Masonry Magazine April 1979 Page. 7
CONTRACT SURETY BONDING:
How It Works and How To Obtain It
By C. D. DRAKE
Vice President
Insurance Company of North America (INA)
Have you had difficulty obtaining surety bonds recently? If you're like many specialty contractors, in recent months you've probably been subjected to more questions, requests for more information and, in general, more caution on the part of your bonding company. For many smaller and less experienced contractors, obtaining bonds is often next to impossible. To understand why this happens, you should know something about how surety or performance bonding works and what its real purpose is.
Bonding is essentially a credit function. It guarantees, in effect, that the bonded contractor will complete a specific job in accordance with plans, specifications and schedules. If he fails to complete the job, the surety company will either finance it through to completion or get bids from other contractors who will complete the project.
One of the primary benefits government agencies or owners derive from bonding is the prequalification service performed by the surety. By requiring performance and payment bonds from all bidders, the owner is not only protecting himself from failure to perform, he is also eliminating those contractors without the organization, equipment knowledge and finances to do the job properly.
The Three C's of Surety
To prequalify contractors, bonding companies use as their standard what are known as the "three C's"- Capacity, Capital and Character.
About the Author
C. Daniel Drake, CPCU. was elected vice president of Insurance Company of North America in December, 1973. He directs the company's bonding department in the underwriting management division. Mr. Drake joined INA in 1949 as a student trainee in the Philadelphia service office. He served as a bond specialist in the Newark, Buffalo and Syracuse service offices prior to becoming bond superintendent in San Diego in 1956. Mr. Drake was named assistant manager of the Pittsburgh service office in 1962 and moved to INA headquarters in Philadelphia in 1967 as deputy underwriter. He was elected assistant secretary in 1968, secretary the following year, and assistant vice president in 1972. A graduate of Haverford College, Mr. Drake is the recipient of the Chartered Property and Casualty Underwriters designation.
To determine if a contractor has the capacity requirement, the bonding company evaluates his equipment, his experience and his management practices. Does he have the equipment needed for the particular job? Does he have the experience? After all, there's a big difference between building a $100,000 house and a $5 million office building.
The surety company will investigate the types of work the contractor has done in the past to determine whether the work he is bidding on is similar to work he has done before. A contractor who has built interstate highways would not necessarily have the experience to build subway tunnels.
As for the capital requirement, few individuals, if suddenly cast in an underwriter's role, would want to bond or give credit to an individual who did not have adequate funds to finance the total workload underway, including its problems as well as its opportunities. And the smaller the company and the less experience it has, the more likely it is to fail.
What Surety Company Wants to Know
This is why the surety company insists on knowing what kind of bank line of credit the contractor has, whether he has an opinion statement from a certified public accountant, what his liquidity and net worth are. In reviewing the contractor's financial statement, the surety company will examine his various ratios debt to net worth, earnings to net revenues, etc. The company will also review the contractor's financial records over at least three years, and possibly longer.
The extent of the analysis of financial statements will differ with every bonding company and often depends on the quality of the financial statement the contractor has provided. A few years back, it was possible to operate with rather casual financial records prepared by the contractor, his wife, a bookkeeper, accountant or CPA without audit or verification. Today, operating in this way can present problems.
Because there are so many different methods and procedures a contractor can use to measure his costs and prepare his financial statement, it is still often very difficult for a surety company to understand the true financial position of a contractor, even with well prepared audited figures, unless the company understands fully the contractor's accounting systems, cost control operations, etc.
Depending on the accounting method used to prepare the financial report, an entirely different picture of the contractor's financial condition can be obtained.
This is why every contractor, regardless of size, ought to have a good workable cost control system which fits his operation so that he knows where he stands on his work in process at all times. And this information should be