surety

Secrets of Bonding #52: “It’s Only a Maintenance Bond”

Steve GoliaLeave a comment

Maintenance Bonds can be troublesome, even though you could say the risk on them is relatively low.  So what’s the deal on these?

A Maintenance Bond normally follows a Performance and Payment (P&P) Bond that guarantees a construction contract.  In many cases the Performance Bond may also cover defective materials and workmanship for some time period after acceptance of the work.  This is referred to as a maintenance period, and the bond that may specifically cover it carries the same name.

There are times when the obligee (party protected by the bond) wants two years of maintenance.  If that is longer than the performance bond provides, a separate maintenance bond is needed.  There are also cases in which no maintenance period is automatically provided by the P&P bond, so there must be a maintenance bond if the protection is desired.

Why is the Risk Relatively Low on a Maintenance Bond?

Assume “Surety A” provided a P&P bond on a contract.  They already faced the risk of the project not being performed properly.  Having now passed that exposure, it is a small step to guarantee the materials and workmanship that went into the project.  For this reason, a Maintenance Bond following a P&P Bond issued by the same surety, may be much less expensive than the related P&P Bond, and would be freely given.

Sometimes They Play Hard to Get

There are a couple of factors that can make these bonds difficult to obtain.

  • No P&P Bond – If no P&P bond was issued, the underwriter will be justifiably suspicious if a maintenance bond is requested.  Perhaps the obligee regrets not having obtained a P&P bond or was unwilling to spend the money for one.  Now they want a cheap alternative that can still cover the entire project.  Maybe they observed a suspected defect in the work and belatedly want the protection of a surety bond.
  • Different sureties – If Surety A wrote the P&P bond, Surety B will obviously ask why “A” is not also handling the maintenance bond.  Maybe “A” knows there was a problem on the contract and they want to run away from it while they can.  The only good candidate for the maintenance bond is the surety that got paid on the P&P bond.
  • Low percentage maintenance obligation – often the maintenance bond is issued for less than 100% of the contract amount.  It may be for 20%.  You have a low dollar amount, but it still covers the entire project.  This is an unappealing situation for the surety.  But it is one they will tolerate If they already reaped the benefit of issuing the P&P bond.
  • Low rates – Maintenance bond rates are normally lower than P&P bond rates because… (*why do you think?) This makes them less rewarding for the surety.
  • Difficult guarantees – Some maintenance bonds cover efficient or successful operations instead of the normal “defective materials and workmanship.”  This is a far more difficult guarantee for the surety to provide.  Many are unwilling to provide such bonds.

Solutions

The only alternative to a bond may be a “cash” type alternative such as a Standby Irrevocable Letter of Credit issued by a commercial bank. The client may not think this is a great solution, and there will be no commission for the agent, but there are not many options at this point.

One consolation is that maintenance bonds are often written for a small percentage of the contract amount.  So cash in lieu of bonds may be feasible.

Maintenance bond rates may be lower than P&P bonds because the work is already in place and has been accepted by the architect and / or owner.

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site, Subdivision, Bid and Performance Bonds since 1979 – we’re good at it!  Call us with your next one.

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.

(Don’t miss our next exciting article.  Click the “Follow” button at the top right.)

Secrets of Bonding #49: Bid with a Check?

Steve GoliaLeave a comment

In Secret # 8 we talked about Bid Bonds.  Bid specifications often provide alternative forms of security to accompany the contractor’s proposal. Cash, a Certified Check, or a Bid Bond may be permitted.

Let’s take a look at the implications of each and when to use them, or not!

First, a quick primer on bids:

When contractors submit a proposal on bonded public work, bid security must be included.  The security assures the bidders sincerity.  They will accept the contract if offered or pay a penalty for walking away.

The contract then requires a Performance and Payment Bond or other form of acceptable security equal to the contract amount.

Typical options for Bid Security are Cash, Certified Check, or Bid Bond

Cash is King, but not when it comes to bid security.  Bid security amounts are usually thousands of dollars so this method is not realistic for many contractors.

