This article explores the roles and responsibilities of the principal or client, the surety, and the agent/broker in procuring corporate surety bonds.
The principal is the party who has a legal and/or contractual obligation to perform.
The obligee is the party who is requiring the bond and who is the direct beneficiary of the bond.
The corporate surety is the party who, for a premium, is guaranteeing the performance of the principal in favor of the obligee.
The agent/broker operates in a dual role: he/she is the party retained by the principal to market and service the surety account and, as a licensed insurance/bond agent, is also an appointed representative of one or more insurance/bonding companies.
Unbalanced Roles
Each of the parties in the process has a role with defined responsibilities to one another. In effect, there can be three out-of-balance scenarios.
The principal who believes it does not need an agent/broker and feels it benefits most by dealing directly with the surety.
The surety who wants to market directly to the principal and views the agent more as an obstacle than a resource and facilitator.
The agent/broker who places himself as the focal point and minimizes the role of the surety or even the principal.
My experience has been that where any party overplays its role, in time the process breaks down, and each of the parties loses something. Basically, when any party oversteps its role and responsibility, it undermines the essential rule of honesty and fair dealing that underlies the entire process.
The Surety Role
The surety as the guarantor of the principal's obligation is the ultimate "risk taker" in the process. As such, the surety has a legitimate need to secure full underwriting information on the principal and the obligations it is bonding.
This involves learning the background and experience about the principal and its owners/officers and key personnel. It entails close examination of the principal's financial statements to assess both the current financial condition and the operations over time. It involves learning about any affiliated operations or outside investments that could affect the principal's operations or financial status.
The surety will want to learn about plans for the continuity of the business in the event the owner and/or other key personnel were to leave or die. Since no business is static, the surety has a need to receive periodic updates on the principal's financial and operational status. The surety is also entitled to be promptly informed when there is or may be a material change in the principal's financial or operational condition. The need for a timely flow of forthright information about the principal and its operations is essential.
Surety Communication
As the ultimate risk taker, the surety has the right to establish its underwriting standards and requirements. Within the context of its rate filings with the State insurance departments, the surety is free to select the premium it thinks is appropriate for the guarantees it is providing. The surety has an obligation to disclose its underwriting requirements/standards and premium charges so its agents/brokers and clients know what to expect.
Just as the principal's operations are not static, neither are the surety's operations. Therefore, it too has an obligation to communicate with its agents and clients when there are changes in its financial or operational situation that will affect future underwriting posture or rates.
Recently, one of the major surety writers informed its agents/brokers that it was going to limit its contract surety writings to clients who had a net worth in excess of $50 million. It provided 90-days' notice. For a client such as a highway contractor who is heavily dependent on surety credit, such news could have a material adverse impact on business. In my opinion, this was inadequate notice considering the limited market for contractors of this size and the potential effort to remarket accounts of that size and complexity.
Surety Interference
A few surety companies have a strong desire to supplant the agent/broker and deal directly with the principal/client. While the surety's need for a timely and forthright flow of information from the principal is without question, especially on very large accounts where there may be hundreds of millions of dollars in bonded exposure, the direct access to the client without the agent/broker's involvement is not in the principal's best interest.
The surety obviously takes comfort that it receives information directly from the principal and is able to strengthen its relationship with the client. This does not necessarily work in the client's best long-term interests as it is receiving only the view/opinion of that one surety. It is unlikely the surety would give equal time to competitors and most likely would sell itself as doing the very best job on the best possible terms for the client.
If the account were appropriately matched with the incumbent surety, then it may well be the best surety for the principal at that point in time. However, circumstances change, and what may have been a very good match at one time may not be the best match at some future time. Therefore, the surety should not interrupt the relationship between the agent/broker and the client by going direct but instead should seek to arrange meetings with the client through the agent/broker with a fully disclosed agenda.
Client Role
The principal or client is central to the entire process because without the client, there would be no need for the surety or the agent/broker. The principal is the primary risk taker and is the party who would have to exhaust its own means and resources before the surety was called on to fulfill the guarantee. Therefore, the surety and the agent/broker should first appreciate the principal's stake and always give a fair hearing to any legitimate request or concern.
Having said this, it is also critically important that the principal understand and appreciate the role of the surety as the ultimate guarantor of the bonded obligation. If the principal understands the surety's role and exposure, and appreciates that this is a partnership, then the principal will realize the need for timely and forthright disclosure and understand why the surety has to establish underwriting parameters for their account.
