Three recent lawsuits brought this home to me. The three lawsuits involved
the surety either suing the agent or in one case the contractor's CPA firm.
The common thread in all three lawsuits was that the surety felt there had been
a lack of disclosure and that the agent and the CPA firm had breached their
fiduciary duty to the Surety. The common thread in the defense of each suit
was that the Surety had ample opportunity to ask questions and underwrite the
account and/or the specific bond requests.
My observation was that the sureties perhaps were too quick to blame someone
else for the bond losses they sustained, and the agent was perhaps too casual
in fulfilling its role and responsibility. In my view, these lawsuits showed
that both the surety and the agent did not clearly understand their role and
responsibilities.
The Surety Role
The surety, as the guarantor of the principal's obligation, is the ultimate
"risk taker" in the bonding relationship. The surety underwriter is the "gatekeeper"
and makes the decision on what accounts are acceptable, what bond requests are
approved, and what the terms and conditions will be for writing the bonds. While
it is true that sureties may extend "underwriting" and signing authority to
their agent or broker, the fact of the matter is that any "authority" the agent
may have flowed from the surety.
The point is that the surety makes the rules and retains all discretionary
authority. The agent's authority is defined and limited as outlined in the Grant
of Underwriting Authority. It will define the parameters within which the agent
may exercise that authority.
To illustrate, the surety may delegate to the agent $1 million of "underwriting"
authority for a specific account conditioned on the following: the work is of
the type, duration, and within the geographic territory customarily performed
by the principal. The principal's total uncompleted work program does not exceed
$3 million including any outstanding bids or pending awards. The authority would
then be further narrowed by including specific exceptions, such as: the principal's
financial condition has not deteriorated from the last financial statement provided
to the surety, the work does not involve any hazardous waste, the contract includes
no efficiency guarantees, the owner has the funds to pay for the work, etc.
The surety cannot abrogate its underwriting responsibility. If one looks
at the titles given to their people it is typically something like bond underwriter,
bond analyst, field or home office underwriter, underwriting officer, or director.
The surety's employee is never identified as the "agent," the "broker," and/or
the "producer." The surety employee is never paid a commission or percentage
of the premium as is the agent or broker. The surety personnel are "employees"
of the surety company, not "independent contractors" operating under an agency
or broker agreement.
These points may seem obvious but they are important as they underscore the
critical point that the surety is the "underwriter" in the bonding relationship.
My observation in these lawsuits was that the surety was somehow trying to shift
the responsibility for "underwriting" to the agent or broker.
Underwriting
The surety company, which is typically licensed by the Department of Insurance
in the states where they operate, holds itself out to the public as being in
the business of underwriting and issuing bonds. The surety's failure to fully
underwrite the account or a particular bond request is not a defense if the
bond was authorized. The fact that the surety may have been duped, lied to,
or even stiffed on the bond premium is not a defense to honoring a legitimately
issued bond. If this sounds harsh, it is because the obligee or the party that
is the beneficiary of the bond typically has no involvement in the procurment
of the bond. The obligee would not know if the principal or the agent had lied
to the surety to obtain the bond or if the premium was paid.
Once the bond is issued, the obligee has a common law right to rely on the
bond. If after a bond was given to an obligee, a surety could deny responsibility
by asserting that they were duped in the application for the bond by the principal
or they were not paid, then corporate suretyship would have little commercial
value. Obviously the surety would have a defense in the case of counterfeit
bonds provided they maintained good control over their power of attorney equipment
and bond numbers.
The surety underwriter is presumed to be a professional in their field. Typically
the underwriter will want to learn the background and experience of 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. The degree of underwriting depends somewhat on the account and the underwriting
posture/guidelines of a particular surety.
Bottom line—the surety is in the driver's seat and decides when they have
sufficient information about the applicant and/or the bond request to make an
underwriting decision. The surety underwriter is free to ask any question or
delve into any area he/she thinks is relevant to underwriting the account or
bond request. The underwriters will most often direct questions or requests
for information to the agent or broker but often also want to meet with the
applicant.
If an underwriter fails to fully read or understand the information provided
or fails to ask pertinent questions then that omission should not be blamed
on the agent, the principal, or anyone else. If the applicant purposely "cooked"
the books and/or if the agent purposely provided information known to be false,
then, of course, the underwriter will not be able to make an informed judgment.
As pointed out earlier in this article, even fraud in the application process
will not void the surety's responsibility once they have approved the bond.
My observation in these lawsuits was that the surety failed to fully examine
the underwriting information that had been provided, failed to ask pertinent
follow-up questions, and/or chose to ignore red flags that surrounded the accounts.
My observation was that at times, the surety actually ignored its own underwriting
guides or rules. Sometimes, in the real world with its competitive pressures,
a surety will deviate from its established guidelines to attract or retain business.
Sureties, of course, can choose to amend, bend, or ignore their own underwriting
rules or guidelines but they do so at their own peril and should not then seek
to place blame elsewhere.
