Performance Bonds Tools of the Trade

Performance and payment bonds, while underwritten by insurance companies and sold by insurance agents are anything but insurance.  A surety bond, is for all intents and purposes, an unsecured guarantee, a third party co-signor if you will.   As such, the underwriting process of a surety bond is a lot more like applying for a loan than applying for an insurance policy.

Any surety bond underwriter learned early on about the three “C’s” of surety, character  capacity and capital.  By  character, the underwriters want to see a company that acts in a responsible manner.  This is by for the most subjective pillar of the three C’s and means, in a nut shell, is this company and its owners fair and honest.

The second ‘C” is capacity.  this means does a contractor have the skill set, equipment, personnel and experience to complete the project.   The third “C” is capital.  Does the contractor have the financial resources available to it to finance its business.

We have added a couple of more C’s” that are not in most of the training materials issued by the surety companies.  The fourth “c” is contract administration,   often referred to as funds control.  This is a tool that can be used to help protect the surety company from payment bond exposures.  The payment bond is there to protect the sub contractors and suppliers, it guarantees that these subs and suppliers get paid and delivers a lien free project to the owner.  With contract administration, a third party, hired by the surety company collects all the progress payments on a job and pays all the subs and suppliers via a joint check.  This way, the surety knows that all the payments on a bonded job are being used to pay the bills on that same bonded job.  Contract administration, while it does come with some additional costs, is a valuable tool in the underwriters tool box.

The fifth “C” is also one not found in the main stream surety underwriters, and that is collateral.  Collateral, usually cash or an irrevocable letter of credit from a bank, is another way to make a performance and payment bond writable that may not be if just using the mainstream 3 C’s”.

The surety companies take a lot of risk for not much compensation. The underwriters are careful; they have to be.  But being turned down by the main street insurance broker that dabbles in surety does not mean a contractor can’t be bonded.  A contractor should seek out a firm that only does surety bonds, and will talk to the contractor about alternative structures to obtain a bond.  These surety bond agents will have the tools at its disposal to get a contractor the bond it needs.