Given the surety's guarantor role, the principal is obligated and benefits from seeking the surety's assistance well in advance of any default. Too often, the principal—out of pride or ignorance—will not seek the surety's assistance or share with the surety the circumstance that could require the surety's involvement. This is an area where the principal's communication with the bonding agent can facilitate timely and appropriate communication to the surety.
Communication Interference
The principal may feel flattered if the surety underwriter, especially someone from the surety's home office, contacts them directly. Some principals think they should initiate or encourage direct contact with their surety underwriters. Obviously, it is mutually beneficial—especially for larger clients—if the principal and the key decision makers at the surety know each other and have some rapport. However, the principal would do well not to encourage direct contact with the surety underwriters for some of the reasons cited earlier.
Such direct communication between home office surety underwriters and the client without the agent/broker's knowledge or involvement can create communication gaps. The local surety field office may not be aware of the content of such communication, and the agent/broker would likewise be in the dark.
My experience has been that some of the biggest surety losses involved accounts where the relationship was mostly between the surety's home office and the principal. To suggest that the direct communication caused the surety loss would be an exaggeration, but it probably would be fair to say that the direct relationship may have caused the surety to lose some of its underwriting objectivity and allowed the principal to go further than was prudent. While we may all want to hear "Yes" to our requests, it is not always in our best interest. If the surety says "Yes" when it should have said "No," both the principal and the surety lose—in that order.
Agent/Broker Role
The agent/broker's role is primarily one of facilitator, communicator, and counselor. The agent has the responsibility to develop the initial underwriting information and to professionally present and sell the account to a surety that provides a good match with the client. The match would require the agent/broker to know the surety's appetite for a given client and to some extent a matching of personalities at the surety and the principal.
Thereafter, the agent/broker has the responsibility to provide the surety with the information required to provide ongoing suretyship, make it aware of any significant events and facilitate face-to-face meetings between the surety and principal as appropriate. The agent has the ability to filter comments made by both the principal and the surety and to act as a sounding board for both. The agent/broker should never deny the surety access to the client if the request is reasonable and timely.
The agent/broker should not place itself as the focal point in the process to the detriment of the surety or the client. Some agents/brokers have gone so far that when the client is asked who their surety is, they will name the agent/broker. As pointed out in the introduction, the agent/broker has a dual role: it represents the interests of the client and the surety. In my view, the agent/broker has a fiduciary role to both parties, and its effectiveness over time relies on its credibility and reputation with both parties.
Conclusion
Given the nature of the bonding relationship, it must be collaborative between all the parties. No one benefits if any party is carved out or minimized from the process. Each party has a role to play, and as long as no one oversteps their own role, the relationship will serve and benefit all the participants.
Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.
This article explores the roles and responsibilities of the principal or client, the surety, and the agent/broker in procuring corporate surety bonds.
Unbalanced Roles
Each of the parties in the process has a role with defined responsibilities to one another. In effect, there can be three out-of-balance scenarios.
My experience has been that where any party overplays its role, in time the process breaks down, and each of the parties loses something. Basically, when any party oversteps its role and responsibility, it undermines the essential rule of honesty and fair dealing that underlies the entire process.
The Surety Role
The surety as the guarantor of the principal's obligation is the ultimate "risk taker" in the process. As such, the surety has a legitimate need to secure full underwriting information on the principal and the obligations it is bonding.
This involves learning the background and experience about the principal and its owners/officers and key personnel. It entails close examination of the principal's financial statements to assess both the current financial condition and the operations over time. It involves learning about any affiliated operations or outside investments that could affect the principal's operations or financial status.
The surety will want to learn about plans for the continuity of the business in the event the owner and/or other key personnel were to leave or die. Since no business is static, the surety has a need to receive periodic updates on the principal's financial and operational status. The surety is also entitled to be promptly informed when there is or may be a material change in the principal's financial or operational condition. The need for a timely flow of forthright information about the principal and its operations is essential.
Surety Communication
As the ultimate risk taker, the surety has the right to establish its underwriting standards and requirements. Within the context of its rate filings with the State insurance departments, the surety is free to select the premium it thinks is appropriate for the guarantees it is providing. The surety has an obligation to disclose its underwriting requirements/standards and premium charges so its agents/brokers and clients know what to expect.
Just as the principal's operations are not static, neither are the surety's operations. Therefore, it too has an obligation to communicate with its agents and clients when there are changes in its financial or operational situation that will affect future underwriting posture or rates.
