Unlike insurance, where the insurance buyer exchanges their premium for a transfer of their risk to the insurance market, in the Surety world, there is no transfer of risk. When/if a surety loss occurs, the surety, via the indemnification agreement that was signed prior to bond issuance, is repaid for any loss paid on behalf of their bonded principal.
In much the same way that suretyship is different than insurance, surety underwriters behave differently than their insurance underwriting counterparts. Surety underwriters are primarily concerned with making sure that their bonded principal has sufficient net worth to repay any losses the Surety may incur. With every underwriting decision, surety underwriters are constantly looking at the downside risk of their extension of surety credit and they are looking to verify the net worth/liquidity of their principal. If the surety underwriter can not verify/rely on the net worth of their principal, they will simply decline to extend surety credit.
Since the contractor’s financial statements are the surety underwriter’s primary underwriting tool when it comes to measuring net worth/financial resources of their principal, the surety usually demands that the contractor supply them with CPA prepared financial statements. Depending on the size of the work program required by the contractor, the surety may request either compiled, reviewed, or audited financial statements.
Financial statements which are prepared directly by the contractor or by the contractor’s accounting system are referred to as “internal” financial statements and they are generally unacceptable to most surety underwriters. The reason for this is that internal financial statements do not provide the surety with the necessary independent third party valuation contained in CPA reviewed or audited financial statements. (CPA prepared compiled financial statements are generally equated with “internal” financial statements since, in a compiled set of financial statements, the CPA firm simply recreates the statements given to them by the contractor without verifying/checking balances.)
The importance of CPA prepared financial statements is not limited to the surety underwriter’s analysis and verification of net worth. In addition to this, a good CPA prepared set of financials will include a Work In Progress, or “WIP”, schedule that ties in to the financial statements. The WIP schedule is very important to the surety underwriter as it allows them to track things such as underbillings, overbillings, profit fade/gain, and pure job borrow. The WIP gives the surety underwriter a predictive tool to analyze future performance, future gross margin, and cash flow in the contractor’s remaining uncompleted work.
To draw a mining analogy; if a contractor seeks surety credit in the same way that a miner seeks gold, the miner must use a pick and shovel to get to the gold and, in the same way, the contractor must use CPA prepared financial statements to get to his gold = surety credit.
Tim Hutton, CPCU, AFSB
timothyjhutton@gmail.com
703 220 7771 mobile
Sunday, December 13, 2009
Saturday, December 5, 2009
Employee Dishonesty Insurance - Ensure Your Policy's Limit of Liability is Sufficient!
As a former underwriter of this line of coverage, I can attest that, when losses occurred, the limit in force at the time of the loss was frequently insufficient to cover the entire loss. As a broker, when I meet with prospects, I frequently find that they have never considered the sufficiency of their Employee Dishonesty Insurance limit of liability. When I bring to their attention how affordable a dramatically increased limit is, most opt to buy a larger limit of liability.
Employee Dishonesty Insurance (also referred to as ‘Fidelity Insurance’ or a ‘Fidelity Bond’) is an important part of any risk management program. The prevalence of these claims is widespread and, in a weak economy, these claims tend to increase. When these types of losses occur, they are frequently caused by long time “trusted” employees and they can be very substantial; even big enough to drive a company out of business. (In fact, the U.S. Chamber of Commerce reports that 1/3 of business failures can be traced to an occurrence of employee theft.)
>Besides buying an adequate limit of liability, there are many steps an employer can take to limit their exposure to an employee dishonesty loss…I’ll save those for another blog post!
Even with the best internal control structure in place, employee dishonesty losses do occur. Make sure that your limit of liability is sufficient! Ask your agent/broker to provide you with optional quotes for increased limits of liability…you will be surprised at how reasonably priced this line of coverage can be, and, with a higher limit in place, you are better protected should a loss occur.
