Monthly Archives: October 2015

Comparing Surety Bonds and Insurance Part Two

In our last installment we began comparing surety bonds and insurance.  Many people are under the misconception that because of the similarities between surety bonds and the fact that often insurance companies offer them that they too are a form of insurance.  This however is not true.  As we previously discussed surety bonds are an agreement between three parties as well as that with a surety bond a loss is not expected instead a guarantee in case an obligation is not met.  Insurance on the other hand is an agreement between two parties where a loss is expected.  At some point you expect an insurance policy will pay out whereas with a surety bond you don’t expect to ever have to receive a payout.

A company offering surety bonds expect to recover any losses occurred.  If the principal defaults on the contract and the surety bond have to pay the obligee the surety expects to get repaid from the principal.  The surety has loaned assets to the principal and therefore will seek reimbursement.  Insurance claims are never expected to be repaid.  In fact with an insurance policy a claim is expected.  The whole purpose of insurance is to cover any losses the insured has experienced.

When the premium is paid on a surety bond it is acting as a service charge for the bond by the principal.  In fact surety companies get to be incredibly selective when choosing companies that they agree to bond.  This is because bonds serve as a non-collateral loan unlike a car or mortgage payment.  A surety company asks for a fee anywhere from half a percent to three percent of the contract amount.  The fee will be dependent upon the financial strength of the principal.  The premium is usually paid on an annual basis.

This is different than insurance premiums in that the premium that is paid is to cover the expenses and losses that are expected to occur. An insurance policy is something that nearly everyone can be issued.  The premium that is paid will depend upon the risk of the person or people being insured.  The greater risk to the insurance company the higher the premium.

As previously stated, surety companies are incredibly careful when choosing companies that they bond.  Years of running a successful business, financial stability and a record of completing projects on time and within the projected budget allotted within the original contract.  Agents handing out surety bonds are trained to ensure they don’t make loans that will default.

Insurance agents however are a lot more flexible when it comes to writing insurance policies.  Insurance companies offer up a higher volume of business in order to make a profit as well as cover any losses experienced.  This allows agents to be flexible with whom they offer insurance policies to.  Although as an example, if a car owner is seeking insurance and they have been in multiple accidents they will pay a higher premium then a client who has not been involved in an accident or had a previous ticket.

There are key distinctions between surety bonds and insurance policies.  Although they function differently they both meet a need that protect someone from experiencing a loss.

Construction Bonding Specialists, LLC are dedicated Surety Bond Professionals that are aligned with several Treasury Listed and AMBest Rated Surety markets which allows them to assist with virtually all Bid, Performance and Payment, Financial Guarantee and Supply bond needs.  Find out more information at http://www.bondingspecialist.com.

Comparing Surety Bonds and Insurance Part One

Most people assume that because surety bonds are offered through an insurance company that a surety bond is a type of insurance policy.  This however is untrue.  Even though surety bonds and insurance policies have a few insignificant likenesses they are not the same thing at all.  In this installment we will discuss the differences between surety bonds and insurance.

The first difference between surety bonds and insurance is the number of individuals involved in the agreement.  With a surety bond there is a three-party agreement that connects the bond issuer, who is known as the surety, with the second party, who is the principal, into a financial guarantee to the third party, who is known as the obligee.  The agreement states that principal fulfills the obligations set forth in the contract.  The principal relies on the monetary power of the surety in order to acquire a contract with the obligee.

The difference with insurance is that the agreement between two parties; the two parties being the insurance company and the insured.  This arrangement is in place to guarantee that if the insured has a loss or is damaged the insurance company agrees to pay an amount set forth in the original policy.

Another distinction between surety bonds and insurance is that losses are not to be expected under a surety bond.  The contracting company to which the bond is issued needs to be financially stout and secure to be eligible for bonding.  The surety company carries out a thorough background check into the contractor’s character, their credit worthiness, the talent and capability to finish a project as contracted.

It is also important that they meet the specific check points in place within the contract.  A surety bond is sought out because the contractor is asked to provide one because the project owner mandates it.   The surety bond amount decreases as certain check points, which are stated in the contract, are met.  Less surety is needed as the job gets closer to the agreed upon end.  As each stage is completed the contractor is required to carry less surety to meet their obligation to the project owner.

An insurance policy is purchased because a loss is eventually expected.  The insurance policy rates are always changing and need to be adjusted based on the law of averages, expenses and losses.  A perfect example is when purchasing car insurance.  The rates are high at first because the expense is greater to cover the amount owed on the car loan.  If the car is in an accident a large amount of money is needed to cover the expense of repair or to cover the payoff on the loan.  As time passes the amount owed becomes less and less, the expense to repair the car decreases and because of all of these factors the insurance policy costs decrease.

