Bonds

We're in the Bond Business

A surety bond is a three party guarantee.  What the bond guarantees varies depending on the language of the bond.  The three parties are the principal (the person or entity required to obtain the bond), the obligee (whoever is requiring the bond of the principal), and the surety (the company backing the bond).  A bond should be thought of as credit, not an insurance product for the principal.  In the event of a valid claim, the surety will pay the obligee a specified amount and look to the principal for compensation for the claim.  The principal pays an annual premium for the financial strength of the surety to write the guarantee rather than obtaining a letter of credit and tying up capital.  

Dakin Insurance represents many A+ rated and Treasury-listed surety companies. We can help you get started with a surety program or improve your existing surety program. 

There are literally thousands of different surety bond requirements for various occupations; all of them are considered to be a certain bond type for which there is a surety bond category that it falls under.  Each surety bond type falls under 1 of 2 bond categories:  commercial or contract bonds.  A bond type is defined by what it guarantees. 

Commercial bonds are also known as non-contract bonds because they are not guaranteeing a specific contract.   A very common commercial bond is a license & permit bond.  These bonds are typically required by state or local regulations in order to obtain a license or permit to legally operate in a particular business.  License & permit bonds may include contractor license bonds or mortgage broker bonds to name just a few. 

Another common commercial bond category is judicial or court bonds.  Court bonds guarantee an appointed fiduciary will comply per a court order and can include appeal, guardianship and probate bonds.      

Contract bonds guarantee a specific contract and are best known as bid bonds, performance bonds, payment bonds and maintenance bonds. 

If you think you want to take on bonded work, your first step is to discuss your plans with your Dakin representative. We will guide you through the bonding process and assist you in establishing a business relationship with a surety company.  Most contractors find that it is necessary to spend a lot of time and effort establishing their first relationship with a surety company. Since the surety is guaranteeing your company's performance, it needs to gather and carefully analyze much information about you and your firm before it will agree to provide bonds. 

Prequalification

The surety underwriting process is focused on prequalifying the contracts. It takes time -- sometimes a lot of time -- to develop and present data, answer questions the surety may have and verify information.

Before issuing a bond, the surety must be fully satisfied that the contractor is of good character, has the experience that matches the requirements of the projects to be undertaken and has, or can obtain, the equipment necessary to perform the work.

The surety also wants to make sure the contractor has the financial strength to support the desired work program and has a history of paying subcontractors and suppliers promptly. It will want to see that the contractor is in good standing with a bank and has established a line of credit.

In short, the surety wants to be satisfied that the contractor runs a well-managed, profitable enterprise, keeps promises, deals fairly and performs obligations in a timely manner.

It is important to realize that each surety company has its own underwriting standards and requirements. But there are fundamentals that are common to underwriting surety bonds, and understanding these fundamentals is helpful to a contractor seeking surety bonds for the first time.

If you understand what's involved in getting bonds, you can weigh the time and expense of obtaining surety bonds against the benefits of being able to take on bonded projects. Your decision to seek surety bonds should be based on long-term considerations. To obtain bonds, even some changes in the way your firm does business may be necessary, and these changes could have certain costs.

Here's What You Need

Let's take a look at the kind of information you may need to provide to your surety agent in order to prepare your case for bonds:

• An organizational chart that shows your key employees and their responsibilities;
• A business plan outlining the type of work you do, how you obtain your jobs, the geographic area in which you operate and your growth and profit objectives;
• A plan outlining how the business will continue in the event of your death or disablement, or that of another key employee. (purchasing life insurance on key people, with your company named as beneficiary is a good idea to include in your plan)
• Subcontractor and supplier references including names, addresses and telephone numbers of persons to contact (the surety will probably also order an independent credit report on your firm);
• Evidence of a line of credit at your bank (sureties generally are looking for an unsecured line of credit that can be used when needed to meet short-term cash requirements; and additional secured line of credit obtained through the long-term financing of equipment or real estate may help to strengthen your case); and
• Letters of recommendation from owners, architects and engineers.

Financial Statements

Financial statements are vital to any business that grants credit, and sureties are no exception. Depending on how long your firm has been in business, the surety will want to see fiscal year-end statements for the last three to five years.

Your financial statements should include the following:

• The Accountant's Opinion Page which discloses whether the statements were prepared to audit, review or compilation standards.
• The Balance Sheet which shows the assets, liabilities and net worth of your business as of the date of the statement. This helps the surety company assess the working capital and overall financial condition of your company.
• An Income Statement which measures how well the business performed. The surety will assess each item, including gross profit on contracts, operating profit before and after tax provisions.
• A Statement of Cash Flow which discloses the cash flow movement from operating, investing and financing activities.
• Schedules of Contracts in Progress and Contracts Completed which show the financial performance of each contract and provide insight into the potential for future earnings from contracts in progress.
• A Schedule of General and Administrative Expenses which may reveal how well overhead expenses are controlled and managed.
• Any Explanatory Notes that the accountant may have included with the statements.

The surety may also require aging schedules of accounts receivable and payable as well as schedules for any other items on the statements that might need support.

Quality of Financial Statements

Financial statements can be prepared by accountants on three levels, referred to as audit, review and compilations. Sureties like audited fiscal year-end statements. They generally require audited statements in larger construction contractors and complex accounts.

A Review statement, which is far less comprehensive than an audit, consists principally of inquires of your company's employees and the application of certain analytical procedures to the financial data. Although far narrower in scope than a full audit, the review does provide some limited assurance about the financial statements. This level of financial statement presentation is most often accepted by surety companies.

A compilation, however, provides no assurance, or very limited assurance, as to the credibility of figures presented because the accountant is not required to follow normal audit procedures or acceptable accounting principles.

In general, neither statements prepared by your own staff nor compilation statements are acceptable to sureties because they are difficult to verify and lack the stamp of approval of an independent auditor.

Accounting Methods

Complete and accurate cost recording and accounting systems are extremely important to surety companies. Without these systems, the contractor may not be able to identify and correct problems before they become too severe.

Although there are a number of accounting methods available for contractors, in most instances the American Institute of Certified Public Accountants Audit Guide for Construction Contractors recommends a method called percentage of completion. This method is also preferred, and in some cases, required, by sureties. Generally, the percentage of completion method best represents a contractor's financial condition and most accurately measures results of work performed during the accounting period.

Depending on the time elapsed since the last fiscal year-end statement, the surety may ask for an interim financial statement to show how the current year is progressing. While the requirement for interim statements varies, a six-month statement is usually minimum.

You also will need to prepare a schedule of work in progress, probably quarterly. This schedule should list each job by name, indicating the total contract price, and include:

• Change orders
• Amount billed to date
• Cost incurred to date
• Revised estimate of the cost to complete
• Estimated gross profit
• Anticipated completion date

Submitting Your Case to the Surety