How To Obtain Surety Bonds PDF
How To Obtain Surety Bonds PDF
How To Obtain Surety Bonds PDF
Surety Bonds
An introduction to contract surety bonding for contractors.
1
How to Begin
Since most surety companies distribute surety
bonds through the agency system, the first step is
to contact a professional agent or broker, also
known as a surety bond producer, who specializes
in contract surety. A professional surety bond pro-
ducer guides the contractor through the bonding
process, helps establish and foster a business rela-
tionship with a surety company, and assists in
managing the contractor’s surety capacity.
A professional surety bond producer can offer
sound business advice and technical expertise,
such as contract document review. The producer
can introduce the contractor to professionals or
Three Basic Types of Contract consultants when appropriate.
Surety Bonds After meeting with the contractor and gaining
■ The bid bond assures that the bid is an understanding of the firm’s business and
submitted in good faith and that the needs, the producer tailors the contractor’s sub-
contractor will enter into the contract at mission for the specific requirements of the
the price bid and provide the required surety company. The producer then submits the
performance and payment bonds. account to a surety company best matched to
■ The performance bond protects the the contractor’s profile and needs. It is important
owner from financial loss should the to recognize that all surety companies are not
contractor fail to perform the contract in
the same. For example, some specialize in large
accordance with its terms and conditions.
contractors, some in middle markets, and others
■ The payment bond assures that the
in emerging contractors. If necessary, the pro-
contractor will pay specified subcontrac-
ducer can guide the contractor through a formal
tors, laborers, and materials suppliers
presentation and meeting with the surety com-
associated with the project.
pany. The producer is an essential link between
the contractor and the surety company and
should maintain communications with both.
2
To find a producer who specializes in contract Surety Company Underwriter
surety bonding, contact the National Association Once the surety bond producer collects all the
of Surety Bond Producers (NASBP) at (202) 686- necessary information, he or she submits it to a
3700 or www.nasbp.org. NASBP members surety company underwriter. The underwriter
adhere to a code of professional standards. takes an in-depth look at the contractor’s entire
business operations and must be satisfied that the
contractor is capable of completing the project.
Qualities of a Professional Surety The underwriter may request a meeting with
Bond Producer the contractor to form his or her opinion and
■ Is well respected and has a reputation for obtain additional information. For example, the
integrity in the construction industry; underwriter may want more information on the
■ Demonstrates a personal interest in the single job size and aggregate workload for all
contractor’s success; projects, bonded or not, in the contractor’s
■ Has a track record of building solid current and projected work program. If the
relationships with surety underwriters; contractor wants to bid on a larger than usual
■ Possesses an understanding of the project, the underwriter will want to know
construction industry; whether it is prudent for the contractor to under-
■ Has knowledge of accounting and take it from a risk/reward standpoint, how it fits
finance, especially construction account- into the current work program, how the project
ing procedures; will be financed, and a projection of the return.
■ Has knowledge of construction Although it may seem as if surety underwriters
contracts, subcontracts, and related focus on the contractor’s finances and financial
contract law;
structure, they are also interested in other ele-
■ Is aware of local, regional, and national ments of the contractor’s business. The contrac-
construction markets;
tor’s organization, track record, and approach to
■ Is experienced in strategic planning and a job, once established, are not generally ques-
management practices that promote
tioned with frequency if the contractor’s results
successful contracting; and
■ Is actively involved in and supports local
and national construction and surety
industry associations.
3
are consistent. However, should there be signifi- The contractor’s financial situation fluctuates
cant changes in ownership or key personnel or from day to day, from job to job, and conse-
the contractor decides to move into a different quently is the area that is subject to the greatest
type of construction or geographic area, this scrutiny. When applying for bonds, the contrac-
information should be shared with the surety tor must be aware that once the surety is satis-
along with any other changes in the contractor’s fied as to the technical ability to perform, it will
capabilities or the way the contractor conducts then review the financial results of performance
business. and translate that into a decision on the firm’s
present and future ability to pay bills, finance
additional undertakings, and accept or mitigate
risk. The numbers are the scorecard that tell all
parties how well the contractor is performing.
