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How can contractors protect themselves from surety bond fraud?

David Hewett
Chief Underwriting Officer
Merchants Bonding Company

To protect themselves from fraudulent surety-bond transactions, Merchants Bonding Company’s experts recommend contractors take two simple steps:

1. Check the authority of the surety to issue the bond. This can be achieved by contacting the state insurance department to confirm the surety is admitted in the jurisdiction of the project, and by consulting the U.S. Department of the Treasury Listing of Approved Sureties, Department Circular 570, to confirm the surety is authorized to issue bonds on federal projects.

2. Verify that the surety actually authorized the issuance of the surety bond by contacting the surety directly. In most cases, contact information for verification purposes can be obtained from the bond form, Circular 570, or several surety industry associations.

The resources and systems in place right now put the onus on contractors (or other obligees) to verify a bond’s legitimacy. But the surety industry recognizes the responsibility to prevent fraud shouldn’t rest solely with contractors (or other obligees), which is why it’s investing in developing technologies to create a bond-issuance system that’s safer, more secure and less vulnerable to fraud. Technologies like blockchain, facial recognition, fingerprint scanning, AI and mobile apps are all potential players in the quest to protect and secure the bond issuance process. Until the future is here, taking these two simple steps can provide the security contractors need.

How can contractors protect themselves from surety bond fraud?

Lisa Deatherage
Director of Sales and Marketing
Surety 2000

Protecting against surety bonding fraud as a contractor involves taking several precautions:

1. Verify surety companies: Ensure the surety company is legitimate and reputable. Check their ratings with rating agencies like A.M. Best or Treasury List. Avoid dealing with unknown or unverified surety providers.

2. Review bond documents: Carefully examine all bond documents, including the bond's terms and conditions, coverage limits and payment terms. Ensure they match the agreed-upon terms.

3. Confirm agent credentials: Verify the credentials of the agent or broker facilitating the bond. Ensure they are licensed and authorized to sell surety bonds in your state.

4. Check references: Ask for references from the surety company or agent and contact previous clients who have used their services. This can help you gauge their reliability.

5. Get multiple quotes: Don't settle for the first offer you receive. Obtain quotes from multiple surety providers to compare terms and pricing.

6. Investigate claims history: Research the surety company's claims history. Frequent claims or disputes could be a red flag.

7. Escrow or joint control: Consider using an escrow account or joint-control mechanism for funds related to the bond to prevent misuse or misappropriation.

8. Due diligence: Conduct thorough due diligence on the project or contract you're bonding for. Make sure it's a legitimate and viable opportunity.

9. Seek legal advice: Consult with an attorney experienced in construction and contract law to review bond documents and contracts before signing.

10. Report suspected fraud: If you suspect fraud or any irregularities, report it to the appropriate authorities, such as your state's insurance regulatory agency or law enforcement.

11. Leverage electronic bonding: E-bonding eliminates the potential for fraud through tracking of all documents issued in real time

Remember that preventing fraud requires diligence and careful consideration throughout the contract.

What is the difference between a payment or contract bond and a performance bond?

Chris Nolan
Head of Large Contract, Surety
Zurich North America

In most instances, both a performance and payment bond cover the full amount of the construction contract as required by the owner, or obligee. While both performance and payment bonds are meant to ensure contractors have the capacity, experience and financial strength to successfully complete the project, each bond has a different purpose.

The performance bond guarantees the contractor will meet all terms, specifications and conditions of the construction contract—that the project will be completed to specifications and within the time specified. The owner, or obligee, is the only party who may make a claim on the performance bond.

The payment bond serves a different purpose, ensuring that the direct subcontractors working on the project, as well as suppliers providing materials on the project, are paid what is contractually owed to them. The payment bond gives suppliers, subcontractors and workers financial protection, rather than the owner, who is protected under the performance bond. Therefore, a payment bond potentially could have multiple claimants for unpaid invoices for labor and/or materials. Both bonds are key risk-management tools in helping protect public funds and ensuring successful completion of construction projects.

How can transition of ownership affect a construction firm’s ability to obtain surety bonding?

