Different Types of Bonds

A common misconception of bonds is that they are all considered surety bonds, but this is not the case. Bail bonds, treasury bonds, investment-grade corporate bonds, junk bonds, foreign bonds, mortgage-backed bonds, and municipal bonds are completely different than surety bonds. Bonds acting as a financial investment pay out agreed upon interest payments to the bond holder, often referred to as the “creditor”. Once the bond matures, the principal (borrowing entity) pays the face value of the bond. Bail bonds have two parties, the court and the defendant, and have the most similarities to surety bonds as they are guaranteeing that the defendant will show up in court. Investment bonds can be sold on secondary markets and publicly traded. However, surety bonds have a three-party structure with a principal, oblige, and surety. Surety bonds are used to guarantee the completion of construction projects, that a business will conduct themselves in accordance to local and federal laws, or fulfill requirements set forth by special courts such as a probate court.

A surety bond producer or agency typically will not issue bail bonds, investments bonds, or municipal bonds. Surety bonds are more similar to insurance products and are sold by surety brokers and agents who are typically affiliated with an insurance company or brokerage. Surety carriers are often the same as commercial insurance carriers. Despite the similarities, surety bonds are not the same as insurance products but are sold by insurance agents. Most insurance agents are unaware they only need a P&C license to earn commission off surety bonds. Most surety bond clients (referred to as the principal) are unaware their commercial insurance agent can sell them the surety bonds they are required to have. This often leads to the principals having to purchase their insurance from their insurance agent then searching for a surety bond broker or agent to purchase their bonds.

Who Can Sell Surety Bonds?

The principal of a surety bond (business owner or contractor) cannot purchase a surety bond directly from the surety carrier. Most principals are unaware they can purchase surety bonds from the same insurance agent who sells their commercial insurance. Making the process of purchasing a surety bond more complex, most insurance agents are unaware they can sell and earn commission on surety bonds. The principal must purchase the surety bond through a licensed insurance agency, agent, or brokerage. An agent, agency, broker, producer, or brokerage must have a Property and Casualty license in order to be paid commission on surety bond premiums.

Oftentimes, the underwriter who assesses the risk with surety bond applications for the carriers does not have a P&C license, as they are not earning commission on their bond sales. Insurance regulations are different in each state but all require that any insurance producer or agent earning commission on surety bond premiums have a P&C license. Earning a salary or bonus does not constitute earning commission. As long as a surety producer or surety broker works for a licensed brokerage or agency with at least one owner or employee being licensed in the state in which the bond is sold, commission can be earned from a surety bond. Oftentimes, the surety carrier will require the surety brokers with power of attorney to have a P&C license before they are granted power of attorney to issue bonds. Surety agents and producers without power of attorney will have to purchase bonds from the carrier or the brokerage on behalf of their clients.

Insurance agents who are unfamiliar with surety bonds should secure an appointment with a trusted surety bond broker. Surety brokers are often appointed with dozens of different surety carriers. Having multiple surety appointments allows the broker to secure the lowest premiums for the appointed agents and clients. An insurance agent can secure their own surety appointment without using a broker. However, if surety bonds are not a big piece of their business, most retail insurance agents will not be able to secure appointments with sureties that have the best premiums. This can cause the insured clients to shop surety bond rates and possibly move their entire commercials book of insurance business to the agent who can handle their insurance and bonding needs.

Different surety carriers have varying standards for their surety appointments. Some may require a minimum volume amount or they may only appoint brokers/agents who are experts in the surety bond industry. If an insurance agent who is unfamiliar with surety secures an appointment directly with the carrier, it can lead to some negative outcomes. Surety underwriters tend to frown on incomplete applications, applications with missing supplemental documents, and surety bond applications that do not match their appetites. This can lead to longer application process times, higher rates, and a decline in service. Surety carriers, who appoint all agents regardless of experience, tend to have a more automated system in place. Applications are sent to a general inbox or can be submitted online, usually without ever consulting with a surety underwriter. These applications can often take weeks to quote.

Securing an appointment with a surety broker such as Allied American Underwriters, a division of USG Insurance Services can allow retail insurance agents to have the best of both worlds. When becoming appointed with USG, retail insurance agents can offer their insureds a fast application process, the most competitive quotes, and a surety broker to answer all questions and set realistic expectations. This allows the insurance agent to focus on assisting all of their clients’ insurance and surety needs, without all of the back-end work of remembering each specific caveat of the 13,000+ different types of surety bonds. Insurance agents appointed with USG earn commissions and have access to easy bond payment portals and additional educational resources from interacting with a surety broker directly.

Identifying Clients Who Need Surety Bonds

Commercial insurance agents have numerous existing clients who are required to purchase surety bonds. It can be challenging to figure out which insureds need to purchase bonds and when. There are three main types of surety bonds: commercial, contract, and court bonds. Understanding each of the three types will allow for easier identification of insureds that also need to purchase surety bonds.