Equally important to the underwriting process is that sureties obtain current
financial and operational information on their account. Most businesses are
not static, and the field of construction is, in fact, very fluid. A contractor's
financials can quickly change for the worse for a variety of reasons, and sureties
need to maintain their vigilance.
My observation was that the sureties involved in these cases did not always
stay on top of their accounts especially considering the sizable surety exposure
and bonding line they had approved. The surety underwriter is the gatekeeper,
and the burden falls on the underwriter to maintain discipline over the underwriting
process and to enforce the information flow. The underwriter has a very powerful
tool at his or her disposal: suspend writing bonds until the needed information
is provided. Again, this is an option the underwriter prefers to avoid, and
with good communication, it can be avoided in most cases.
Agent/Broker Role
The agent or broker is the "sales force" for the bonding or insurance company.
The agent is an "independent contractor" who produces new clients and services
existing clients. To do that effectively, the agent typically represents a number
of insurance/bonding companies who in some degree differ in such areas as the
client base they want to target, production appetite, underwriting posture,
premium rates, and/or compensation structure. The agent will most often try
to target one or more surety markets that he/she believes may be a good match
for their client.
To initiate the process, the agent will prepare or make a submission to the
underwriter. Many times this submission will be exploratory in nature in order
to find a carrier that shows an interest in the account. The more familiar an
agent or broker is with a particular market's appetite and underwriting posture,
the more focused the search and the submission. Once an insurer expresses an
interest in the account, the underwriter will normally outline what additional
information may be required to underwrite the account. If the information received
meets with the surety's approval, the agent will normally arrange for a face-to-face
meeting with the company underwriter and the applicant/client. The surety underwriter
is then free to ask the client any question that will add to his/her underwriting
knowledge and that will allow for an informed decision.
A professional agent will normally perform some level of analysis of the
account to properly represent the client, to determine what market(s) to target,
and to determine if the basic underwriting package required by the targeted
market(s) is available. While the agent may perform an analysis and screening
of the account, this does not make the agent or broker the "underwriter."
The agent or broker is not the ultimate risk taker on the bond and does not
formulate the underwriting rules by which the account or bond will be approved
or declined. If one reads the customary company agency agreement there is no
provision requiring the agent to perform any underwriting function. The standard
agency agreement also confers no bond underwriting or signing authority to the
agent. The agency agreement typically only creates a defined fiduciary obligation
for the agent relative to the remittance of premiums collected on behalf of
the carrier. All of this is to underscore that the agent is not the party in
the bonding relationship charged with the responsibility to "underwrite" the
account or bond. Where the agent has been granted limited and defined "underwriting
authority," the agent is obligated to see that the bond request fits within
the parameters set by the surety for that account or type bond.
The agent/broker does have an obligation not to intentionally omit or distort
material underwriting information in his/her possession. That said there is
no obligation on the part of the agent/broker to independently investigate the
veracity of the information provided by the applicant/client or any outside
party, such as the CPA. This responsibility again rests with the surety underwriter
to determine if the information provided is truthful. Often, the information
given to the surety underwriter is in summary or capsulated form, and the underwriter
will need to request further detail if they believe it may be relevant or important.
To illustrate this point, the CPA-prepared financial report for the applicant
may state in a footnote that the contractor initiated a claim with the Department
of Transportation for cost overruns on a project that was completed in 2005.
Such a footnote provides little tangible detail for the reader. If the underwriter
thinks this may be an important issue, then the underwriter needs to make the
request for specific additional supporting information or documentation. Likewise,
the agent in the submission may inform the surety that a number of claims or
liens were filed against one or more projects (past or present). Such disclosure
should prompt the underwriter to ask for pertinent additional information to
determine if those claims or liens have any present bearing on the account.
The agent/broker's role in the bonding relationship is primarily one of facilitator,
communicator, and counselor. The agent/broker has a responsibility to provide
the surety with the information they require to provide ongoing suretyship,
make them aware of any significant events of which he/she has knowledge, and
facilitate face-to-face meetings between the surety and principal as appropriate.
All of this is somewhat subjective in the eyes of both the agent and the company
underwriter. Most agents value their reputation with their clients and with
their company underwriters and will try to reasonably balance the needs of each
party. Forthright and timely communications between agent, underwriter, and
client will best serve the long term interests of all the parties.
Conclusion
My observation as an expert witness in the three lawsuits initiated by the
surety is that there seems to have developed some blurring of who in the bonding
relationship is responsible for underwriting, and who provides the sales and
service function to the client. The surety underwriter should possess a healthy
sense of skepticism and curiosity. As I learned all too well as a company underwriter
many years ago, "all that glitters is not gold."
The agent is in the business of helping his client or potential client find
the best possible market for their insurance and bonds. To that end, the agent
has an obligation to represent an account in the most favorable light possible
while at the same time not purposely misleading or omitting know facts from
the underwriter. The better the communications and flow of vital information
are between the parties, the better the underwriter can respond to the clients
needs and the less the possibility for ugly lawsuits in the future.