Doug Dusso
Surety Director
CNA Surety

Ownership transition is important in the surety-underwriting process and should be contemplated well before the actual transition of ownership takes place.

Due to potential significant negative effects on the company’s balance sheet, the contractor’s surety should be brought into the discussion early in the process. Pro forma financial information outlining the effects of the ownership transition on the balance sheet will aid in the surety discussions. One area of focus is typically the available working capital/cash flow needed to support the ownership transition as well as ongoing operations of the company. Additionally, what is the effect on their debt structure as well as their potential to add debt capacity should it be needed in future operations? Is the bank willing to continue to maintain the same level of support via their bank line of credit or possibly even increase the support to assist with cash-flow flexibility?

If former owners are holding a portion of the debt related to the ownership transition, are they willing to subordinate that debt to the surety? Is it feasible to maintain some level of personal indemnity on the prior owner(s) after the ownership transaction is completed? 

Any changes in management/operations will need to be discussed in detail with the surety to make sure those changes will not affect the relationship. Communication is the key. A construction company should consult with all of their business partners, including their surety, well in advance of an ownership transition to avoid any disruption of their surety program.

How can transition of ownership affect a construction firm’s ability to obtain surety bonding?

Michael Zahn
Surety Sales Executive
Marsh McLennan Agency

Surety programs are primarily underwritten based on the equity and liquidity held within a construction firm. To oversimplify, the more of each you have the more surety credit you will have access to.

Because ownership transition typically results in material changes to the balance sheet and is often partially or wholly funded by the assets of the entity, access to surety credit can be significantly impacted because of the resulting reduction in equity and/or liquidity. In any transaction where the prior owner is paid out and assets are subsequently leveraged, this effect is magnified. Generally, bond underwriters eliminate goodwill and intangible assets from their analysis via a dollar-for-dollar adjustment to net worth. No matter the structure of the deal, buyers are typically in a much tighter financial position post-closing.

If your company relies upon consistent access to surety credit and is starting down the path of a potential perpetuation or sale, it is imperative that your surety team is involved early in the process to help ensure the transition plan for bond credit alongside your CPA and counsel. You do not want to end up on the wrong side of claw-back provisions because your professional advisors were kept out of the loop. A strong agent and underwriting team will be able to help you formulate a proper strategy to transition your bond program and capacity. The end goal should always be to make your sale a success for all parties involved.

How can transition of ownership affect a construction firm’s ability to obtain surety bonding?

Joseph Crawford
Vice President, Contract Surety
Philadelphia Insurance Companies

As construction owners from the Baby-Boomer generation retire, this question has emerged more frequently. The surety underwriter considers the timing of the transition, experience and trust of the ownership, the transition process and the funding vehicle.

Ideally, sureties prefer an owner who is committed to the future success of the business and who has mentored the future ownership team for two years or more. Who will give the green light to a large project or difficult scope? Who will make the tough overhead and personnel decisions? How will the key employees react to the new ownership team?

Funding for the transition can vary. The stock can be bought by the new team and funded with personal capital or an individual loan. Resultant off-balance-sheet debt does not appear on the corporate financial statement. Leveraged buyouts carry the debt on the balance sheet, as do employee stock-ownership plans and private equity purchases. These methods can be lucrative for the existing shareholders, but the stock valuation often carries a multiplier, meaning the payout exceeds the book value. The balance sheet will carry goodwill as an asset. Surety markets may not consider this asset when calculating financial ratios, so often the business will have negative net worth in their analysis and severely impair surety credit.

Ownership transition presents the surety underwriter with qualitative information to explore as well as quantitative data points. Future personal indemnity will be a part of those discussions. It is important to have sound advice from a professional broker and CPA firm, as well as the surety.

Why do some owners require surety bonding for private sector projects?

Patrick Pribyl
National Association of Surety Bond Producers

Surety bond protections are most associated with public construction contracts, but savvy private owners also know that such protections are important on their projects. Whether an infrequent private owner undertaking a high-visibility community project, such as a private school or religious facility, or an institutional owner regularly undertaking complex projects, both benefit from considerable assurances and risk transfers provided by bonds, such as thorough vetting of contractor qualifications and third-party guarantees of payment and performance.