Tim Hutton, CPCU, AFSB
timothyjhutton@gmail.com
703 220 7771 mobile
Employee Dishonesty Insurance (also referred to as ‘Fidelity Insurance’ or a ‘Fidelity Bond’) is an important part of any risk management program. The prevalence of these claims is widespread and, in a weak economy, these claims tend to increase. When these types of losses occur, they are frequently caused by long time “trusted” employees and they can be very substantial; even big enough to drive a company out of business. (In fact, the U.S. Chamber of Commerce reports that 1/3 of business failures can be traced to an occurrence of employee theft.)
>Besides buying an adequate limit of liability, there are many steps an employer can take to limit their exposure to an employee dishonesty loss…I’ll save those for another blog post!
Even with the best internal control structure in place, employee dishonesty losses do occur. Make sure that your limit of liability is sufficient! Ask your agent/broker to provide you with optional quotes for increased limits of liability…you will be surprised at how reasonably priced this line of coverage can be, and, with a higher limit in place, you are better protected should a loss occur.
Tim Hutton, CPCU, AFSB
timothyjhutton@gmail.com
703 220 7771 mobile
Sunday, November 1, 2009
Overlooked Advantages of a Surety Line
Unlike insurance, in which the buyer purchases the product for their own protection, a performance/payment bond is ‘purchased’ by the buyer for the owner/client’s protection. In other words, the bond is a hurdle put in place by the owner. In order to work for the owner, the contractor (the Principal) must pass the hurdle. (The owner, (the Obligee), is the entity requiring the bond and could be the actual ‘owner’ or another contractor.) So, one may assume that the only beneficiary of a surety relationship is the owner. This ‘one-sided’ view of suretyship is misguided and bonded principals need to know the benefits they receive as a result of their surety relationship.
Since bonded principals must pass through a rigorous level of underwriting prior to establishment of their bond line, the surety (with all of the resultant underwriting knowledge) should be viewed as a business ally and contacted frequently for advice and direction. In this way, the surety operates as an ‘extra set of eyes’ in matters regarding the principal’s business plan, their competition, and the local business environment. To only call on one’s surety for advice/direction when a bond is needed, is missing the chance for advice and guidance from a business ally. (Remember: the surety is a
for-profit entity that wants to write many bonds for you. By routinely seeking their input/direction, you ‘cement’ your relationship with the market and you can gain valuable information with which to better your company.)
Another overlooked benefit of an established surety relationship is in new business acquisition. Too often, contractors only react to bond requirements (hurdles) when they can/should be proactive and offer a bond to potential owners even when a bond is not required. (The premium for the bond can be passed on to the owner in your bid.)
Let’s assume: Contractor A established a bond line because Owner B required a bond of Contractor A. So, Contractor A sought the services of an experienced surety broker who assisted in establishing a surety line with Surety C. The contract was signed, the work was completed, and the bond was released. Now, let’s further assume that Contractor 1 is in negotiations with Owner D and Owner D’s contract makes no mention of a performance bond requirement. With an established bond line, Contractor A may have an advantage over his competition. (If the competition is not bonded and/or bondable, then bring that to the owner’s attention!) Why not offer Owner D a letter of bondability from your broker that glowingly states that you are bonded and backed by a highly rated surety and that your surety would look favorably on providing a bond for the job in question if asked. By bringing to the attention of the owner the fact that your firm is bondable, you immediately drive a wedge between your competition and the owner. (“Why doesn’t this other company have one of these ‘bondability’ letters?)
As touched on above, another benefit of an established bond line is the ally you have in your surety. When/if a dispute and/or claim should arise, the surety will not simply ‘pay’ the owner. The owner’s claim must be proved and the surety is there, as your ally, between you and the owner seeking to settle the claim. This alliance should not be underestimated…the surety wants your firm to succeed. When you succeed, the surety succeeds, when you lose, they lose. As a for-profit entity, the surety has a vested interest in making sure your firm is around for a long time and that you will continue to win new bonded work which will result in new bond premiums for the surety.
Don’t overlook the advantages of your surety line!