Commercial Bonds

Commercial surety bonds, also referred to as “license and permit bonds”, are most often required when a business applies for a business license and must be renewed each year for the life of the business. Businesses that are required to have this subtype are:

  • Appraisal Management Companies
  • Auctioneers
  • Bars, Restaurants, and Any Business With Alcohol Sales
  • Cannabis Related Businesses
  • Car Wash Owners
  • Cleaning Services
  • Contractors
  • Convenience Stores Who Sell Lottery Tickets
  • Driver Training Schools
  • Health Clubs
  • Home Health Care Providers
  • Immigration Consultants
  • Mobile Home Manufacturers
  • Mortgage Brokers
  • Motor Vehicle Dealerships
  • Notaries
  • Pharmaceutical and Medical Equipment Businesses
  • Public Officials
  • Realtors
  • Retailers of Tobacco Products
  • Telemarketing or Fund Raisers
  • Travel Agents
  • Truckers and Other Transportation Related Businesses
  • Unaccredited Schools or Colleges

Contract Bonds

Contract bonds tend to have the highest premiums and are needed by contractors, though not all contractors need contract bonds. Contractors may need to purchase a commercial bond for their business license or a permit to operate in a specific city or county. They will also need to purchase bid bonds, performance and payment bonds, labor and materials bonds, warranty bonds, maintenance bonds and developer bonds.

Public and private construction projects are the two general project types for contractors. Public jobs, such as renovations to a school or a contract with the city to maintain roads or salt sidewalks, require a bid bond and performance and payment bond to be purchased for public over a certain amount. Each city, county, state, and federal government entity can require a bond for any size project if they choose too. The same applies with private work. If an owner of a retail store wants a new location to be constructed, they can choose to require any contractors who wish to bid on the project to be bonded.

Court Bonds

The last and least common type of bond is a court bond. Court bonds are required by a court. A court may require executors of wills and trusts to obtain a surety bond to ensure that the trust or will is executed as the benefactor intended it to be. Pennsylvania for example, has a requirement that any executors who reside in a different state than the benefactor must obtain a probate bond before being granted approval to execute a will. Court appointed guardians must obtain a probate bond in order to have control over a minor or incapable person’s well-being and their assets. Public officials such as a local treasurer must obtain a type of court bond in order to sign checks on behalf of the city. Different states, cities, and industries have varying types of bonding requirements. If an agency is in California, their clients may need numerous bonds of all types. If an agency is located in a less populated state such as Missouri, they may not need as many commercial bonds as they do contract bonds. States located in the northeast that are clustered together may require more probate bonds than larger states in the Midwest. Becoming appointed with a broker such as AAU will enable an agency to have access to surety insight that can be used to penetrate their existing book of commercial insurance with surety bonds.

Empowering Insurance Agents with the Power of Surety: Step 1

Surety bonds are not the most common product in an insurance agent’s commercial book of business. Many insurance agents are unaware they are able to fulfill their insureds’ surety bonds needs. Even more, insureds are unaware they can purchase their surety bond through their insurance agent! It’s time to change that! A multiple part blog series will cover the various aspects of surety bonds that agents need in order to empower themselves.  With the proper knowledge, agents will develop the confidence to penetrate their existing book of commercial business, as well as attract new commercial insurance business by offering surety bonds.

The first step is becoming appointed with a surety or a surety bond broker, such as Allied American Underwriters (AAU), a division of USG Insurance Services, Inc. Some sureties will appoint retail insurance agents to submit bond applications directly. Other sureties are more selective with which agencies they will appoint. A surety that values top-line growth will appoint as many agents as possible. In order to protect their bottom line, these sureties may not be able to underwrite every type of surety bond and must enforce higher underwriting criteria. These sureties tend to have a general email for agents to submit submissions or online platforms, allowing agents to do all of the work. Sureties that value their bottom line will be more selective with appointing agents. An appointed agent will often have an individual underwriter assigned to them, to personally review each bond submission. Underwriting tends to be more relaxed and a variety of bonds can be underwritten. These sureties are selective, as they must appoint agents who are familiar with surety bonds and the specific appetites each surety has.

A way for retail insurance agents to have the best of both worlds is to become appointed with a surety bond broker, like AAU. By using a broker, agents can have access to all types of surety bond markets, underwriting styles, and free up their time and resources for commercial insurance business. Agents who are appointed with a broker still earn surety commissions and fulfill their client’s needs, despite their credit or backgrounds. AAU is appointed with 24 surety carriers and can place all types of bonds with varying degrees of risk.

