Understanding the basic principles of how insurance works are key to understanding how and why bonds work the way they do. Standard insurance premiums are typically evaluated by looking at large exposures of differing risk levels and finding which exposure is more characteristic of your business. The hope is that the premiums collected will surpass the funds administered to cover a claim and expenses. Underwriting of these policies is not based on an individual’s exposures, but more so in the risk type as a whole. This is where bonds and insurance underwriting can differ and a bonding agent can be incredibly helpful. Performance and payment bond underwriting adhere to much stricter and more detailed evaluations. Unlike insurance, a bond is not issued unless there is no expectation of a claim being made. You’ve heard the saying “it’s not a matter of if, but when.” That is the underlying theory for typical insurance coverage as stated above, but not in bonding. They only plan for the “if” and underwrite in order to prevent the “when”.
An experienced bonding agent that knows your industry inside and out, can be the difference between your company receiving approval for a bond request, especially if you are trying to push the envelope into a new space to grow your company. Why may you ask? As you look at the following evaluation criteria, think of your own company and consider whether these reports truly show the whole picture you’d like? Or are there details between the lines that could and should be expressed to an underwriter for them to understand the true picture of where your company is today, as well as where it will be tomorrow? A good bonding agent that knows your industry can better translate to the underwriters who you really are.
What follows are most of the details an underwriter is looking for and how they view this information is critical to the success in receiving a bond.
The Three C’s:
When it comes to bonding the three most important things are character, capacity, and capital!
- Character – This is the first priority for very good reason because most underwriters deem that you aren’t of good character, it is useless to look at the rest of the information. Your company’s management, operations, and personnel will be examined at this stage. They will analyze the caliber, experience, and history of your outfit in order to get a feel of your company culture and whether it aligns with the risk model.
- Capacity – Since a bond is unique to a specific project, underwriters will consider if your company has ever performed a project that is comparable in size, scope, and location to understand any risks for not completing the project.
- Capital – This is where your company’s financial reporting needs to be clean and accurate. At this stage, the underwriter will become involved in evaluating a company’s cash flow. They will be trying to understand if your organization has access to adequate working capital, how liquid the assets on the balance sheet are, what projects are currently in the works, and if there is consistency in profit margins with respect to completed projects. All of the different aspects that are common in financial reporting will be considered with a keen eye on the history and current expected use of company profits. In other words, are you building a company with longevity or are you using it as a personal penny bank to rob from?
As you can see, there is a totally different mentality when it comes to underwriting for standard insurance coverages and bonding. The most striking difference is that, typically, insurance coverages are paid into consistently because, in the event of a claim, there is no expectation of paying for the damages beyond your deductible. However, in bonding, it is fully expected that you will pay back all costs that the insurance carrier incurred in a claim should you not complete a project as contractually agreed to. As such, there is an incredible amount of scrutiny involved in evaluating a company wishing to be bonded for a project.
At Alliance, we have all the necessary experts on hand for full-service insurance, bonding, and business development support. Reach out today via the short form below to see how we can help you grow your business with bonding or insurance services.