Tim Hutton, CPCU, AFSB
timothyjhutton@gmail.com
(703) 220-7771
Since bonded principals must pass through a rigorous level of underwriting prior to establishment of their bond line, the surety (with all of the resultant underwriting knowledge) should be viewed as a business ally and contacted frequently for advice and direction. In this way, the surety operates as an ‘extra set of eyes’ in matters regarding the principal’s business plan, their competition, and the local business environment. To only call on one’s surety for advice/direction when a bond is needed, is missing the chance for advice and guidance from a business ally. (Remember: the surety is a
for-profit entity that wants to write many bonds for you. By routinely seeking their input/direction, you ‘cement’ your relationship with the market and you can gain valuable information with which to better your company.)
Another overlooked benefit of an established surety relationship is in new business acquisition. Too often, contractors only react to bond requirements (hurdles) when they can/should be proactive and offer a bond to potential owners even when a bond is not required. (The premium for the bond can be passed on to the owner in your bid.)
Let’s assume: Contractor A established a bond line because Owner B required a bond of Contractor A. So, Contractor A sought the services of an experienced surety broker who assisted in establishing a surety line with Surety C. The contract was signed, the work was completed, and the bond was released. Now, let’s further assume that Contractor 1 is in negotiations with Owner D and Owner D’s contract makes no mention of a performance bond requirement. With an established bond line, Contractor A may have an advantage over his competition. (If the competition is not bonded and/or bondable, then bring that to the owner’s attention!) Why not offer Owner D a letter of bondability from your broker that glowingly states that you are bonded and backed by a highly rated surety and that your surety would look favorably on providing a bond for the job in question if asked. By bringing to the attention of the owner the fact that your firm is bondable, you immediately drive a wedge between your competition and the owner. (“Why doesn’t this other company have one of these ‘bondability’ letters?)
As touched on above, another benefit of an established bond line is the ally you have in your surety. When/if a dispute and/or claim should arise, the surety will not simply ‘pay’ the owner. The owner’s claim must be proved and the surety is there, as your ally, between you and the owner seeking to settle the claim. This alliance should not be underestimated…the surety wants your firm to succeed. When you succeed, the surety succeeds, when you lose, they lose. As a for-profit entity, the surety has a vested interest in making sure your firm is around for a long time and that you will continue to win new bonded work which will result in new bond premiums for the surety.
Don’t overlook the advantages of your surety line!
Tim Hutton, CPCU, AFSB
timothyjhutton@gmail.com
(703) 220-7771
Friday, September 25, 2009
Commercial Insurance and the H1N1 Flu
Commercial Insurance and the H1N1 Flu
The anticipated ‘outbreak’ of the H1N1 flu has certainly raised personal concerns for many people. However, business owners must also be concerned and prepared for the flu’s potential impact on their businesses and, working with their agent/broker, must examine the coverage that may or may not exist in their commercial insurance programs.
Since a true ‘outbreak’ would be a first time event, it makes the various coverage scenarios difficult to predict as there is no existing case law surrounding such an event. An ‘outbreak’ of the H1N1 flu could have an impact on any or all of the commercial insurance policies below (along with others):
>Workers’ Compensation (A “disease” acquired as a result of one’s work is generally covered under most WC policies, but, how would an employee prove they contracted the flu at work/as a result of their work?)
>Business Interruption - Business interruption coverage protects a business from losses due to unavoidable interruptions in their business operations, however, this is a property policy and the required coverage ‘trigger’ is physical damage. Since an outbreak of flu would not be considered “physical damage”, coverage may not apply.
>General Liability – This policy includes coverage for third party claims for bodily injury (such as a ‘slip and fall’ injury). However, the flu may not meet the GL policy’s definition of ‘bodily injury” and the GL policy may include exclusions that limit or deny coverage for bodily injury related to infectious disease and/or “organic pathogens”.
To respond to the potential gaps in coverage, some insurance carriers are offering new policies providing extra expense coverage for a suspension of operations by a public health official. Since these policies are new, careful attention must be paid to the terms and limitations contained therein. (These policies are generally written on a ‘non-admitted’ basis, have limited coverage per location, have strict exclusions, and can be very expensive.)
