The Dominoe Effect, Surety Bonds And The Economy

I have written many articles about the hard surety bond market. To my surprise, many want to know more details as to how we got to where we are at. Like all industries, the surety bond industry is heavily influenced by the economy. We can all remember the strength of the US economy at the end of the millennium; it seemed that businesses were flourishing with prosperity everywhere you turned. By the end of 2000, the economy began to slow down. The success of any contractor is directly effected by changes in the economy, thus more contractor’s businesses began to fail. With the failing of the contractor businesses came an abundance of claims. This is not to say that the soft economy was the only cause for the increase in claims, but it was the start of the domino effect.

What actions set up the rest of the dominos to trigger the current hard market? In an attempt to generate more premium, bonding companies used very loose underwriting practices. These loose underwriting guidelines allowed for contractors to be approved for bonds they should not qualify for. The sureties were not only writing bonds for contractors that do not qualify, they also wrote bonds that should not be written even for the best contractors. Maintenance bonds exceeding 5 years were much more common; these days anything over 3 years is pretty much unheard of. To put it simply, the sureties grew too hungry for business and wrote what they should not have and got burnt because of it.

The bonding companies set up the dominos and the softening economy started the chain reaction of them falling. What was the outcome for the bonding companies? In the past, the surety bond industry saw losses around 25%. In 2001, the industry saw a staggering 82% loss for the year. In 2002, the industry produced $3.7 billion in premium, however the industry as a whole showed a 70% loss. The 2002 Insurance Expense Exhibit reported the industry losing more than $2.5 billion from 2000-2002. The losses resulted in many bonding companies getting downgraded to junk status by AM Best. Others simply had to close their doors permanently. The rest of the sureties took note and quickly changed their ways. Underwriters have returned to more traditional underwriting guidelines and go through accounts with a fine tooth comb. The entire industry has become much more cautious about how to use capital. Contractors have since seen their bond lines reduced for single contracts and their aggregate capacity.

If you are a contractor and are discouraged with your current bonding limitations, keep in mind you are not the only one. Many contractors compare what they have today to what they had a couple years back and go looking for a new agency only to find similar terms elsewhere. Always keep in mind that every cloud has a silver lining. Bond lines have been reduced, however the value of a bond has improved due to the conservative underwriting practices in place. Contractors can no longer obtain the bonding required to participate on contracts they are not financially qualified for (obviously this is only a plus for contractors that are financially healthy).

It is more important than ever for contractors to have an agent that truly understands suretyship. A surety bond agent should be able to give you sound advice to improve your financial situation and help your business grow. A good agent does not just write bonds, they consult contractors to make changes so the bonding companies have less of a risk, thus increasing bond capacity and lowering premium rates. A contractor must be comfortable that their agent is knowledgeable enough to help them make the right decisions. It is absolutely necessary in today’s surety bond market.