4
Prequalification Process the surety underwriter may have, and assists
Each surety company has its own underwriting in verifying information. The surety must be
standards and requirements, but there are shared satisfied that a contractor has the ability to meet
fundamentals common to the underwriting of current and future obligations, has a good repu-
most surety companies. Before a surety under- tation, has experience meeting the requirements
writes a bond, the contractor typically undergoes of the projects to be undertaken, and has (or
a careful, rigorous, and thorough process, often can readily obtain) the equipment necessary
referred to as prequalification. to perform the work. The surety also looks for
contractors who run a well-managed, profitable
The prequalification process takes time as the
enterprise, keep promises, deal fairly, and
producer collects information, answers questions
perform obligations in a timely manner.
Prequalification Checklist
Here is what a contractor may need to provide:
■ An organization chart of key employees life insurance on key owners with the con-
and their responsibilities; struction company named as beneficiary);
■ Detailed resumes of key employees; ■ Evidence of a bank line of credit to augment
■ A business plan outlining the type and size working capital and to handle temporary
of work sought, prospects for such work, the cash flow deficits or strains. Sureties will look
geographic area in which the company at the security for the credit and the extent
operates, and growth and profit objectives; to which bank loans are used and the
■ Current work in progress as well as a history amount and terms of their repayment.
of the largest completed jobs, including Sureties generally look for an unsecured line
the name and address of the owner, the of credit or a line of credit obtained through
contract price, date completed, and the the long-term financing of equipment or
gross profit earned; real estate; and
5
Financial Statements ■ Schedule of general and administrative
expenses—may reveal how well overhead
Depending on how long the contractor has
expenses are controlled and managed.
been in business, the surety will request fiscal
■ Explanatory footnotes—qualifications made
year-end statements for at least the past three
by the accountant.
years and may require a financial statement
■ Management letter—conveys the CPA’s find-
audited by a certified public accountant (CPA).
ings, observations, and recommendations
Financial statements typically include the following:
about the contractor’s business. Not all CPAs
■ Accountant’s opinion page—discloses provide management letters.
whether the statements were prepared
according to audit, review, or compilation Accounting Methods
standards.
Complete and accurate accounting systems
■ Balance sheet—shows the assets, liabilities,
are extremely important to surety companies.
and net worth of the business as of the date of
The American Institute of Certified Public
the statement. This helps the surety company
evaluate the working capital and overall finan- Accountants’ (AICPA) Audit Guide for Construction
cial condition of the company. Contractors recommends the percentage-of-
■ Income statement—measures how well the completion accounting method, which is also
business performed. The surety analyzes each preferred by most sureties. The percentage-of-
item, including gross profit on contracts, completion method best represents a contractor’s
operating profit, and net profit before and financial condition and most accurately measures
after tax provisions. results of work performed during the accounting
■ Statement of cash flow—discloses the cash period. The percentage of contract values recog-
movements from operating, investing, and nized as revenue typically is done on a cost-to-
financing activities. cost percentage-of-completion method.
■ Accounts receivable and payable Depending on the time elapsed since the last
schedules—should reflect aging. fiscal year-end statement, the surety may ask for
■ Schedules of contracts in progress and an interim financial statement every three or
contracts completed—show the financial six months to show how the current year is
performance of each contract and provide
progressing.
insight into the potential for future earnings
from contracts in progress. This should tie into
the balance sheet.
6
Contractors also need to prepare a quarterly ■ Revised estimate of the cost to complete;
schedule of work in progress. This schedule ■ Estimated final gross profit; and
should list each job by name and include: ■ Anticipated completion date.
■ Total contract price; The format of this exhibit and the amount
■ Approved change orders; of information required varies among surety
companies and almost always is required in
■ Amount billed to date;
connection with the full CPA reports.
■ Cost incurred to date;
7
Commitment After the bonds are written, the surety contin-
The surety company expects the contractor to uously evaluates the overall performance and
perform its contractual obligations under the financial position of the contractor. Adverse
bond. Surety companies usually require a changes may cause the surety to reduce or termi-
demonstration of commitment from the con- nate the bonding program, whereas positive
struction company’s owners through personal results may serve as the basis for an increase in
and/or corporate indemnity. surety capacity.
