Understanding Contract Surety Bonds

In the realm of construction and development, contract surety bonds are indispensable tools that ensure the successful completion of projects.  

Contract surety bonds can be categorized into four primary types:

1. The Bid Bond – ensures that a bidder will enter into the contract and provide the necessary performance and payment bonds if awarded the contract.
2. The Performance Bond – guarantees the project’s completion according to the contract’s terms and conditions.
3. The Labor & Material Payment Bond – ensures that subcontractors and suppliers are compensated for their work and materials.
4. The Subdivision Bond – guarantees that developers will complete improvements in line with local government specifications.

Underwriting contract bonds is a meticulous process based on three critical factors:

1. Character – involves evaluating the business and personal background of the company principals, including any prior bankruptcies. 
2. Capacity – assesses the organization and key personnel, as well as the type, size, and location of previously completed projects. 
3. Capital – reviews fiscal year-end financial statements prepared by a third-party financial professional.

For contracts generally valued at $1 million or less, the underwriting process is simplified. This transactional bond underwriting relies on the personal credit history of the construction company principals, without requiring company financials. The bond rate typically ranges from 2.5% to 3%, and personal guarantees are required from owners and their spouses. This process can apply to a single contract or multiple contracts totaling $1 million or less.

For larger contracts, a more detailed underwriting process is followed. The underwriting process involves an evaluation of character, capacity, and capital. It includes a detailed assessment of the business and personal background of company principals, an in-depth evaluation of the organization and key personnel, and a comprehensive review of financial statements, including the quality of presentation and the basis of revenue recognition.

Specific financial analysis factors under capital underwriting considerations include the company’s history of profitability, working capital, corporate equity, total debt to equity, surety credit limits, and the availability of bank credit.

The surety industry plays a vital role in the construction sector, emphasizing its importance in risk management and insurance. A thorough understanding of contract surety bonds, their types, and the detailed underwriting processes involved is essential for anyone involved in construction and development projects, ensuring they are well-equipped to navigate the complexities of surety bonds.

Ron Metcho is a surety specialist at OneGroup with over 40 years of experience, and serves as a resource to organizations for all surety-specific questions and concerns. OneGroup has a team of specialists, dedicated to risk management and construction industry specific insurance issues. Our team takes great pride in being at the forefront of industry trends and assisting others where we can. You can find out more about us here.

For more information please contact Brett Findlay, Senior Vice President Business Risk Specialist at (315) 280-6376 or [email protected] 

This content is for informational purposes only and not for the purpose of providing professional, financial, medical or legal advice. You should contact your licensed professional to obtain advice with respect to any particular issue or problem. Please refer to your policy contract for any specific information or questions on applicability of coverage.

Please note coverage can not be bound or a claim reported without written acknowledgment from a OneGroup Representative.

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