Understanding Surety Bond Collateral Requirements
September 14, 2021
In certain circumstances, your customers may be required to put up collateral to qualify for surety bond coverage. When faced with collateral requirements, your customers are likely to ask you something along the lines of “why do I need to put up assets as a prerequisite to obtaining insurance coverage? It’s not like I’m taking out a loan or buying a house.” So why do surety companies require collateral? Long story short, to protect themselves from losses if your customer cannot repay them for valid bond claims. In this week’s blog article, we provide insurance agents with a comprehensive guide to surety bond collateral requirements, helping you better assist your surety customers.
Why Do Surety Companies Require Collateral?
As mentioned above, surety companies require collateral to offset their level of exposure in the event a valid claim is filed against the bond. This is the part that generally trips up most agents who are used to dealing in more traditional insurance lines such as home and auto. To better grasp this concept, agents need to adjust their perception on what surety bonds are. Surety bonds are technically insurance. However, they don’t protect your customer from harm, rather the entity requiring them to be bonded (obligee). Additionally, surety bonds are subject to indemnification, which means that your customers are legally required to repay the surety company for valid bond claims.
Think of surety bonds as a line of credit extended to your customer, by the surety, that ensures the obligee will receive compensation should your customer violate the bond provisions. So when your customer asks why they are required to put up collateral prior to obtaining bond coverage, simply inform them that surety bonds aren’t actually protecting them, and the indemnity aspect of these bonds means surety companies will sometimes implement collateral requirements to further ensure they don’t suffer losses if a valid claim were to occur.
When Do Surety Companies Require Collateral?
Surety companies will rarely require your customers to put up collateral, and typically only implement this requirement for non-standard lines and judicial bonds. To add a bit of context, “non-standard line” is a term used to describe bonds issued to principals (your customers) who are considered too risky to qualify for standard premium rates. But what causes your customer to be considered risky? Generally speaking, if your customer has poor credit and weak business financial statements then they may need to put up collateral to obtain bond coverage. For more information on how surety companies classify risk, check out our article on surety underwriting requirements. Additionally, judicial bonds will typically require some form of collateral prior to issuance. There are multiple different types of judicial bonds, as outlined below:
Injunction
Ensures that the plaintiff will pay all costs and fees suffered by the defendant in the event an a court deems the injunction should not have been issued.
Appeal
After a lawsuit has been tried and the court has rendered a judgment, the losing party may wish to appeal the decision to a higher court. Plaintiffs and defendants are usually required to furnish an appeal bond before a higher court will hear the appeal.
Supersedeas
Required for defendants seeking to appeal a court’s ruling. The bond ensures the plaintiff will receive compensation in the event the defendant loses the appeal and is unable to pay out the judgment. Also referred to as an “Appeal Bond”.
Surety companies generally require 100% of the bond amount in collateral for these types of bonds.
What Types of Collateral Do Surety Companies Accept?
The most common form of collateral used in the surety industry is cash. To submit cash collateral, your customer can simply write a cashier’s check to the surety company or conduct a wire transfer. However, if your customer doesn’t have the required cash on hand, or simply does not wish to tie up their working capital, then surety companies will sometimes accept the following substitute:
Letter of Credit
A promissory note, backed by a financial institution, guaranteeing the surety company will receive payment. Surety companies consider LOCs to be very secure, as they are guaranteed payment. However, using an LOC to cover collateral requirements doesn’t make much sense, as financial institutions will often require the full LOC amount to be set aside in a trust account, therefore defeating the purpose.
How Long Will Surety Companies Hold Collateral For?
Surety companies will hold onto collateral until their liability to repay bond claims has extinguished. Depending on the bond type, the surety’s liability can sometimes last for years after the bond has expired. Each surety company will have a unique collateral receipt and security agreement outlining the terms of the collateral they are holding. It is important to thoroughly review this document as it will outline the conditions by which the collateral may be released to the customer.
Collateral requirements are rare, and are generally only required for non-standard lines and judicial bonds. If your customers do need to put up collateral, guide them through the process by explaining that these requirements are necessary to protect the surety, and that claims made against a surety bond are completely avoidable. Your customer has full control over whether they will lose the collateral offered up, and as long as they comply with their bond’s provisions, they shouldn’t have any claims made against them.
How Can an Insurance Agent Obtain a Surety Bond?
BondExchange makes obtaining a surety bond easy. Simply login to your account and use our keyword search to find their bond in our database. Don’t have a login? Enroll now and let us help you satisfy your customers’ needs. Our friendly underwriting staff is available by phone (800) 438-1162, email or chat from 7:30 AM to 7:00 PM EST to assist you.
At BondExchange, our 40 years of experience, leading technology, and access to markets ensures that we have the knowledge and resources to provide your clients with fast and friendly service whether obtaining quotes or issuing bonds.