The indemnity agreement obligates the Sufficient lead time should be allowed when
named indemnitors to protect the surety com- seeking surety bonds—especially when seeking a
pany from any loss or expense caused by the bond for the first time. In no event should a bid be
contractor’s failure to fulfill its bonded obligation submitted for a bonded project before surety
on the project(s) and any resultant loss under the arrangements are in place.
surety bond. This gives the surety company some
assurance that the contractor will stand fast in
the face of problems and use its talent and finan-
cial resources to resolve any difficulties that may
arise in the performance of the bonded work.
Surety companies stand behind the commit-
ments undertaken by a contractor through a
bonded contract. The contractor is primarily
responsible to fulfill the contract’s obligations
and the surety’s obligations are secondary to the
contractor’s. Surety bond premiums are service
fees for the surety’s expertise, underwriting
services, and financial backing.
8
What do Bonds Cost? When bonds are specified in the contract
Surety bond premiums vary from one surety documents, it is the contractor’s responsibility
to another, but can range from one-half of one to obtain the bonds. The contractor generally
percent to two percent of the contract amount, includes the bond premium amount in the bid
depending on the size, type, and duration of the and the premium generally is payable upon
project and the contractor. Typically, there is no execution of the bond. If the contract amount
direct charge for a bid bond, and in many cases, changes, the premium will be adjusted for the
performance bonds incorporate payment bonds change in contract price. Payment and perform-
and maintenance bonds. ance bonds typically are priced based on the
value of the contract being bonded, not
necessarily on the size of the bond.
Benefits of Bonding
The surety industry is an integral part of the ■ Funding verification—This service becomes
construction business. A good surety under- very important if a contractor is involved in pri-
writer and surety bond producer can be two of vate construction. Many contractors have
a contractor’s greatest assets. The producer faced bankruptcy because they did not ask the
and underwriter are professionals who possess source of funding on private projects. The
or have access to a wide variety of resources to surety will insist on knowing the source and
assist contractors. They do all they can to see adequacy of funds before it will commit to
that a contractor remains viable. The surety bonding a project.
team interacts with a cross section of the con- ■ Contract reviews—Many sureties perform
struction industry and can assist the contractor contract reviews to identify contract terms,
with: general condition requirements, or anomalies
■ Professional references—The surety team in the specifications, or bond forms that may
knows accountants, bankers, and lawyers who be onerous, unacceptable, or add undue risk
understand the construction business. to the project.
■ Corporate experience—Producers and ■ Continuity plans—Sureties can assist the
surety company personnel can share their contractor with a continuity plan to protect the
experience on issues facing a contractor. contractor’s family, estate, partners, creditors,
employees, and assets.
9
Maintaining the Surety Relationship Maturing into a growing partnership requires
To maintain and increase surety capacity, it is teamwork and an organized effort among the
important for a contractor to develop and main- contractor, the surety underwriter, and the surety
tain an ongoing relationship with the under- bond producer. There may be difficult times, and
writer and producer. Developing a relationship the surety may not always be willing to extend
requires commitment, trust, and above all com- the surety capacity the contractor would like, but
munication. Maintaining the relationship maintaining a relationship with the surety
through open communication and timely report- company builds trust and increases the surety’s
ing on the company’s financial condition and job commitment to the contractor over time.
status builds trust with the surety.
Conclusion
Even after all the information is provided to
the surety, there is no guarantee it will result in
approval. The bond will be approved only if the
surety is confident the contractor is qualified to
perform the contract and work program success-
fully and has the financial capacity to withstand
the numerous risks involved in the construction
business. The decision to seek surety bonds
should be based on long-term considerations.
To obtain bonds, some changes in the way a
contracting firm does business may be necessary
and these changes could have associated costs
and benefits.
10
Resources
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© 2007 Surety Information Office
Surety Information Office (SIO)
1828 L Street NW, Suite 720
Washington, DC 20036-5104
(202) 686-7463
(202) 686-3656 FAX
www.sio.org
[email protected]
The Surety Information Office (SIO) is the information source
on contract surety bonds in public and private construction.
SIO offers complimentary brochures and CDs and can provide
speakers, write articles, and answer questions on contract
surety bonds. SIO is supported by The Surety & Fidelity
Association of America (SFAA) and the National Association of
Surety Bond Producers (NASBP). All materials may be accessed
at www.sio.org.