu-

als or, where the law allows, on a blanket bond form.

Judicial Bonds Judicial bonds are written for parties tolawsuits or other court actions (plaintiffs and defen-dants).

In anticipation of a favorable judgment, plaintiffs

often want to take possession of the property, cashor merchandise in question without waiting for thetrial. Those who are nancially reliable can often

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achieve that goal by posting a plaintiff’s court bond.

The plaintiff’s bond is usually required to protectthe defendant should the court decide that he, andnot the plaintiff, is entitled to the property or the

judgment.

Types of plaintiff bonds include Indemnity toSheriff Bonds which protect the sheriff against suitwhen dispossessing a person of property or goodsand Cost Bonds which guarantee payment of trial

costs. Other types of plaintiff’s bonds include Cost on Ap-peal, Injunction, Attachment, Objecting Creditors,Replevin and Petitioning-Creditors-in-BankruptcyBonds.

The second type of Judicial Bond is the defen-dant’s bond. A defendant in a court case might wanta bond to counteract the effect of the bond that the

plaintiff has furnished. Some common types of defendant’s bonds are Re-lease of Attachment and Counter Replevin. Generallyspeaking, these bonds have proven to be morehazardous than plaintiffs bonds. Accordingly theycan only rarely be written without the posting ofadequate collateral to protect the surety from loss.

In criminal actions, bail bonds are the most com-

mon type of defendant’s bonds. They guarantee thatthe defendant will show up for trial.

Fiduciary Bonds A duciary is a person appointed by thecourt to handle the affairs of persons who are notable to do so themselves. The duciary is often called

a Guardian or Conservator if he handles the affairsof a minor or an incapacitated person. An Adminis-trator is a duciary who handles the affairs of some-

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one who has died; he or she is known as an Executor

if specically named in the will. Fiduciaries are often required by statute, courts,or wills to be bonded. Statutes prescribe howduciaries should handle others’ affairs. However,the surety company often assists in keeping theduciary within the law.

Assistance of a surety is available to the principals

or their attorneys. Supervision by the surety helpsprevent problems and secure the assets entrusted tothe duciary. Through careful underwriting prac-tices, a surety also attempts to minimize losses.

In addition to the loss prevention services per-formed by a surety, the bond creates protection. Ifthere should be a loss, the surety pays heirs,wards, creditors, and benefciaries.

License and Permit Bonds A business takes few actions today withoutgovernmental permit or approval. Many of these gov-ernment permits are granted only after the businessposts a bond guaranteeing compliance with laws, or-dinances, and regulations.

License and Permit Bonds “put teeth” into the lawspassed for public protection. For example, sewerbuilders must conform to city sanitary regulations.

They must give a bond to guarantee compliance withcity regulations. If they do not comply, the suretypays damages or ensures compliance. The surety’sgreat care in selecting its risk helps insure that onlycapable sewer builders will be licensed. License and

Permit Bonds are divided into ve classes:

(A) Those designed to protect the health and

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safety of the public, e.g., a sewer builder.

(B) Bonds required of an individual who has been granted some public privileges which may become a hazard to the general public, e.g., hanging a sign over the street.

(C) Those bonds which protect the public against loss of money or goods entrusted to the licensee, e.g., real estate broker,

public warehouseman, etc.

(D) Those required of businesses highly sus-ceptible to unscrupulous practices, e.g.,small loan companies, motor vehicle deal-ers.

(E) Bonds which guarantee payment of taxes collected, e.g., gasoline tax bonds, sales tax

bonds. This latter category represents one of the most im-

portant types of surety bonds. These bonds guaran-tee that the principal will pay over to the state all taxmonies received. In the event the principal fails or isunable to pay the tax, the surety company pays forany losses. Without corporate surety, a state pro-gram may not be able to collect its revenues.

In all these cases, bonds endeavor to protect thepublic against irresponsible licensees.

Contract Bonds (Bid, Performance and Payment Bonds)Bid Bonds

Bid Bonds are usually the rst step in a bondedcontract process. Each bidder for a contract mustguarantee the price bid by posting a certied check

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or indemnity bond, which is forfeited if the contrac-

tor fails to enter into the contract awarded. Usuallythe amount forfeited is the difference between hisbid and the next lowest bid. The charges for BidBonds are nominal so as to encourage contractorsto use Bid Bonds rather than certied checks.

Bid Bonds guarantee that the contractor will enterinto a contract at the amount bid. When he does this,the Bid Bond is released.

Performance and Payment Bonds Typically issued together, Performance and Pay-ment bonds are usually referred to collectively as“nal” bonds. The Performance Bond guaranteesperformance of the terms and conditions of a con-tract. Payment bonds cover payment by the con-tractor of labor and materials used in the bondedproject. It may be for the construction of a building

or road or it may be a supply contract. It may be atransporation contract or almost any kind of con-tract where one party might experience harm if theother party fails to perform.

These bonds are largely the result of government-al and other public bodies which are required bylaw to award contracts for public work to the lowestresponsible bidder. The requirement of a Perform-

ance Bond and the screening process which thesurety must do, eliminates unqualied contractorsbefore the bidding process begins.

Performance Bonds are also frequently requiredin the private sector and by General or PrimeContractors of their subcontractors working on abonded project. The bonds cover completion of thework and payment of all labor and material costs.


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Miscellaneous and Federal Bonds There are almost as many categories of suretybonding as there are categories of agreements, con-tracts and situations where people may fail to per-form as promised.

Some of these are: (A) Bill of Lading Bonds, Adoption Bonds, Fi-

nancial Responsibility Bonds and Travel Agency Bonds.

(B) Lost Securities Bonds.

(C) United States Excise Bonds. (IncudesBrewer’s Bonds, Distiller’s Bonds, Indus-trial Alcohol Bonds, Wine Maker’s Bonds,and Tobacco Manufacturer’s Bonds.)

(D) Custom Bonds. (Includes Importer/Ex- porter Bonds, Carrier Bonds and Ware-

house Bonds.)

There are many others too numerous to mention.In these special situations, the experience of a cor-porate surety can be very helpful.

The surety bonding business is hazardous--andalways has been. Francis Bacon once said that“Going surety for a neighbor is like putting on ironto swim.” Still, the need for bonding grows daily.

Therefore, the number of agents required to servicethis great need also increases.

Agents are the link between the surety companyand those who need bonds. The primary source forbonding agents is established independent insurance

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The SuretyBonding Agent


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agents. And today, most licensed independent

casualty agents write at least some surety bonds.Only licensed insurance agents can sell suretybonds .

Licensing individual agents helps keep un-scrupulous and incompetent people from doingbusiness on behalf of a surety. Agents must alsosign a contract with the company they represent. Thecontract and the license are necessary because each

agent is granted certain authority agreed upon bythe company and agent.

Agents are often granted a Power of Attorneywhich gives them the authority to execute bonds.Each agent is limited in the amount and type ofbonds that can be executed.

Powers of Attorney and pre-executed bond forms

literally put a surety company in the agent’s ofce. The agent can execute a bond on the spot. This re-quires the use of considerable discretion and is animportant part of this highly service-oriented indus-try.

The typical sales problem of creating a need is not

a factor in the surety business. A need for the bondhas already been created either by law or by the na-ture of a particular business.

The surety agent earns a commission providingthe customer’s bond. Until that bond is properly exe-cuted and led, it does not begin to function. There-fore, availability is critical.

Since an agent cannot “create a need” for mostsurety bonds, service and availability are key to be-coming the source when bonding needs arise.

How is a SuretyBond Sold?


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Suretyship - A Practical Guide to Surety Bonding

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