Given the exposures outlined above, a careful review of one’s current commercial insurance program with a qualified insurance agent/broker is certainly warranted.
Timothy J. Hutton, CPCU, AFSB
timothyjhutton@gmail.com
LinkedIn Profile: http://www.linkedin.com/pub/0/190/12b
The anticipated ‘outbreak’ of the H1N1 flu has certainly raised personal concerns for many people. However, business owners must also be concerned and prepared for the flu’s potential impact on their businesses and, working with their agent/broker, must examine the coverage that may or may not exist in their commercial insurance programs.
Since a true ‘outbreak’ would be a first time event, it makes the various coverage scenarios difficult to predict as there is no existing case law surrounding such an event. An ‘outbreak’ of the H1N1 flu could have an impact on any or all of the commercial insurance policies below (along with others):
>Workers’ Compensation (A “disease” acquired as a result of one’s work is generally covered under most WC policies, but, how would an employee prove they contracted the flu at work/as a result of their work?)
>Business Interruption - Business interruption coverage protects a business from losses due to unavoidable interruptions in their business operations, however, this is a property policy and the required coverage ‘trigger’ is physical damage. Since an outbreak of flu would not be considered “physical damage”, coverage may not apply.
>General Liability – This policy includes coverage for third party claims for bodily injury (such as a ‘slip and fall’ injury). However, the flu may not meet the GL policy’s definition of ‘bodily injury” and the GL policy may include exclusions that limit or deny coverage for bodily injury related to infectious disease and/or “organic pathogens”.
To respond to the potential gaps in coverage, some insurance carriers are offering new policies providing extra expense coverage for a suspension of operations by a public health official. Since these policies are new, careful attention must be paid to the terms and limitations contained therein. (These policies are generally written on a ‘non-admitted’ basis, have limited coverage per location, have strict exclusions, and can be very expensive.)
Given the exposures outlined above, a careful review of one’s current commercial insurance program with a qualified insurance agent/broker is certainly warranted.
Timothy J. Hutton, CPCU, AFSB
timothyjhutton@gmail.com
LinkedIn Profile: http://www.linkedin.com/pub/0/190/12b
Friday, August 14, 2009
Avoid the "Stovepipes"!
By purchasing insurance from a variety of carriers, in a “stovepipe” fashion, insurance buyers can expose their firms to an uncovered loss and/or an overly complicated loss/claim scenario. Therefore, when analyzing your commercial insurance program, keep in mind the benefits of purchasing all of your insurance policies from the same carrier.
Frequently, a given company’s insurance program may look something like this:
Workers Compensation (WC), General Liability (GL), Property, Auto, and Umbrella from INSURANCE CARRIER 1…
Errors and Omissions (E&O) from INSURANCE CARRIER 2…
Directors & Officers (D&O) from INSURANCE CARRIER 3
Employment Practices Liability (EPL) from INSURANCE CARRIER 4, and so on….
Consider what may happen when a claim includes aspects covered by Insurance Carrier 1’s policy AND Insurance Carrier 2’s policy? For example, what if a claim included both bodily injury aspects (covered under GL) and financial harm aspects (covered under E&O)? Depending on the set of facts surrounding the claim, you could have a situation where Insurance Carrier 1 declines because of the Financial Harm aspects (which are excluded under their GL policy) and Insurance Carrier 2 declines because of the Bodily Injury aspects (which are excluded under their E&O policy). Another example would be a claim that included allegations covering both the Directors & Officers Liability policy and the Employment Practices Liability policy. Consider also a situation with an excess Umbrella from Carrier 5 on top of the entire program? Would coverage under the Umbrella be triggered? As you can see, the possibilities of ‘combined’ claims are extensive.
By purchasing different lines of coverage from the same insurance carrier, (without ‘stovepipes’), the claim will ‘fit’ somewhere within the various scopes of coverage of the policies issued by the single carrier. Similarly, the payment/processing of the claim should proceed in a more streamlined, timely, fashion since the single carrier will recognize that they will not have to ‘do battle’/negotiate with a competitor over the claim.
