Performance and payment bonds are not a well known concept. Most people, if they have never been asked to provide a surety bond, have never even heard of them. As such, most people do not realize the primary function of the corporate surety is qualification of the principal (principal is the party providing the surety bond). The corporate surety underwriters spend their days analyzing finical statements, looking at the work in progress report, performing due diligence at a level higher than most banks. They do this make sure a contractor is qualified to perform the work the company will bond. The corporate surety will then provide a guarantee to the owner that a project will be completed and the subs and suppliers will be paid.
On public works projects, this qualification process is put to the test as a statutory regulation; if one wants to build in the public arena, one must provide the corporate surety bond. To make any money, the surety company must be right 99%+ of the time. It’s a case of simple math, if the rate charged by the surety is 1% to 3%, the expense ratio (amount of each dollar that the corporate surety spends on underwriting) is 60%, that means the surety has .5 to 1.5% to pay claims. If a surety has a $1mm loss, it would require the premium from $66mm to $200mm worth of work to pay that one claim. As such, the surety must do a great job of qualifying a conractor if it is to turn a profit.
So how can someone steal surety?
In the case of a private owner, there is no statutory requirement to provide a performance and payment bond. Also, General contractors hire subcontractors and again, there is no statutory requirement to require bonds of the subcontractors. As such if you knew for sure that a contractor was able to provide a bond for a particular project, you would know that a great deal of due diligence was done on that contractor. How much due diligence you ask? Based on the above analysis, there is a 99%+ chance that the contractor will complete the project and pay the subs. Again, if you knew for sure that the contractor could bond the project.
Letters of bond-ability are requested quite often of contractors on private works projects and of subcontractors bidding work to GC’s. These letters state that a contractor is theoretically bond-able up to a limit, assuming they “continue to comply with underwriting standards”. The level of underwriting that goes into these letters is far less than what goes into actually providing a bond. That said, if one has no intention of actually requiring a bond and paying the bond premium, even this is stealing the qualification services of the surety that provides the letter.
Some private works owners and general contractors are more brazen when it comes to stealing surety. The bond-ability letter is very general; however a bid bond is underwritten as if a final bond (the performance and payment bond) will be issued and bid bonds are free. Some companies (that lack integrity) will actually require bid bonds, even though they have no intention of requiring performance and payment bonds. There is no nice way to say it, requiring a bid bond when there is no intent of requiring a performance and payment bond is stealing. It is theft of services. No different than climbing a pole and tapping into the electric grid.
The highest level of theft of surety I have seen, however, is an owner or general contractor sticking with the ruse that performance and payment bonds are required all the way up to the time the contractor actually provides the bonds. Then the unscrupulous GC or private owner says “we decided to waive the bond requirement”. To get to that point, the corporate surety has spent hours underwriting the bond, the contractor that had to provide the bond, especially if they are not a public works contractor, probably had to spend hours of time and a good deal of money preparing information for the surety.
The qualification services of the surety are a great tool. To take advantage of this service without paying for it is wrong.