What Surety Underwriters Review on Your Bond Applications and Construction Contracts

This post is part of a series sponsored by Old Republic Surety.

Why do surety underwriters ask so many questions of construction contractors? We have answers for you to share with your construction insurance clients. And if they aren’t yet your surety clients, too, it’s time to begin building your book of surety business.

Surety underwriters ask a lot of questions. They do so because if your organization cannot carry out the terms of your construction contract, your surety insurer may be standing in your shoes. This two-part article will familiarize you with bond terms, contract issues that arise in typical construction projects, and explain why surety underwriters ask so many questions in the surety bond application process.

Surety construction bonds are generally performance bonds. According to the International Risk Management Institute, a performance bond “guarantees that the contractor will perform the work in accordance with the construction contract and related documents, thus protecting the owner from financial loss up to the bond limit (called the penal sum) in the event the contractor fails to fulfill its contractual obligations.”

If a contractor defaults on a project or cannot complete the project ― for reasons such as bankruptcy or labor challenges, for example ― the surety must perform in the contractor’s place. Surety underwriters want to write bonds on projects where they will never be asked to perform. Therefore, they’ll review your bond application and the accompanying contract before agreeing to write your bond.

Let’s review some of the participants and questions you’ll see on your surety underwriting application.

Performance bond parties

Obligee. Think of the “o” in obligee as the “owner” of the project. It’s the entity, often a governmental body, that requires the bond. It could be a state, local government, or even a federal agency.

Principal. That is you. You are the company that requests the bond, so you can satisfy the terms of the obligee’s contractual requirements. Perhaps even before you bid on a project, the owner and your underwriter will want to know more about your character, capacity and capital, the “three Cs” of bonding.

Surety. That’s us or any surety insurance company where you apply for coverage.

General application questions

Next, underwriters will want to understand the project you’re about to undertake, so they’ll ask for a thorough project description. Simply attaching the contract is only the start. The underwriter will want to know the following, at a minimum:

Have you, the principal, ever worked with this owner or general contractor (if you’re a subcontractor)? What was that project? Was the project outcome successful?
Can we confirm financing on any private project? This question aligns with Section 2.21 on the American Institute of Architects (AIA) Document A201.
What is the proposed project scope? Have you worked on a similar project before, and what was the outcome of that project?
Geographically, are there any constraints that could impact your ability to complete the project? For example, if you’re working in a state with proprietary workers’ compensation laws, can you obtain the necessary insurance coverage to comply with that state’s statutory workers’ compensation requirements?
What is the warranty period? Is this a normal warranty length, or is it an unusually long warranty period?
Are any manufacturers involved in the warranties? Do the contract terms allow you to tender claims to manufacturers?

Other items your surety will review

What is the contract date? Are all dates feasible?
What is the bid bond amount if this is a bid bond?
What are the start and completion project dates? Are they feasible?
What does the contract include as warranty terms? Are they sensible?
What are the payment terms? Will those terms realistically allow the general contractor to manage fund flow throughout the life of the project?
Retainage? This is a holdback of final payment for a specific period to ensure the contractor and all the subs have correctly completed the project.
What damages apply? We’ll talk more about these later in the article.
Contractor’s cost to complete backlog is another component reviewed by the underwriter. The underwriter may want to see that the backlog gross profit is at least 50% of projected general and administrative costs for the following year. Falling below this threshold can mean you may be unable to meet your financial obligations in the next year. This can impact current project completion.

In part No. 2, we’ll review some important sections of the bond application and your construction contract and review some other criteria for surety bonding.

Topics
Underwriting
Construction
Surety

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