Weathering the Storm
September 15, 2020
By Curtis Bowden, Commercial Surety Underwriter
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Financial Guarantee Bonds are generally known as one of the riskier bond classes in surety. With economic uncertainty growing, the risks have become more acute. Financial guarantee bonds ensure that a bonded individual or entity will pay the monetary burden to which they are legally bound. Should the individual or entity fail to pay per the terms of their obligation, the surety becomes liable for those payments.
While class four underwriting is required on these bonds, Merchants Bonding Company does not have strict formulas or ratios to meet like many competitors do. Rather, we make our decisions based on the submission as a whole.
Current Economic Environment
Some common examples of financial guarantee obligations in surety include: tax bonds, lease agreement bonds, utility fee bonds, wage payment bonds and, in California and New York, car wash bonds. Each of these bonds carry a heightened risk in our rapidly changing economic environment. Understanding the economic impact we as a country are experiencing as well as the risk involved with these bonds may be the path to mitigating risk, and ultimately, loss experience.
Throughout the pandemic, we have seen trends emerging that mirror historic precursors to insurance losses. Peaking in April at 14.7%, unemployment rates have continued to remain at historic highs through May (13.3%) and June (11.1%) (BLS.gov) With the increased unemployment rates comes a decrease in projected Gross Domestic Product (GDP), a measure of all goods and services a country produces within a year.
The surety industry may have a buffer before the impact is felt, but claims may be more likely in this economic climate. Luckily, there are steps to take to help nip losses in the bud.
What can I do as an agent on financial guarantee bonds that will reduce my chances of loss? This is a question we receive a lot at Merchants in times of economic uncertainty. Asking questions about the principal's company will give you a picture of their charter along with a sense of the applicant's capacity to weather the storm and fulfill their bonded obligations.
- What industry are they in?
- Are they set up well geogrpahically?
- If your agency runs credit, how does that look?
- Are you familiar with the individual or entity?
- If so, what has your loss experience been like?
- How responsive are they?
How are we mitigating losses on the company side? Merchants uses consistent underwriting, due diligence efforts, and the ability to "underwrite outside of the box." At Merchants we pride ourselves on net worth underwriting; however, these bonds do require a closer review of work capital and cash flow due to the short term payment obligations in the guarantee.
- Is there evidence of financial stability?
- Will cash flow remain the same?
- Historical data is great, but a continuity play is also a key: how will they jump the financial hurdles they are experiencing?
Some more tangible items Merchants underwriters are considering with your requests: financial guarantee bonds are generally hazardous obligations. Oftentimes the bond form will contain adverse language such as forfeiture requirements. This requires us to conduct a class four underwriting, including a signed application, review of credit, and review of business and personal financial statements. In some cases, collateral will also be required. This makes information from our agents all the more pertinent as we draw a lot of background and character from these insights in order to form our decision. Other underwriting factors include: checking the Secretary of State page to see if the principal is in good standing: understanding the risks of the bond obligations and associated statutes, where applicable; and background information from our agents.
Times may be tough right now, but by asking the right questions, understanding the risk of the specfic bond, and conferring with your underwriting resources, we all have the ability to reduce loss experiences. Please contact your local underwriter for a more in-depth discussion if you have any questions, comments or concerns.