Chapter 12 - § 12.2 • UNDERWRITING PRINCIPLES

• Jurisdiction: Colorado

§ 12.2 • UNDERWRITING PRINCIPLES

§ 12.2.1-Background

A surety will not issue any contract surety bond without first obtaining approval from its underwriting department. There may be additional levels in this process but, at a minimum, the process of issuing a bond normally involves an independent producing agent, regional and/or branch offices of the surety, and the home office of the surety. The producing agent works with the contractor to facilitate the issuance of bonds by sureties with whom the agent has a working relationship.

§ 12.2.2-Role of the Agent

The agent plays a crucial role in the underwriting process. He or she represents the principal and aids the contractor in preparing the necessary materials to present to the surety, with the goal that the underwriters will approve the issuance of the requested bond. Underwriters will only approve risks after the principal has submitted complete financial information. Usually, the producing agent will assemble and present to the surety all the required information. Once the bond is approved, the agent then executes it in accordance with his or her powers of attorney, and then forwards the bond to the principal for execution and delivery to the appropriate obligee. The agent has powers of attorney from various sureties authorizing the agent to issue bonds not exceeding a certain monetary amount. The local surety office usually has a certain level of authority, and if a certain project exceeds the authority, regional or home office approval may be required.

§ 12.2.3-Qualifying a Surety Bond Applicant

The aggregate of the premiums accepted by a liability insurance carrier is intended to compensate the carrier for the risks involved in writing the insurance policies. The insured is protected from loss by the insurance company. In suretyship, however, the principal is obligated to indemnify and hold harmless the surety if the surety ever is called upon to perform under the terms of either its performance or payment bond. Thus, even if the surety has to pay a loss on behalf of its principal, the surety should be reimbursed. The premium dollars paid to the surety only defray the costs of servicing the particular account. They are not calculated to defray the surety's losses. Accordingly, the potential risk to the surety company is very high in relation to the premium collected, so its underwriting process must efficiently determine whether the contractor is qualified to be bonded.

Underwriting considerations classically are grouped into the "Three Cs": character, capacity, and capital. "Character" means whether the individual applicant is worthy of the trust and financial risk that the surety is preparing to make on behalf of his or her company. "Capacity" means whether the applicant has the necessary skill and ability to perform the particular contract. "Capital" means whether the financial condition of the contractor justifies approval of the risk.

It is safe to say that the majority of an underwriting analysis focuses on questions of capital, which overlap with capacity. The issuance of a surety bond is essentially the same as extending a line of credit to the contractor; thus, the underwriter's analysis is similar to that of a banking financial officer when considering whether to extend a loan. General sources of credit information, such as Dun & Bradstreet, will be checked, and particular focus will be placed on the current and past financial statements of the company. If an audited financial...