North Carolina General Contractors License Bonds

Each state requires contractors to be licensed and bonded, and requirements differ from state to state. General contractors in North Carolina must meet certain net worth requirements or obtain a surety bond in order to apply for a contractor’s license. The first step in determining if a general contractor must obtain a surety bond is determining the type of general construction work and which project limitation amount is desired.  Contractors can expect to pay between 1% to 3% of the bond amount as the premium. When applying for this bond, contractors should expect to submit personal and business financial statements.

There are five subcategories of general contractor licenses; building, residential, highway and public utilities, and specialty contractors. Within each subcategory, there are 3 classifications – limited, intermediate, and unlimited types of licenses.

Limited License

A limited license entitles a general contractor to perform work on any single project up to $500,000. The general contractor must have a total net worth greater than $80,000 or current assets that exceed total current liabilities by at least $17,000. If not, they must obtain a $175,000 surety bond.

Intermediate License

An intermediate license entitles a general contractor to perform work on a single project with a value up to $1,000,000. This cost does not include the cost of the land in which the project is being performed or any costs to improve the land. The contractor must have at least $75,000 worth of current assets that exceed their total current liabilities. If that requirement is not met, the contractor will need to obtain a $500,000 surety bond.

Unlimited License

An unlimited license entitles a general contractor to perform work without restriction for a single project. The contractor must have at least $150,000 of current assets exceeding current liabilities. If not, they must obtain a $1,000,000 surety bond.

Surety Bond Claims

A surety bond claim is a complaint against a bond principal (most often a business owner) for violating a contractual agreement or failing to conduct their business within the legal obligations dictated by the obligee (most commonly a state government). If a claim is made on a business, it is expected that the business takes care of the claim. If not, the surety will investigate the claim to determine the validity.  If proven valid, the surety will reimburse the consumer losses, up to the full amount of the bond claim. The surety will then look to the bond principal to reimburse the surety for any losses. If the claim is not legitimate, as determined by the surety, the principal may still be responsible for covering any costs associated with the investigation.

The principal signs an indemnity agreement prior to receiving an executed bond, which legally entitles the surety to any assets owned by the business and the personal assets of the business owners and any spouses of the owners. Therefore, if a business goes bankrupt, the business owner will have to personally indemnity their assets to the surety in case of a bond claim payout. Once a claim is paid, the bond claim is closed. It will be expensive and costly to obtain any further bonding coverage. It is important to avoid claims, as once a bond claim is made it is very difficult and expensive to obtain bonding coverage. Even if a bond claim is made, state laws and regulations still require principals to obtain a surety bond in order to perform work or maintain a business license.

When a consumer or obligee feels a bond claim is necessary they will file a claim with the surety. This can be done by verifying the surety who bonded the principal and making contact with the surety, whose contact information is often found on the bond and can also be found on insurance licensing board websites. The surety will investigate the claim and if they feel the claim is valid, the principal will first have a chance to pay the claim. If the principal fails to pay the claim, the surety will step in and pay the claim amount. Then the surety will take the responsibility of being made whole by principal through legal means.

Here are some common examples of bond claim scenarios:

  1. A contractor fails to complete a construction project in a timely manner and the obligee files a claim on the payment and performance bond to cover the damages resulting from the delays. The surety will investigate why the delays occurred. Currently COVID-19 has caused a lot of delays as State governments have prevented the contractors from working. In this case, if a Force Majeure clause is contained in the bond form language, it will deem the claim invalid.  Viral pandemics and government interventions preventing a contractor from completing a project on time are of no fault of the contractor and could not be avoided. If the contractor simply mismanaged their labor force or experienced delays from their vendors and suppliers- those reasons would validate a bond claim.
  2. A private cosmetology school goes bankrupt mid-semester and leaves the students without a degree or any tuition reimbursement. The students can make a bond claim on the license and permit bond the school was required to obtain prior to obtaining a license to do business. If the school is bankrupt, the students may not have much to be reimbursed from the business. However, the bond indemnifies the school owner’s personal assets. The school may not have any money left for tuition reimbursement, but the owner’s personal bank account, cars, or houses will be used to correct the consequences experienced by students through the bankruptcy.
  3. A motor vehicle dealer fails to supply a valid title for vehicles sold. If the customer is unable to return the car for a full refund or obtain a valid title, a bond claim can be made on the license and permit bond to be made whole again.
  4. A contractor bids on a project and is awarded the contract as they were the low bidder. They realize after the bid tabulations by their competitor are read aloud that they made a mistake during the estimating process. If they choose to accept the contract, they will make zero profit and possibly even pay for construction work. The contractor rejects the contract they have been awarded. The obligee can make a claim on the bid bond and be reimbursed 5%, 10%, or 20% of the original bid to cover the expenses with re-awarding the contract to the next lowest bidder. 