Certified Checks are similar to cash.  This means the contractor must estimate the maximum proposal amount and arrange for a check payable to the obligee.  Initially, the bid percentage is known but not the bid dollar amount.  The specifications require security for amounts ranging from 5-20% of the proposal amount.  However the actual proposal amount is often not compiled until close to bid time when all the vendor prices have been received and negotiated.  To use a check, the contractor must estimate an amount sufficiently high so it is adequate to cover the bid figure when it is finally known.

Third choice, a Bid Bond issued by the surety.  The advantage of it is that the bidder’s money is not tied up (as compared to cash or a check). As a precaution on public work, obligees hold the bid security of the second and third bidders until the contract is awarded – which could take weeks.  Their bid security is tied up and the likelihood is that they will not win the contract.

Looking at the three options, a bid bond is the preferred choice. However, a bid bond is not always available when needed. When this happens, the bidder may still have the option to use cash or a check.

Normally there is no requirement to use a bid bond specifically.  The bidder also has the latitude to use one surety for the bid bond and a different one for the P&P bond (although many sureties dislike following someone else’s bid bond.)

Why would a bid bond not be available?

1.  The contractor does not have a surety.
2.  Short notice: Not enough time for the surety to make an underwriting decision.
3.  Short notice 2: The surety has approved the bid bond but there is not enough time to issue.
4.  Bid bond declination: The surety considered the project but will not support it.
5.  Bid bond declination 2: The surety wants to support the project but they are unable to due to their lack of credentials, their insufficient capacity, licensing issues, or other problems on the surety’s part.
6.  When contractors are changing bonding agents or sureties, there could be a gap in service where the new surety is not ready.

In all these cases, the contractor can decide to bid with a check. However, there may be a downside to consider. Let’s look at each of the six scenarios described above.

Risks of Bidding with a Check

1.  No surety: The contractor could forfeit the bid check if they are awarded the project but are unable to bond the ensuing contract.
2.  Short notice: The risk here is the same as #1.  Forfeiture could be the result if no bonding can be arranged for the contract.
3.  Short notice 2: This is one situation where the check may be a reasonable alternative assuming the surety has provided a written approval to bond the contract.
4.  Bid bond declination: This is a particularly troubling situation because the effort to arrange a Performance Bond faces two obstacles:

  • Time: Contract awards demand the issuance of the P&P bond by a specified date.  There could be insufficient time to set up a new surety relationship.
  • The new surety, which hardly knows the contractor, is being asked to bond a project the incumbent surety declined.  The incumbent was willing to lose the account over this project. Can the new underwriters be confident they are making a better decision than those who know the account well?

5.  Bid bond declination 2: This example isn’t as onerous as #4. The problem is that the surety wants to bond the project but can’t.  The new underwriters will be less hesitant than in #4. (So why don’t they just issue a bid bond to help the client get to the next step with another surety?  See answer below.)  If a check is used, a surety must be arranged to prevent forfeiture.
6.  Changing sureties: Handle the same as the short notice situations.

Conclusion

While its true bidding with a check is usually an option, it places the contractors funds at risk unless there is a verifiable means to bond the contract upon award.

Don’t advise your client to consider using a check unless the path forward is confirmed in writing.

Answer to #5: The surety would not want to issue the bid bond if they can’t provide the performance bond.  They make their money on performance bonds which are the main product of the surety operation.  Second reason, if no performance bond is arranged by the client, the bid bond could go into claim.  There is little for the surety to gain in this situation.

Note to our agents and other readers: We are not offering legal advice and do not assume to have covered all possible situations in this article.  When these scenarios arise, talk to your client, their attorney, the surety and feel free to call us for specific advice based on the unique circumstances.

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site, Subdivision, Bid and Performance Bonds since 1979 – we’re good at it! Call us with your next one. 

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.

Don’t want to miss our next exciting article?  Click the “Follow” link in the upper right corner.

Secrets of Bonding #46: Turn IRON into GOLD

Steve GoliaLeave a comment

When contractors apply for Performance Bonds, the underwriting review always includes a financial analysis along with other elements.

Two key components of the financial analysis are Working Capital (WC) and Net Worth (NW).  WC is a measure of short term financial strength.  NW is the ultimate value of the company upon liquidation.