Surety bond requirements ensure that private sector contracts are attractive to subcontractors and suppliers, who know that they have a critical avenue to redress non-payment, so they provide better pricing, ultimately inuring to the owner’s benefit by lowering overall project costs. Payment bonds also avert imposition of mechanics’ liens against the project property. Lenders also understand the benefits of bonds, as they often require them as a condition of project financing.

NASBP developed videos to help convey the value of surety. In addition, a study sponsored by the Surety & Fidelity Association of America and conducted by the accounting, consulting firm Ernst & Young found additional benefits. The EY study discerned that unbonded projects have a much higher likelihood of contract defaults and a significantly higher cost of completion in such default circumstances. With these reasons in mind, private owners are well served with bond requirements in place, as they provide prequalification of contracting entities, lower default risks, incentivize better subcontract pricing and enhance credibility and reputations as responsible project owners.

Why do some owners require surety bonding for private sector projects?

Michael Heidrick
Head of Construction Surety
The Hartford

It simply makes economic sense to bond. In a recent report that came out from Ernst & Young and commissioned by The Surety & Fidelity Association of America, several advantages of bonded projects were indicated, including: unbonded projects default up to 10 times more than bonded projects, bonded projects are more likely to be completed on time and a lower cost of completion upon a default.

Owners, like banks and developers, are financing a project that is of questionable value if it’s not complete. A bank has little recourse on a half-finished building, and a foreclosure will not make them whole. What value is a multifamily building to a developer if it isn’t complete and they can’t collect rents? Risk of the project to financiers and end users is mitigated if a bond is put in place to guarantee the project will be built according to plans of the contract. They also get the assurance their project will be completed lien free.

Why do some owners require surety bonding for private sector projects?

Matthew Lubin
President, Surety
Crum & Forster

Surety bonds, like other forms of insurance, are purchased to protect assets. The Surety & Fidelity Association of America, of which I am a board member, commissioned a study by EY to quantify the protection and other financial benefits surety bonds deliver. Those results are significant and clearly show that private as well as public project owners can benefit from surety bonds.

Bonded projects have a default rate up to 10 times lower than the rate for unbonded projects. Per the study, 96% of bonded projects were pre-qualified versus 61% of unbonded projects. So bonded projects typically undergo a more rigorous review and prequalification process because the surety has the resources, expertise and motivation to provide an in-depth evaluation of the contractor. The surety also provides general oversight during construction. In addition, when contractors face financial challenges, they typically prioritize bonded projects.

Another key EY finding is that 75% of owners and developers in the study reported that surety bonding reduces contractor pricing and thus the overall cost of the project. Some of this is due to the fact that bonded projects are five times more likely to be completed on time than unbonded projects.

Last, should a project default, the EY study found that the cost of completion for unbonded projects can be 85% higher than for unbonded projects. Some of these results can be attributed to the Surety’s ability to manage a reprocurement process and transition to a new contractor.

Why do some owners require surety bonding for private sector projects?

Gregory S. Horne
AVP, Contract Surety
Liberty Mutual Surety

Private owners require bonds because they understand mitigating construction-performance risk is as important as mitigating fire risk. Both are rare occurrences but can be catastrophic. Unlike fire insurance, the existence of a surety bond significantly contributes towards successful project completion.

The economic value of surety bonds published in November 2022 by EY Consulting affirmed that upon contractor default, a bonded project has a lower cost of completion because the surety brings completion expertise and resources. More importantly, EY asserts that every surety bond represents value to the owner because: 1) all bonded portfolios outperform unbonded portfolios; 2) bonded portfolios have a lower rate of default; and, most importantly, 3) there is an average 3.2% construction cost savings on bonded projects. 

Those tangible owner benefits arise from the intangibles realized by securing a bond. The surety’s contractor prequalification process is continuous and independently verifies the contractor has the capacity to perform the project. Subcontractors and vendors do not add contingency for non-payment when a payment bond exists. Because a surety is typically a contractor’s largest creditor, bonded jobs get additional oversight and higher priority, as bonding capacity and reputation are threatened by poor performance, and surety indemnity potentially creates individual liability in the event of failure. Consequently, contractors are more likely to assign their better teams to bonded projects, improving the chances for meeting owners’ expectations. 