DMEPOS Bonds

A $50,000 Durable Medical Equipment, Prosthetics, Orthotics, and Suppliers (DMEPOS) bond is required of businesses who submit bills to Medicare and Medicaid for the sale of durable medical equipment, prosthetics, orthotics and other medical supplies. The Center for Medicare & Medicaid Services requires this bond to be renewed for the life of the business license. DMEPOS bonds are commonly referred to as Medicaid or Medicare bonds and patient trust bonds. These bonds have premiums that are based on the credit of the owner, business and personal financials, and how long the business has been operating. Premiums can range from 1% to 15% of the bond penalty amount.

These bonds are required to ensure that medical suppliers, dentists, pharmacists and other businesses that submit billings to Medicaid and Medicare do not market medical equipment that is unnecessary to clients or submit fraudulent billings to Medicaid or Medicare for reimbursement.

One business may need to purchase numerous DMEPOS bonds. A $50,000 DMEPOS bond is required for each competitive bidding area (CBA) in which a business location operates. So if a business has multiple locations in different CBA’s, they will need to purchase multiple DMEPOS bonds for each location in different CBA’s. Currently there are 130 bidding areas with sixteen different product categories. Bidding for each category has an open period to bid for specific categories in certain areas. Round 2021 is currently closed.

New Executive Order in Georgia Requiring Electronic Surety Bond Execution

Commercial and contract surety bonds in Georgia can now be submitted with electronic seals and signatures. On June 11th, 2020 Governor Kemp released an executive order clarifying the Empowering a Healthy Georgia executive order. Section VIII- Governments, clarifies that state requirements which previously required raised seals for contract surety bonds or commercial bonds may be electronically sealed and signed if the bond is notarized in accordance to Executive Order 04.09.20.01 and the original bond document be provided within seven business days if requested. This executive order can be found here:

Georgia is one of many government entities adapting to the health risks posed of COVID-19. On April 30th, 2020 the U.S. Department of Defense allowed deviations from the Federal Acquisition Regulation (FAR) and the Defense Federal Acquisition Regulation Supplement (DFARS). The deviation includes allowing for electronic seals and signatures for bond forms submitted for federal construction work – form SF24, SF25, and SF25A. On May 21st, 2020 the SBA issued a notice allowing for electronic signatures to be accepted for bonds and bond documents issued through the Surety Bond Guarantee Program (SBG).

Hard Market vs. Soft Market: Impacts on Surety Bond Industry

For the last 15 years, the surety industry has flourished in the soft market. The soft market has allowed for ample competition, innovative submission platforms, higher bonding limits, and increased profits. A hard market, relative to the insurance industry is when there is a high demand for insurance coverage and a reduced supply. Profits are lower and claim payouts are higher and more frequent. This leads to an increase in premium amounts, strict underwriting, less competition, and fewer bonds being written. A soft market exists when there is ample competition among insurance carriers. More competition leads to lower premiums, more lenient underwriting criteria, and more high-risk bonds being written.

Despite an increase of competition and capacity, nationwide recessions, global pandemics, and natural catastrophes and disasters can force the market to transition from a soft to a hard market. Impacts of COVID-19 have thrust the surety industry into a hard market. As the impacts of COVID-19 are felt, the surety industry quickly adapted to allow for more electronically sealed and executed bonds. This adaptation has paired well with most surety brokers and producers having an electronic platform integrated into their business model.  As the soft market transitions into a hard market, online platforms with “instant” quotes will become more challenging. Success in the surety producing sector will boil down to pure experience and knowledge of each carrier’s appetites, underwriting criteria, and specific risks attributed to each type of bond. The thinning of competition among surety producers and agents has already begun. What can be done in order to thrive in a hard market?

Surety agents should prepare their contractors for the inevitable hard market. The transition will be less harsh when expectations are properly adjusted. Agents should discuss with their contractors the implications of stricter underwriting criteria, decreased bonding capacities, and higher premium rates. Contractors who are able to identify the scopes of work that are most profitable to them will be able to weather economic hardships. For example, if a contractor who performs mechanical and plumbing work does not have a sheet metal shot, they may elect to pursue more plumbing jobs and new mechanical projects. Having to purchase sheet metal from a supplier would make renovations and projects involving ductwork less profitable.

Commercial and financial guarantee bonds will now require personal and business financials to accompany the applications. Performing a soft pull on a business owner’s credit will no longer suffice for some of the more risky bonds, especially in those industries who have been directly impacted by COVID-19, such as health spas and motor vehicle dealerships. This will create more front end work for insurance agents and surety producers as they must request additional documentation of their clients.

Knowing each surety carrier’s underwriting criteria and appetites will be the advantage in thriving in a hard market. Establishing realistic expectations for underwriting procedures, preparing clients for increased premium rates, and knowing the markets are the keys to excelling in a hard market. It’s time to have those difficult conversations with clients; get to know your surety’s underwriting criteria and prepare for a more in-depth application process.