SIC 6351 Surety Insurance

SIC 6351

This classification provides coverage of establishments primarily engaged in underwriting financial responsibility insurance.

NAICS CODE(S)

524126

Direct property and Casualty Insurance Carriers

524130

Reinsurance Carriers

INDUSTRY SNAPSHOT

Surety insurance, sold in the form of a surety bond, is a tool used to guarantee the performance by one party of an obligation to another. It differs from other types of insurance in several ways — including the number of parties involved, the way companies determine premium rates, and in the way that the burden of risk is apportioned. The most common type of surety insurance is construction bonding, which insures that contractors will be able to complete a construction contract and pay their suppliers and subcontractors. Other common types of surety insurance include bonding of employees (fidelity insurance), license and permit bonds, and court bonds.

According to the Surety Association of America, in the mid-2000s the surety industry generated approximately $3.5 billion in written premiums from surety bonds and another $930 million from fidelity bonds. After suffering losses during the first half of the 2000s, the surety industry began to stabilize by 2005 as underwriters became much more conservative and the economy rebounded from a recession.

ORGANIZATION AND STRUCTURE

Surety insurance can cover almost any contractual agreement, whether the contract is written or implied. Although it is often classified as a line of property/casualty insurance, surety is similar to other types of insurance only in that it is a form of risk management. Because it is different in other ways, surety bonding is usually offered through a separate division or department within an insurance company and is governed under a different set of laws from other insurance lines.

Surety insurance involves three parties: the principal, the obligee, and the surety (insurer). The principal is the party who agrees to perform an obligation. For example, a builder may contract to construct a building. The obligee expects the principal to fulfill a contract. In the example above, the obligee would be the party with which the builder agreed to construct the house. The surety, then, is the party which guarantees that either the principal will perform adequately or the obligee will be compensated for the principal's failure. For instance, if the principal finished building only part of the house and then quit, the surety might compensate the obligee for any losses incurred in getting another builder to finish the home. In the example, and in most cases, the surety is not necessarily responsible for fulfilling the broken contract, but only for the obligee's losses related to completion of the contract. For this reason, surety insurers do not necessarily cover risks associated with devastating losses, but only with varying degrees of default risk.

Another major difference from other types of insurance is that surety insurers look to the insured party for repayment of losses it incurs. In the example, the surety would be entitled to recover its losses from the principal, unless the principal was insolvent. For this reason, the risk associated with writing bonds has traditionally been very low. In fact, theoretically the surety anticipates no losses if the underwriter has used the necessary information about the principal required to determine whether or not to write the bond.

Surety insurance also differs from other insurance lines in the methods insurers use to determine premium rates. Because the risk to the surety is usually very low, premium rates for surety bonds are primarily service fees and are less influenced by the risk of loss. Fidelity insurance, which covers a company against losses caused by dishonest performance by its employees, is a major branch of the surety industry. By the mid-2000s, fidelity bonds constituted about 21 percent of all direct surety premiums written.

Company Structure

The surety market is divided into the standard market and the specialty market, each of which is served by different types of surety companies. The standard market represents the more traditional approach to surety bonding and is served primarily by large national agency companies. These companies tend only to underwrite clients which have a very sound financial history and represent little risk of insolvency or contract...