Recently, one of the major surety writers informed its agents/brokers that it was going to limit its contract surety writings to clients who had a net worth in excess of $50 million. It provided 90-days' notice. For a client such as a highway contractor who is heavily dependent on surety credit, such news could have a material adverse impact on business. In my opinion, this was inadequate notice considering the limited market for contractors of this size and the potential effort to remarket accounts of that size and complexity.
Surety Interference
A few surety companies have a strong desire to supplant the agent/broker and deal directly with the principal/client. While the surety's need for a timely and forthright flow of information from the principal is without question, especially on very large accounts where there may be hundreds of millions of dollars in bonded exposure, the direct access to the client without the agent/broker's involvement is not in the principal's best interest.
The surety obviously takes comfort that it receives information directly from the principal and is able to strengthen its relationship with the client. This does not necessarily work in the client's best long-term interests as it is receiving only the view/opinion of that one surety. It is unlikely the surety would give equal time to competitors and most likely would sell itself as doing the very best job on the best possible terms for the client.
If the account were appropriately matched with the incumbent surety, then it may well be the best surety for the principal at that point in time. However, circumstances change, and what may have been a very good match at one time may not be the best match at some future time. Therefore, the surety should not interrupt the relationship between the agent/broker and the client by going direct but instead should seek to arrange meetings with the client through the agent/broker with a fully disclosed agenda.
Client Role
The principal or client is central to the entire process because without the client, there would be no need for the surety or the agent/broker. The principal is the primary risk taker and is the party who would have to exhaust its own means and resources before the surety was called on to fulfill the guarantee. Therefore, the surety and the agent/broker should first appreciate the principal's stake and always give a fair hearing to any legitimate request or concern.
Having said this, it is also critically important that the principal understand and appreciate the role of the surety as the ultimate guarantor of the bonded obligation. If the principal understands the surety's role and exposure, and appreciates that this is a partnership, then the principal will realize the need for timely and forthright disclosure and understand why the surety has to establish underwriting parameters for their account.
Given the surety's guarantor role, the principal is obligated and benefits from seeking the surety's assistance well in advance of any default. Too often, the principal—out of pride or ignorance—will not seek the surety's assistance or share with the surety the circumstance that could require the surety's involvement. This is an area where the principal's communication with the bonding agent can facilitate timely and appropriate communication to the surety.
Communication Interference
The principal may feel flattered if the surety underwriter, especially someone from the surety's home office, contacts them directly. Some principals think they should initiate or encourage direct contact with their surety underwriters. Obviously, it is mutually beneficial—especially for larger clients—if the principal and the key decision makers at the surety know each other and have some rapport. However, the principal would do well not to encourage direct contact with the surety underwriters for some of the reasons cited earlier.
Such direct communication between home office surety underwriters and the client without the agent/broker's knowledge or involvement can create communication gaps. The local surety field office may not be aware of the content of such communication, and the agent/broker would likewise be in the dark.
My experience has been that some of the biggest surety losses involved accounts where the relationship was mostly between the surety's home office and the principal. To suggest that the direct communication caused the surety loss would be an exaggeration, but it probably would be fair to say that the direct relationship may have caused the surety to lose some of its underwriting objectivity and allowed the principal to go further than was prudent. While we may all want to hear "Yes" to our requests, it is not always in our best interest. If the surety says "Yes" when it should have said "No," both the principal and the surety lose—in that order.
Agent/Broker Role
The agent/broker's role is primarily one of facilitator, communicator, and counselor. The agent has the responsibility to develop the initial underwriting information and to professionally present and sell the account to a surety that provides a good match with the client. The match would require the agent/broker to know the surety's appetite for a given client and to some extent a matching of personalities at the surety and the principal.
Thereafter, the agent/broker has the responsibility to provide the surety with the information required to provide ongoing suretyship, make it aware of any significant events and facilitate face-to-face meetings between the surety and principal as appropriate. The agent has the ability to filter comments made by both the principal and the surety and to act as a sounding board for both. The agent/broker should never deny the surety access to the client if the request is reasonable and timely.
The agent/broker should not place itself as the focal point in the process to the detriment of the surety or the client. Some agents/brokers have gone so far that when the client is asked who their surety is, they will name the agent/broker. As pointed out in the introduction, the agent/broker has a dual role: it represents the interests of the client and the surety. In my view, the agent/broker has a fiduciary role to both parties, and its effectiveness over time relies on its credibility and reputation with both parties.
Conclusion
Given the nature of the bonding relationship, it must be collaborative between all the parties. No one benefits if any party is carved out or minimized from the process. Each party has a role to play, and as long as no one oversteps their own role, the relationship will serve and benefit all the participants.
Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.