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Commercial bond underwriting takes more than just personal credit into consideration. In general, a commercial bond submission must include: a bond application with general information on the principal, business financial statements and or a on the owner(s), personal financial statements of the owner(s), personal credit of the owner(s) and possibly their spouse(s), and the bond form that must be used to create the original bond. There are specialty programs available for some classes of business that will require less information. However, these programs are far and few in between.
A principal must qualify on all surety items named above. A surety can decline a principal if they fail to meet any of the sureties underwriting guidelines. The best way to understand what the surety is looking for is to go through everything one item at a time in detail. Some of the items below can be fixed immediately, others can take years to correct.
General Bond Application: A bond application will help the surety to determine: the bond amount, who is requiring the bond of the principal (obligee), principal's contact information, owner(s) contact and personal information, etc. A surety can decline an applicant if they find that any of the information is inaccurate. At times, a surety will not want to write bonds when certain obligees are involved.
Business Financial Statement: The business financial statement of the applicant is the bloodline of the company and is one of the most critical items reviewed by the surety when applying for a bond. The statement should be done in an orderly fashion. Handwritten and sloppy internal statements are not recommended in a submission. Instead, it would be wise to contact a CPA to complete at least a "Compilation" Financial Statement for your business. This statement should also be done on an accrual method of accounting. This is necessary as it shows a clearer financial picture of your business. The unacceptable method of, "cash basis" should be avoided as it does not include several items on the balance sheet making the financial picture "cloudy". The CPA business statement should always include full notes and disclosures. In-house financial statements can be used for bonds $100,000 and less, but CPA is still preferred.
Resume: A surety needs confidence in the principal when approving a bond, especially at a low rate. The bonding company wants to know the principal has experience in their field of expertise and they can successfully run a business without triggering a claim.
Personal Financial Statement: Bonding companies are going to want to see that the owner(s) have enough liquid assets. Real estate ownership is also a must for most bond types. Obviously, they will want to see that the net worth of the individual is strong. Items such as life insurance, personal property, automobiles are less valuable in comparison to liquid cash or real estate equity.
Personal Credit: Many have the misconception that score is all that matters on a credit report. There are several items that are just as if not more important in the eyes of a bonding company:
1) Bankruptcy: Declaring bankruptcy can negatively effect you for the rest of your life. Fortunately, most bonding companies will write an account 7 years after it has been discharged. If it is within 7 years, the principal is usually stuck in a high risk bond program.
2) Tax Lien: For the most part, tax liens are underwritten similar to bankruptcies. The majority of sureties like to see them 7 years old and paid. If they are not paid or not far enough in the past, the principal will most likely be in a high risk program.
3) Civil Judgment: Bonding companies vary greatly when it comes to civil judgments. Some bonding companies will never write an account that has had a judgment placed against them. Other bonding companies will write an account with a satisfied judgment and a brief explanation of it.
4) Unpaid Collection: A collection on a credit report is not a good thing, but can still be written in a standard market if the collection is paid. An unpaid collection will immediately put an applicant into a high risk bond program.
5) Late Child Support: With out a doubt, unpaid child support is the worst item an underwriter can see. If an owner has late child support showing on their report they might as well start looking for bond alternatives. Not even high risk bond programs will write a bond for someone with late child support.
Of course, credit scores still count as well. Most bonding companies will be looking for credit scores of 670 or higher. However, some sureties have more liberal underwriting guidelines for low risk classes of business. Some sureties will base their decision on the owner that is considered the highest risk, while other bonding companies will average the credit scores of the owners.
Bond Form: The bond form is exactly what it sounds like, a form used to create a bond. The bond form contains the specifics of what the bond is guaranteeing. Therefore, bonding companies are careful as to what they are willing to write. Some classes of business are considered riskier than others (i.e. ICC Freight Brokers, Wage and Welfare, etc.). Sometimes a line of business is considered less risky, but the bond forms language is considered a higher risk. There are two clauses bonding companies will typically look for:
1) Cancellation Clause: A cancellation clause allows the surety to cancel a bond. An example read as follows, "The surety may cancel this bond and be relieved of further liability hereunder by giving 30 days' written notice to the principal and the [obligee]".
2) Aggregate Clause: This clause creates a cap to the aggregate amount of claims. In other words, a $50,000 bond can pay out no more than $50,000 on a single claim or multiple claims. Therefore, if the bond pays out $50,000 on a claim, then it is maxed out and will not pay out on any additional claims. An example of the clause would be, "In no event shall the aggregate liability of the surety exceed the penal sum specified herein.".
For most bonding companies, a bond form missing the proper language will result in an immediate declination regardless of who the applicant is.
As you can see, a bonding company reviews a multitude of information prior to approving a bond. A good agent knows not to quote or even give a ball park quote based on a credit score alone, as it will likely be very inaccurate. In the next installment of this two piece series we will go over what a principal can do to be considered less of a risk and obtain the lowest bond rate the bonding company has to offer.