Of course, this premise must be compared to the potential costs savings and/or coverage enhancements that may be achieved through purchasing insurance policies from different carriers. Regardless of which approach is adopted, attention to this matter is warranted and advisable.
Frequently, a given company’s insurance program may look something like this:
Workers Compensation (WC), General Liability (GL), Property, Auto, and Umbrella from INSURANCE CARRIER 1…
Errors and Omissions (E&O) from INSURANCE CARRIER 2…
Directors & Officers (D&O) from INSURANCE CARRIER 3
Employment Practices Liability (EPL) from INSURANCE CARRIER 4, and so on….
Consider what may happen when a claim includes aspects covered by Insurance Carrier 1’s policy AND Insurance Carrier 2’s policy? For example, what if a claim included both bodily injury aspects (covered under GL) and financial harm aspects (covered under E&O)? Depending on the set of facts surrounding the claim, you could have a situation where Insurance Carrier 1 declines because of the Financial Harm aspects (which are excluded under their GL policy) and Insurance Carrier 2 declines because of the Bodily Injury aspects (which are excluded under their E&O policy). Another example would be a claim that included allegations covering both the Directors & Officers Liability policy and the Employment Practices Liability policy. Consider also a situation with an excess Umbrella from Carrier 5 on top of the entire program? Would coverage under the Umbrella be triggered? As you can see, the possibilities of ‘combined’ claims are extensive.
By purchasing different lines of coverage from the same insurance carrier, (without ‘stovepipes’), the claim will ‘fit’ somewhere within the various scopes of coverage of the policies issued by the single carrier. Similarly, the payment/processing of the claim should proceed in a more streamlined, timely, fashion since the single carrier will recognize that they will not have to ‘do battle’/negotiate with a competitor over the claim.
Of course, this premise must be compared to the potential costs savings and/or coverage enhancements that may be achieved through purchasing insurance policies from different carriers. Regardless of which approach is adopted, attention to this matter is warranted and advisable.
Wednesday, July 15, 2009
Insurance Market Cycles and Surety Reinsurance: How Do They Impact a Contractor’s Surety Line?
Insurance markets tend to run in cycles of ‘hard markets’ and ‘soft markets’. Simply stated, a ‘hard market’ exists when underwriting terms and conditions favor the insurance provider and a ‘soft market’ exists when underwriting terms and conditions favor the insurance purchaser. These hard and soft market cycles can last years and can change slowly or quickly depending on a number of issues. One thing that is certain: the cycles always occur.
When a given insurance market is ‘hard’ and capacity is tight, the following takes place: prices increase, underwriting rules become more conservative, and losses moderate. Eventually, new capacity enters the market. As excess capacity grows and becomes overabundant, a ‘soft’ develops with the following characteristics: prices will decrease, underwriting will become more liberal, losses will increase and the market begins to harden; launching a new cycle.
Like all other insurance markets, the surety reinsurance market runs in cycles. In fact, the hard/soft status of the surety reinsurance market affects the hard/soft status of the overall surety market. To understand the impact of surety reinsurance on a given contractor’s surety line, one must first examine and understand reinsurance in general. A quick definition of reinsurance is, simply, insurance purchased by and for the benefit of insurance companies.
Through the purchase of reinsurance, an insurance company cedes some of its overall exposure and transfers some of its risk to the reinsurer. Thus, reinsurance serves to protect the ceding insurer from exceptionally large, unanticipated losses. Reinsurance also helps insurers diversify their books of business, it enables insurers to provide increased capacity, and it ‘smoothes out’ underwriting results.
Surety reinsurance is one form of reinsurance that is purchased by sureties to back a given surety company’s surety results. It is usually purchased in one of two forms:
>Facultative – surety reinsurance written on a per risk basis, or
>Treaty – automatic protection for an entire class of business/covers the portfolio. Reinsurance is further broken down into the two following classes:
>Pro Rata – here, the reinsurer assumes a portion, or pro rata, share of each loss, and,
>Excess of Loss – the reinsurer assumes losses only over a mutually agreeable dollar threshold.