The inspiration for this article came from a new bond account we recently reviewed.  The company is a trade contractor, the kind that normally performs their own work rather than subcontracting. This means their financial statements should show appropriate levels of labor, plant, and equipment.

In this case, the Profit and Loss Statement (P&L) showed sales in excess of $10 million, not a small company. The Balance Sheet showed an acceptable amount of WC, but NW was low – resulting in some weak ratios.

Another element caught our attention: On the Balance Sheet, the net value of the equipment asset was only $65,000! This made us wonder how a company could perform $10 million in sales with so little in physical resources.

There could be a couple of explanations:

  1. They could be subcontracting most of their work.  This is unlikely, however, because they themselves are subcontractors. Typically there is not enough profit to share between two firms. A review of this company’s P&L statement did not indicate extensive subcontracting.
  2. They could be renting almost everything (instead of owning).  This doesn’t sound like a practical approach with sales as high as $10 million, and the P&L did not show high rental expenses.
  3. The equipment could be substantially depreciated resulting in a low net value on the Balance Sheet.  This did turn out to be the scenario in their case.

Let’s talk more about #3. But first off, what is depreciation?

IRS definition: http://www.irs.gov/Businesses/Small-Businesses-%26-Self-Employed/A-Brief-Overview-of-Depreciation

It says in part, “Depreciation is an income tax deduction that allows a taxpayer to recover the cost or other basis of certain property. It is an annual allowance for the wear and tear, deterioration, or obsolescence of the property.”

This means when a $100,000 backhoe is purchased, its value as an asset on the Balance Sheet goes down each year as the depreciation progresses.  Bear in mind, this is an accounting entry.  It is not an indication of the current market value of the asset.

Eventually, the asset is depreciated to zero. However, even if it is valueless on the Balance Sheet, it may still be out on a job site working and producing revenues.  It may still have a market value. So therein lies the Gold.

Assets such as heavy equipment (referred to as “Iron”), may have value that is not reflected on the Balance Sheet. So the question is: How to recapture that value and help the bond worthiness of the account?

One way is with a professional appraisal.  Even if the backhoe is depreciated to zero, if the current market value is $25,000, that represents NW that can be added to the financial ratios.

Imagine the effect for the company in question.  Upon further review, we determined that the cost of their equipment was nearly $2 million.  They had a lot of it and it was older so depreciation had reduced the net value on the Balance Sheet to $65,000.  However the current market value was actually $500,000!

Q. Based on these facts, what value should the bond underwriters use for the equipment:  $65,000, $2,000,000, $500,000 or some other amount?

A. If you’ve been following along, that’s where the appraised value comes in.  You need an independent determination of current market value that recognizes the amount of cash these assets could bring.  If well maintained, they have a value higher than that shown on the Balance Sheet. ($500,000)

How else can the value be determined?  The client could provide a copy of their equipment floater as evidence of current value.  You could also get an informal appraisal from their equipment dealer.  Any of these options are better that living with the unrealistically low value shown on the Balance Sheet.

Going back to our example, if the backhoe’s market value is currently $25,000, give that info to the underwriter.  The newly found net worth for all such assets can be added to the bonding analysis.  You turned the Iron into Gold, a POT of Gold!  It can totally transform the ratios and the client’s ability to qualify for the bonds they desire.

Consider this technique for companies with a sizable fleet of mature equipment, especially when their Net Worth is less than desired for bonding purposes.  This analysis can also help strengthen the banking relationship.

FIA Surety / First Indemnity of America Insurance Company
2740 Rt. 10 West, Suite 205
Morris Plains, NJ 07950
Office: 973-541-3417

P.S. Check out our upcoming Free CE schedule here!

Follow this BLOG in the upper right hand corner for more cool bond stuff…

Secrets of Bonding #45: Backpedaling and How to Avoid It

Steve GoliaLeave a comment

Sureties commonly rely on a variety of elements when deciding if they will provide surety bonds for contractors. All relevant underwriting factors are considered, including the applicant’s financial condition.

In most bonding scenarios, the applicant for the bonds is a construction company – typically a corporation or LLC. An important element of the financial evaluation is the company’s financial statement.

