Expert Commentary

Surety Underwriting, Sales & Service—A Delicate Balance

My April 2002 article, "Roles and Responsibilities—A Delicate Balance," explored the roles and responsibilities of the principal or client, the surety, and the agent/broker in procuring corporate surety bonds. The focus was that each party has defined responsibilities and, if any party overplays its role, the relationship will become unbalanced to the potential detriment of all the parties. While that article remains valid, there needs to be a better understanding of where the responsibility for underwriting, sales, and service lies in the dynamic relationship between surety and agent.


May 2006

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.


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.

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