When a contractor’s supplier/subcontractor increases rates for their product/service, contractors will ‘pass through’ to an owner, the increased costs placed on them by the suppliers and/or subcontractors. Similarly, the surety industry will ‘pass through’ to contractors the increased rates, the more stringent underwriting criteria, and the many exclusions/restrictions placed on them by the surety reinsurers.
As you review the terms and conditions of your surety line with your agent/broker, keep in mind that the terms are, at least in part, reflective of the surety reinsurance marketplace. Insurance cycles are dynamic and in a constant state of flux. As surety results improve/decline...new surety reinsurance capacity will emerge/contract, terms and conditions will be relaxed/strengthened and these conditions will be passed on to the surety markets who, in turn, will pass them on to the contractors…and the cycle will continue....
Timothy J. Hutton, AFSB, CPCU
mobile (703) 220 - 7771
timothyjhutton@gmail.com
When a given insurance market is ‘hard’ and capacity is tight, the following takes place: prices increase, underwriting rules become more conservative, and losses moderate. Eventually, new capacity enters the market. As excess capacity grows and becomes overabundant, a ‘soft’ develops with the following characteristics: prices will decrease, underwriting will become more liberal, losses will increase and the market begins to harden; launching a new cycle.
Like all other insurance markets, the surety reinsurance market runs in cycles. In fact, the hard/soft status of the surety reinsurance market affects the hard/soft status of the overall surety market. To understand the impact of surety reinsurance on a given contractor’s surety line, one must first examine and understand reinsurance in general. A quick definition of reinsurance is, simply, insurance purchased by and for the benefit of insurance companies.
Through the purchase of reinsurance, an insurance company cedes some of its overall exposure and transfers some of its risk to the reinsurer. Thus, reinsurance serves to protect the ceding insurer from exceptionally large, unanticipated losses. Reinsurance also helps insurers diversify their books of business, it enables insurers to provide increased capacity, and it ‘smoothes out’ underwriting results.
Surety reinsurance is one form of reinsurance that is purchased by sureties to back a given surety company’s surety results. It is usually purchased in one of two forms:
>Facultative – surety reinsurance written on a per risk basis, or
>Treaty – automatic protection for an entire class of business/covers the portfolio. Reinsurance is further broken down into the two following classes:
>Pro Rata – here, the reinsurer assumes a portion, or pro rata, share of each loss, and,
>Excess of Loss – the reinsurer assumes losses only over a mutually agreeable dollar threshold.
When a contractor’s supplier/subcontractor increases rates for their product/service, contractors will ‘pass through’ to an owner, the increased costs placed on them by the suppliers and/or subcontractors. Similarly, the surety industry will ‘pass through’ to contractors the increased rates, the more stringent underwriting criteria, and the many exclusions/restrictions placed on them by the surety reinsurers.
As you review the terms and conditions of your surety line with your agent/broker, keep in mind that the terms are, at least in part, reflective of the surety reinsurance marketplace. Insurance cycles are dynamic and in a constant state of flux. As surety results improve/decline...new surety reinsurance capacity will emerge/contract, terms and conditions will be relaxed/strengthened and these conditions will be passed on to the surety markets who, in turn, will pass them on to the contractors…and the cycle will continue....
Timothy J. Hutton, AFSB, CPCU
mobile (703) 220 - 7771
timothyjhutton@gmail.com
Monday, July 6, 2009
*What does the Blog title mean?!
Many hold that modern commercial insurance started in the mid 1600's at Edward Lloyd's coffee shop which was a popular meeting place for local merchants and shippers. To insure a shipment and earn a premium, a wealthy merchant would 'write' their name 'under' the description of the vessel/voyage posted on the wall of Mr. Lloyd's coffee shop. For a premium, the shippers were able to transfer risk to these 'underwriters' and make their voyages feasible ventures. This process of transferring risk continues today with insurance carriers 'underwriting' various risk transfer offers from brokers and their clients.
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