Why so much emphasis on this one document? The financial statement is considered a report card on the quality of management. It shows a range of important indicators. To name a few:

  1. How strong a financial commitment the owners made to the company (capitalization)
  2. The amount of revenues management has acquired in the previous operating cycle
  3. The extent to which construction contracts were realistically estimated and successfully managed
  4. Management of overhead expenses
  5. Tax planning
  6. Adequacy of cash flow
  7. Liquidity
  8. Profitability
  9. Reliance on banks and other creditors to finance operations
  10. Collectability of receivables

The analyst’s favorite financial statement date is the company’s fiscal year-end (FYE), which is “tax day.” We prefer this date for two reasons.

  • Underwriters need to make a periodic review to monitor the applicant’s financial status, so an annual review on the FYE is perfect.
  • The tax day numbers will be realistic and conservatively presented – to minimize the tax exposure. This conservative approach is ideal for the bond underwriters who hope to make a realistic analysis of the applicant.  For most companies tax day is December 31st.

So where does the backpedaling come in?

Company managers rely on their Certified Public Accountant for financial advice, especially tax planning. Limiting taxes is a popular goal, but at what price? Lower taxes may be the result of lower pre-tax profits. Lower profits mean less financial growth and possibly an inadequate net worth. (See Secret #3: Taxes) Why should stockholders continue to support a company that fails in its primary mission: Producing a profit?

Obviously these issues are a great concern to surety underwriters, who want successful, well-managed companies as clients. If tax avoidance is aggressively pursued, it is not unlikely that bonding capacity will be compromised. The surety may limit their support or even terminate the relationship if financial performance is weak.

Once the financial document is carved in stone, company management may face an entire year of backpedaling: “We showed poor results because…” until the next FYE report can show better numbers.

The problem is not uncommon, and the solution is simple if executed properly. Avoid backpedaling by having a draft financial statement initially produced by the CPA. The document will be marked “For Discussion Purposes” and discussion is exactly what’s needed. A review by the underwriter will determine if any elements of the report are detrimental for bonding purposes. Plans for the coming year can be discussed and bonding capacity evaluated.

If the financial statement does not support the desired amount of surety capacity, now is the time to make adjustments before the final version is produced. Backpedaling is avoided!

With some planning and open dialogue agents can help their contractors avoid the missteps that prevent companies from realizing their full bonding and financial potential.

  • Agents, 60 days prior to your client’s fiscal year-end is the time to act. Get the ball rolling!
  • Contractors, tell your accountant a draft fiscal year-end statement will be needed for discussion with the bonding company.

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site, Subdivision, Bid and Performance Bonds since 1979 – we’re good at it!  Call us with your next one.  856-304-7348

First Indemnity of America Ins. Co.

Secrets of Bonding #43: Subcontractors and Subcontracts

Steve GoliaLeave a comment

“If you are a bonding company, why won’t you bond subcontractors?”

It might seem odd, but some Sureties do not embrace the opportunity to serve subcontractors.  So what’s differentfish about subcontractors and subcontracts?  Why do some sureties red line this entire segment of the market?

The Food Chain

One complaint underwriters may have about subcontractors is that they are farther down the food chain than General Contractors. GCs have a “prime” contract, meaning they work directly for the project owner, and are the first recipient of monetary payments.  The subcontractors are subsequently paid by the GC.  Subs may face delays and sometimes even harassment at the hands of GCs. Remember, subcontracts are all private contracts not regulated by governmental rules even if the prime contract is public. Put simply, subs have a harder time collecting their money.

