Performance Bond Match Game

A decade ago, one surety company came out with a “short form” program.  The program had a catchy name, 2 x 4 program and small contractors could qualify for performance and payment bonds of $200k single bond within a $400k aggregate program with little more information than a three page application. This was during a tough time in the surety industry and for years, they were the only player, then another market decided to write small contractors on a short form.  Of course it had to differentiate itself so the limits were raised to $250k single job within a $500k aggregate program.

Today there are a dozen or more short form programs and I have heard a rumor that a market on the east coast will write performance bonds up to $1 million with very little underwriting information.  The truly innovative company that started the program has increased its limits to $350k single within $700k aggregate and there seems to be new entrants everyday to an already crowded niche.  This trend will continue with increasing limits, followed by lower rates, followed by acceptance of lower credit scores and so on.  I think the trend will continue for about two more years, when the loss ratio will become unacceptable.  The providing of $1 million in surety credit with very little information is surprisingly similar to what happened in the mortgage industry just a few years ago. Remember the no verification loans?  Contractors, like people seeking a mortgage will often follow the path of least resistance. Its just not rational.

I am not saying the sky is falling and that all the companies participating in these programs will fail.  Some will resist the competition and forgo premium. Others will not.  After 30 years in the surety bond business I know that competing for surety premium by not requiring enough information to properly access risk is going to fail.  History has a funny way of repeating itself.