EY developed their study utilizing bonded and unbonded job schedule data from the healthcare and educational markets, applying advanced modeling, and conducting surveys.

Why is it important to provide the surety with a certified financial report?

James Milos
Assistant Vice President, Head of Surety & Fidelity Claims
Nationwide Surety

A certified financial report is a comprehensive financial document that offers an independent and accurate representation of a company's financial condition. It is typically prepared by a certified financial accountant or other qualified financial professional.

Providing a certified financial report to the surety is important for multiple reasons. First, the certified financial report supports the underwriting process. The surety uses this information to make informed decisions regarding bonding limits, terms and premiums. With accurate financial data in hand, the surety can tailor the bonding program to align with the company's financial capacity, ensuring that it can handle the responsibilities associated with the bonded project.

Secondly, the report enables the surety to assess the bonded party's financial capability to fulfill its obligations under a bonding arrangement. By evaluating the company's liquidity, solvency, profitability and debt levels, the surety can determine whether the bonded party has the financial strength to manage potential risks and meet its contractual commitments and also act as a monitor to aid the surety and business owner in evaluation of efficiency of operations and management.

When claims arise, the certified financial reports are critical for the surety to assess the bonded party's financial capacity to address claims or fulfil its responsibilities. Adequate and reliable financial information helps the surety determine the appropriate course of action and facilitate the resolution of the claim.

In summary, a certified financial report is of the utmost importance to a surety. It is an essential tool that allows the surety to evaluate a company's financial strength, determine its ability to meet obligations, and guides the surety in making informed decisions.

Why is it important to provide the surety with a certified financial report?

Christina Chifici, CPA, CGMA, CIT, CCIFP
Director in Charge, Audit and Assurance Services
LaPorte CPAs & Business Advisors

Providing a surety with a certified financial report, in the form of an audited financial statement, is important when obtaining a bond for a construction project. Here are some key reasons why certified financial reports are important:

Credibility and trust: Certified financial reports are prepared by certified public accountants. These reports carry a level of credibility and trust because they are subject to independent verification and auditing. Providing a certified report demonstrates the commitment to transparency and financial responsibility.

Risk assessment: Certified financial reports provide the surety with a clear picture of the financial health and stability of the construction company. This information helps the surety assess the level of risk involved in underwriting the bond.

Financial viability: The certified financial report provides insights into the construction company’s financial resources, assets, liabilities and cash flow, which are critical factors in assessing financial viability to fulfill contractual obligations.

Risk mitigation: By thoroughly reviewing certified financial reports, sureties can identify potential financial risks and work with the construction company to mitigate those risks. This may involve setting financial conditions, collateral requirements or adjusting bond terms to protect both the surety and the construction company.

In summary, providing a certified financial report or audited financial statements to a surety helps assess financial risk, builds credibility and trust, and facilitates transparent and informed decision-making in the context of surety bonds and contractual agreements. It benefits both the construction company and the surety by creating a foundation of financial confidence and accountability.

What should contractors consider when selecting a surety bond producer?

Jacob Fulmer
Chief Underwriting Officer, National Accounts

Surety bond producers and underwriters are uniquely positioned to help their customers succeed. Contractors should engage their surety providers when they are considering major strategic decisions or project pursuits. Surety professionals can offer important perspective on industry or market specific financial trends, and even perform an initial review of contracts and bond forms. Some sureties have large amounts of data that can be leveraged for insights that contractors can use to make more confident strategic decisions. At Travelers, we recently helped a customer evaluate several new geographic territories that they are considering, along with specific market sectors within those territories. Working alongside the surety producer, our team was able to deliver a detailed report highlighting both the positives and potential risks associated with expanding into these new territories, including owners, procurement trends, subcontractor coverage, etc. Many of those insights could only come from experienced surety professionals who have learned from witnessing actual contractor performance over time.

Contractors should look for surety providers who will not only listen, but who will ask thoughtful questions and offer candid feedback. It’s very tempting and easy to align with a surety who will tell you what you want to hear, but the best relationships are built on trust and candor.


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