Other Issues for Subs and Their Sureties

  • GCs do not normally disclose bid results (2nd & 3rd  bidder’s figures).  This makes it difficult to evaluate contract price adequacy – a disadvantage for both the sub and surety.
  • Unregulated procurement procedures and contract administration – GCs may be aggressive in their procurement methods, pressuring subs for price concessions: “Knock their heads together.” Such practices make the subcontracts less profitable and therefore more risky for the sub and surety.  Subs can also be victimized with verbal awards and unwritten change orders.
  • Contract documents (including bond forms) may be non-standard, drafted by GCs specifically to give strong advantages over subs and sureties.  In some cases the normal Performance bond is transformed into a forfeiture type financial obligation.
  • Flow-down or pass-through clauses in subcontracts force subs to assume obligations rightfully belonging to the GC. An example would be wording that makes the sub responsible for the liquidated damage amount on the prime contract if they are found to have caused a delay on the subcontract.
  • “Pay when paid” language can result in delayed payment to the sub.  “Pay if paid” can result in the sub never being paid.
  • Unbonded public work is rare, but in such cases there is no Payment Bond at the GC level to protect the sub, and liens (filed against the project for failure to receive payment) may be prohibited.
  • Indemnification: Broad form indemnity clauses in the contract can make the sub financially responsible even if they are not at fault.
  • Delay damages: Subs may be barred from seeking financial recovery.
  • Lien waivers: When read literally, these documents may operate to waive and release claims for which the subcontractor has not yet been paid. (Learn about Conditional and Unconditional Lien Waivers: Click!)
  • Termination for Convenience: This contract clause can enable the GC to terminate the contract and leave the sub with a series of unreimbursed expenses and lost profits.
  • Some trades perform their work late in the project, meaning the bond is carried for a lengthy period with no progress on the contract.
  • Certain trades can operate with minimal capitalization, so the field may be populated with lightly financed companies. Such competitors can drive down contract prices making it harder to bond their work.
  • Financial reporting may be less sophisticated than for GCs (CPA financial statements vs. bookkeeper or QuickBooks).
  • Due to their size and circumstances, subs may lack bank support, such as a working capital line.

Conclusion

Subcontractors literally perform the majority of all construction work.  They are the backbone of the construction industry and cannot be ignored by sureties.

When it comes to bonding, subcontractors need to demonstrate that they are well-managed companies that reflect the same attributes as a successful GC.

Secrets #5 and #15 contain important guidance to help agents get subcontractors approved.

Start by choosing a surety that is actively seeking to support subcontractor accounts without requiring collateral.

Steve Golia
First Indemnity of America Insurance Company
2740 Rt. 10 West, Suite 205
Morris Plains, NJ 07950
Office: 973-541-3417

“Follow” this BLOG in the upper right hand corner for more exciting surety bond stuff!

Secrets of Bonding #42: My Bond Amount Can Beat Your Contract Amount

Steve GoliaLeave a comment

Q. What is the normal relationship between the contract and bond amounts?

A. Performance and Payment Bonds are normally issued for 100% of the initial contract amount.

Q. What do you call a bond that’s for less than the full contract amount?

A. Underwriters call these “percentage bonds,” such as a 50% Performance and Payment bond. Some obligees stipulate these in order to make the bond cheaper (doesn’t work), to help the contractor preserve their bond capacity (doesn’t), or to make the bond easier to obtain (nope). What it does do is deprive the obligee of part of the protection they are buying.

Q. What happens with the original 100% bond amount if there is a subsequent amendment increasing the contract price?

A. The bond is often required to automatically follow an increase in the contract amount, without “notice to or consent of” the surety.

Q. Is there a limit to how much the bond can be automatically increased?

A. A limitation may be stipulated in the bond to protect the surety from huge unanticipated increases, such as no more than a 10% increase without the written agreement of the surety.

Q. What is the basis of the calculation for the bond cost?

A. The cost of the bond is normally based on the amount of the contract being guaranteed, not the bond.  If the bond is for 75% of the contract amount, the bond cost would be unchanged. Why does this make sense?

  1. The surety’s decision making process is still based on the entire scope of the contract including all technical aspects and the difficulty of performance. The underwriting expenses are unchanged.
  2. Which 75% of the contract does the bond cover? It covers the entire contract, but subject to a lesser maximum bond penalty. You could say it covers the bad 75% where the claim lies.  Full penalty bond losses are extremely rare, so the reduction to 75% has little benefit for the surety.

Q. What is the cost difference for Performance only, no Payment bond?

A. Since the underwriting is unchanged, there is no cost reduction.

The Maximum Rule:

Does your brain hurt yet?  It will after this.