In our next installment we will look at more comparisons between surety bonds and insurance companies.  These two very different industries and products have qualities that are similar but they are indeed two very different things when side by side comparisons are completed.

Construction Bonding Specialists, LLC are dedicated Surety Bond Professionals that are aligned with several Treasury Listed and AMBest Rated Surety markets which allows them to assist with virtually all Bid, Performance and Payment, Financial Guarantee and Supply bond needs.  Find out more information at http://www.bondingspecialist.com.

A brief look at common construction loan credit enhancements

As the competition for construction loan projects remains at unprecedented levels in much of the country, lenders are frequently being asked to waive, modify or re-visit their standard construction loan credit enhancement requirements. The following is a brief look at some of the more common credit enhancements required by lenders and the benefits and shortcomings of each.

Guarantees. Guarantees continue to be the most common credit enhancement for balance sheet lenders on small and medium-sized construction loans. Lenders generally obtain either a payment guaranty, a completion guaranty or some combination of the two from key principals of the developer.  Obtaining guarantees from developers with significant assets and liquidity is obviously ideal, however, obtaining guarantees from principals with limited financial resources can still be helpful as these principals are less likely to walk away from a project with the threat of the enforcement of a guaranty hanging over them.

Payment guarantees are best, but they may not always be available due to the competitive landscape for a particular project or developer. Completion guarantees, while helpful for the same “skin in the game” reason pointed out above, tend to be far less reliable credit enhancements for a lender.  Generally, courts will not require the guarantor on a completion guarantee to “specifically perform” the developer’s obligations under the loan and cause the completion of project. Instead, a lender will need to sue the completion guarantor for the damages the lender has incurred as a result of the project not being completed under the terms agreed to in the construction loan documents. Damages under a completion guarantee can be fairly difficult to prove and require expert witness testimony. The damages are subject to varying calculations based on competing appraisals presented by the lender and guarantor and oftentimes will be non-existent if the current value of the land and the partially-completed project are determined to exceed the outstanding balance of the loan.

Payment and Performance Bonds. Payment and Performance Bonds (P&P Bonds) are often a standard requirement for construction lenders, but, like guarantees, pose their own set of limitations. A P&P Bond is an insurance contract made by a surety company under which it insures that its “bonded” contractor will (1) complete a construction project under the terms agreed to by the contractor and the developer and (2) pay its subcontractors. A construction lender may become a beneficiary of a P&P Bond by being named by the surety company as a “co-obligee” pursuant to a dual-obligee rider attached to the P&P Bond.

While P&P Bonds can be very useful to construction lenders (especially in instances involving inexperienced or undercapitalized developers), they often can be difficult to obtain.  Not only do they drive up the cost of a project, P&P Bonds are generally only available to more established and well-capitalized general contractors. Even when available, P&P Bonds can be difficult to collect on as a result of shortened deadlines in which to assert claims and other standard limitations and restrictions contained in the bonds, resulting in protracted and expensive litigation to determine a construction lender’s actual coverage under the bonds.

Letters of Credit. Letters of Credit tend to be less common credit enhancements for a lender providing construction financing, but can serve as an attractive alternative when P&P Bonds are not a viable option. An irrevocable, standby letter of credit is the unconditional obligation of an issuing bank to, for a specified period of time, pay the beneficiary of the Letter of Credit (i.e., the construction lender) all or some portion of the face amount of the Letter of Credit upon the beneficiary’s demand and presentment of the Letter of Credit to the issuer. The terms of the loan agreement detail when the construction lender may draw upon the Letter of Credit – typically, an event of default under the loan or the failure of the borrower to renew the Letter of Credit prior to construction completion or loan repayment.

Unlike P&P Bonds and Guarantees, Letters of Credit provide, for the most part, more readily available access to cash for a construction lender and fewer obstacles to obtaining it.  Like P&P Bonds, however, Letters of Credit are expensive (even more so) and require that the applicant-developer either be well capitalized, provide collateral security to the issuer, or both.

Each of the above credit enhancements continues to play a significant role in construction financing.  Understanding the economics, benefits and limitations of each is a critical component to determining when and how each may be used to enhance the credit of a construction loan.

Original Source: https://www.lexology.com/library/detail.aspx?g=54e6743b-c2b1-40d1-a9a0-314bca5a1c91