The purpose of the Maximum Rule is to limit how much is charged (the maximum) for a “percentage” bond.  Suppose you have a 10% P&P bond on a $1 million contract with a straight rate of $25 / thousand.  Based on the contract amount, the bond fee would be $25,000.  Will the obligee pay $25,000 for a $100,000 bond?  Even though the bond will cover the entire $1 million of work, it’s a hard sell.  This is where the Maximum Rule comes in.

The price calculation under the Maximum rule is different.  Here is a typical example:

If the rate used in the Maximum Rule is $50 / thousand for the aggregate of the Performance ($100,000) plus Payment bond ($100,000) amounts, it will equal $50 x 200 or $10,000.  So in this example the maximum applicable charge would be $10,000 for the $100,000 bond, in recognition of the greatly reduced bond penalty.

With the Maximum Rule, you charge the normal price or use the Max Rule price – whichever is less.  As the percentage of the bond amount increases, the advantage of using the Maximum Rule disappears.  In this example the tipping point is 25%.  The Performance and Payment bond amount must be less than 25% of the contract amount for the Max Rule to result in a reduced charge.

Conclusion

Here’s the good news.  The vast majority of contracts stipulate a P&P bond equal to 100% of the contract amount; this is the typical statutory requirement on public work.  The same routine is normally followed on private contracts as well because it is the best way to protect the obligee’s interests.

Call us with you next Contract, Site or Subdivision Bond.

FIA Surety / First Indemnity of America Insurance Company
2740 Rt. 10 West, Suite 205
Morris Plains, NJ 07950
Office: 973-541-3417

An “A Rated” Carrier

Visit our Free CE school.

Secrets of Bonding #41: Escaping the Stigma of Bankruptcy

Steve GoliaLeave a comment

BKs come in a couple of flavors – all nasty tasting for surety underwriters.

Chapter 7: This is a liquidation bankruptcy, which means that a trustee sells off all non-exempt assets held by the debtor so that the debts can be repaid to the fullest extent possible. Businesses generally try to avoid Chapter 7 because it is impossible to conduct business operations.

Chapter 11: Business operations continue during this process.  Chapter 11, the most complex bankruptcy filing, is the one that most troubled businesses file. The debtor continues to function, maintains ownership of all assets, and tries to work out a reorganization plan to pay off creditors.

Chapter 12 is exclusively for farm operators.

Chapter 13 is like Chapter 11 but is for individuals instead of businesses.

It would be an understatement to say it is harder to qualify for surety bonds if you have a BK in your past.

Bonding companies typically use a structured method of decision making where each underwriter works within a framework.  The details are described in a Letter of Underwriting Authority which may say things like “All clients must have been in business at least three years” (*why?) or “Do not approve bonds for environmental remediation work.”

A common restriction would be: “Do not bond companies that have previously declared bankruptcy.”

Such rules are handed down by senior management of the surety company and their reinsurers. They just want the field underwriters to avoid such applicants – end of story!

Why is the BK a significant black mark? Why does this one checkbox effectively end the underwriting process with many sureties? We can only guess it is because surety underwriting uses credit analysis as a key element. So the ultimate bad credit event, a BK, is an automatic deal killer with those markets.

Escape the BK

When a construction company comes out of Chapter 11, what is the next step if surety support is desired?  Over the years, we have seen many cases where the owners decided to form a new company.  It’s a fresh start. But is this the best step?

Every bonding questionnaire asks about prior BKs, not only for the company involved, but also the individual people.  For example, ours says:

 “Has the company, any affiliate or subsidiary, or any owners / spouse or companies in which they have had an ownership interest or managerial role ever experienced a bankruptcy?”

That’s pretty broad. Note that forming a new company doesn’t change a bad “Yes” to a good “NO.”  Can it help at all with bonding?  Actually it may do more harm than good.

As we have discussed, the prior BK is likely to be revealed through the questionnaire and also the credit reports. And what the applicant company loses is the history, which is very important to bond underwriters.  The ability to say we have been in business for years and completed a long list of projects carries tremendous weight in the underwriting process. To a large extent, you throw all that away when you start a new firm.

* Remember the underwriting restriction above? Most sureties are reluctant to bond companies until they have a few successful years under their belt – so being new is always a disadvantage.

Conclusion

So how does a company escape the stigma of a BK?  The answer is you don’t.  The BK becomes a part of the company and personal credit history that may not be avoided or erased.

However, there may be a solution with the surety.  The contractor and agent need to select a surety with the flexibility and expertise to evaluate the details surrounding the BK.  The underwriters must be open-minded and willing to identify the strengths of the applicant, despite the BK.  Key points to develop:

  • Responsibility for the factors causing the BK
  • Final disposition of the BK debt
  • Continuity of ownership and key management
  • Current financial strength and trends
  • Current banking and other credit relationships

The reality is that most “prior BK” companies are not bad applicants for bonds. But agents need a surety with the ability to appreciate the value of these clients and support them without requiring collateral.

Call us with you next Contract, Site or Subdivision Bond.

FIA Surety / First Indemnity of America Insurance Company
2740 Rt. 10 West, Suite 205
Morris Plains, NJ 07950
Office: 973-541-3417

An “A Rated” Carrier

Visit our Free CE school.

Secrets of Bonding #39: Design/Build vs. Design/Bid/Build

Steve GoliaLeave a comment

Underwriters are watchful for “Design/Build” contracts.  If you feel like D/B projects are becoming more common, you’re correct!  The concept emerged in the 1980s and was formally codified by the federal government in 1996 after two years of collaboration with the private sector. The Clinger-Cohen Act established a two-step procurement process for such work.

Some sureties balk at the additional risk their clients assume on these projects. Put simply, the contractor becomes responsible for both design and construction.  In the event of a performance problem, this really cuts down on the finger pointing!

Bear in mind, it is the contractor (not the designer) who obtains the surety bond.  On “contractor-led” D/B projects, the contractor hires a licensed and insured architect to perform the design work. Another option is to form a joint venture between the architect and contractor.  In either case, a certain tension exists between these “partners” who have slightly different agendas, and this has implications for the surety – the guarantor of the project.

There is no denying we face unique risks on D/B contracts.  Let’s review them.

  • The designer must agree that their design (and subsequent revisions) will conform to the project budget “as bid.”  Without this, the contractor could be forced to absorb the cost of design changes.  Unprofitable contracts are more likely to go into default.
  • Similarly, designers must agree to conform to the project schedule. They cannot make changes that require construction timelines unsupported by the contract. Such changes could force the contractor to choose between significant unreimbursed expenses or failure to complete on time.
  • The design work must also conform to the project owner’s specifications at all times.

Design/Build contracts require some extra care, but can be bonded successfully.  Underwriters need to have the proper procedures and expertise to make these evaluations.

The alternative: Design/Bid/Build

You may encounter contracts specifically called Design/Bid/Build. So is this another new thing we have to learn?!

No, actually D/B/B this is the traditional construction method where the project owner hires and directs the architect. It is nothing new but may be named as such to identify the project as not Design/Build.

We may not have known it by name, but we have been helping contractors bond Design/Bid/Build projects for years!

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site, Subdivision, Bid and Performance Bonds since 1979 – we’re good at it!  Call us with your next one.

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.

(Don’t miss our next exciting article.  Click the “Follow” button at the top right.)

Secrets of Bonding #38: Capacity – How to Preserve It

Steve GoliaLeave a comment

For contractors, Bonding Capacity is a good as gold.  It enables the company to pursue new projects with the confidence that their surety will back the contracts when the need arises.  This is the source of increased revenues and greater profits!

How is available bonding capacity calculated? First a bonding line is determined, consisting of an Aggregate (total) amount and a Single per job limit.  The Aggregate is then decreased by different factors that consume the line. What can be done to minimize this effect so bonds remain available for the client? Let’s look at how the numbers are developed and how they can be appropriately managed.

Bonded and unbonded work is included in the analysis.  (*Why is Unbonded work included?)  Here’s the math:

Aggregate Capacity amount  Minus:

  1. Undecided bids (full contract amount)
  2. Low but unawarded bids (full contract amount)
  3. Projects that are awarded, signed or started (full contract amount)
  4. Remaining Costs to Complete on open contracts

Equals the Available Bonding Capacity.

So how can agents help their contractors preserve this vital asset?

1.  Prompt reporting of bid results – When bid bonds are issued, the entire estimated contract amount is deducted from available capacity, not the bid bond amount.  The capacity is not restored until the “not low” results reach the underwriter.

2.  Updated Work In Process (WIP) schedule:

  • Surety underwriters and accountants determine a contractor’s “current work load” based on the costs they must incur (such as labor and materials) to complete their open contracts.  When there are no remaining costs to incur on a project, by definition, it is considered completed.  The WIP schedule shows revised Costs Incurred to Date and Estimated Costs to Complete. Both increased costs incurred and decreased future costs improve available capacity.  Future costs may be reduced by progress on the contracts and also by greater labor efficiency, material cost savings, improved scheduling and other factors.
  • A reduction in the contract amount (by amendment) has the same effect because it reduces unincurred costs. Report such amendments immediately.

3.  Prompt reporting of completed or terminated work, including unbonded projects, removes them from the work load and therefore increases availability.

Note: Factors that can reduce available capacity include unincurred contract costs that increase for any reason and the addition of new unbonded projects.

*The aggregate capacity amount is based on all the contractor’s professional and financial capabilities. If unbonded projects are acquired, they consume resources (supervisory staff, equipment, etc.) and therefore must be recognized within the use of the bond line.

Available Bonding Capacity is a moving target subject to frequent revision.  To maximize availability, send us the right info and keep it current.

First Indemnity of America Insurance Company
2740 Rt. 10 West, Suite 205
Morris Plains, NJ 07950
Office: 973-541-3417

An “A Rated” Carrier

 

Secrets of Bonding #37: Counting Counts!

Steve GoliaLeave a comment

One for you, one for me.

Two for you; one, two for me.

Three for you; one, two, three for me!

What fun, unless you are a surety underwriter and you’re incorrectly evaluating a financial picture.

When we review a new applicant for bonding, a range of factors are considered and the financial aspect is always one of them.  Sureties want to be confident that the company is stable and will be able to perform the bonded contract.  This includes the financial capability to finance the start of the work and deal with any issues that arise.  Such problems, if left unresolved, are the things bond claims are made of.

Who is the typical applicant for performance bonds?  Most often it is a privately owned company.  The focus of the financial evaluation is the fiscal year-end (FYE) of the company, which frequently is December 31st.

A range of elements are reviewed to determine the health of the company and its ability to survive the issues that often arise on construction projects.  One element is Cash.  Always the first (most liquid) asset listed on the Balance Sheet, you’ve heard the expressions: Cash is king, Cold hard cash, A cash cow!  A strong cash position is universally recognized as a sign of health.

As part of the primary financial evaluation, underwriters calculate the company’s FYE cash position.  Secondarily, the finances and cash position of the company owners will be reviewed.  These parties are indemnitors to the surety even though they are not direct bond applicants (bond “Principals”).  In the event of loss, the surety is entitled to look to these parties for salvage and subrogation (financial recovery) – so the financial strength they add to the picture is relevant.

Trick Question: If financial statements show that the company has $100,000 cash at the 12/31 FYE and the owners personally have $100,000 on 1/31, do you have $200,000 for underwriting purposes?

Answer: You do unless that’s the same $100,000 that you’re counting twice.

Company owners may loan money to the firm and later pay it back. Money gets moved around, sometimes quickly.  There should be corresponding debt entries on the financials.  But if people “forget” to show them, readers can be tricked into counting the same asset twice.  How can underwriters prevent being fooled into double counting dollars?

The solution is to always require concurrent financial statement dates.  We will always request personal financial statements as of the fiscal year-end date of the company. Personal year-ends are automatically 12/31.  But if the company has chosen a different date, that will be the personal FS date we want.

It is also typical, when reviewing unaudited (unverified by an independent third party) financial reports, to ask for proof of the cash assets – such as bank or brokerage statements.

So there you have it.  When bond underwriters count the cash, they prevent counting the same dollars twice by requiring business and personal financials as of the same date, because Counting Counts!

Call us with you next Contract, Site or Subdivision Bond.

FIA Surety / First Indemnity of America Insurance Company
2740 Rt. 10 West, Suite 205
Morris Plains, NJ 07950
Office: 973-541-3417

An “A Rated” Carrier

Visit our Free CE school.