Fourth installment in The Evolving Risks series: surety bonds for small businesses

In this post, we'll delve into the evolving landscape of surety bonds, exploring their increased importance, how they differ from other insurance products, the opportunities they present for agents and customers, and ways commercial agents can effectively guide business owners in securing this valuable risk management tool.

The Surety and Fidelity Association of America states “No other risk management product provides the comprehensive protection that surety bonds provide. Bonds serve as a critical risk management and public policy function, protecting small businesses, workers, and taxpayers, creating economic growth, and enabling innovation. A business will demonstrate its commitment to financial responsibility and ethical business practices by purchasing a surety bond.”

What are surety bonds and who needs them?

Simply put, surety bonds are risk management tools that help guarantee that contractual obligations will be fulfilled. 

According to the Insurance Training Center, “A surety bond guarantees performance as contracted or provides security. The bond doesn’t protect the buyer of the bond but rather a third party who is at risk of experiencing a loss.”

A variety of businesses and individuals, including construction companies, service providers, retailers, government agencies and contractors, and more, use the two general categories of surety bonds: “contract” and “commercial” (with subcategories within each general category). 

Joe Perschy, President of Propeller, highlighted in a recent interview the importance of surety bonds in protecting investments and why they are a crucial risk management tool, “Bonds provide financial security, enhance credibility, and create a foundation for trust between the small business and its stakeholders, whether they are clients, suppliers, or government entities. The ability to obtain and fulfill bond requirements is often integral to a small business's growth and success.”

Because of the financial and reputational role surety bonds play in a business’s success, and the recent increase in their demand that we’ll touch upon below, the market is experiencing substantial growth. According to Business Market Insights, “The North America surety market was valued at US$ 8.57 billion in 2019 and is expected to grow at a compound annual growth rate (CAGR) of 6.4% during the forecast period to reach US$ 13.49 billion by 2027.”

Surety bonds vs. general liability insurance

Despite their importance and increased prevalence, surety bonds are often misunderstood. While both general liability (GL) insurance and bonds are risk mitigators that offer financial protection to businesses, they serve different purposes and provide different types of coverage. As a trusted advisor to small and medium-sized businesses (SMBs), it’s important to educate them on these differences in order to find them the right coverage. 

One difference is in the number of parties involved. There are three parties involved in surety bonds (the principal, the obligee, and the surety), while in GL there are two parties (the insurer and the insured party). The bond doesn’t protect the buyer of the bond (the principal) but rather a third party (the obligee) who is at risk of experiencing a loss. They provide assurance to the obligee (the party requiring the bond) that the principal (the party obtaining the bond) will fulfill their contractual or legal obligations, with the surety (the party issuing the bond) providing financial compensation if the principal fails to do so. For example, a customer files a claim against a contractor for not completing the house addition according to the terms of the contract. The surety company will pay the customer the cost to rehire another contractor to complete the work.

Another key difference is who receives the money if a claim is filed. Surety bonds provide financial compensation to the obligee up to the bonds’ face value, or bond amount. Also good to know is that the face value of the bond is a factor in the price of the bond.

General liability insurance compensates and protects the business owner for losses that are covered by the insurance policy.  GL covers claims for bodily injury or property damage caused to third parties due to the business's operations, products, or services.

Another key distinction is that GL insurance premiums are based on risk assessment. The cost of a surety bond is based on other variables such as the policyholders’: location, i.e., economically stable regions are more favorable; type of industry, i.e., industries with stable cash flows and low risk gain are more favorable; and credit rating, profitability, and overall financial stability, i.e., stronger is better. The size of the business might also affect the surety bond terms, as larger businesses with more assets might appear less risky to bond investors. We’ll discuss how business size is an evolving factor below.

Surety Bonds represent cross-selling opportunities

Once the commercial agent has had the opportunity to outline the differences between GL and surety bonds, Taylor Rutledge, Chief Growth Officer of Propeller, added that it’s important to address the misconceptions and use them as cross-selling opportunities for those in need of proper protection.

“Small business owners might mistakenly believe that their general liability insurance covers all risks, including those related to bonds. Insurance agents need to clarify the distinctions between general business insurance and bond coverage, emphasizing that bonds serve specific purposes, such as guaranteeing performance or protecting against employee dishonesty.”

Additionally, a typical SMB in need of a surety bond might take on multiple projects throughout a year, creating multiple cross-selling opportunities for an agent, as compared to a standalone general liability renewal which would happen once a year. 

Recent trends in surety bonds

We’ve outlined three important trends for agents serving SMBs to watch:

Regulatory changes bring increased demand

Several recently passed federal statutes will contribute to the increased demand and opportunity for surety bonds, including the Infrastructure Investment and Jobs Act, (also known as the Bipartisan Infrastructure Law) with $1.2 trillion invested in public construction projects and the Inflation Reduction Act of 2022 and the CHIPS and Science Act which will likely create more construction projects. Projects like these, ultimately designed to support technology and clean energy initiatives domestically, typically require bonding and insurance for contractors.

Increased access to surety bonds for contractors

And while a wide range of SMBs in various industries (retail, manufacturing, etc.) benefit from these trends, perhaps they are most beneficial for trade professionals such as contractors, who are often required to submit proof of bond purchase for a permit or per contract terms in order to bid on construction projects and ensure project completion. A 2022 Insurance Marketplace Realities study states, “We do not expect a hardening of the surety market due to healthy U.S. construction output, which is anticipated to grow 4% in 2023”. 

This mutually beneficial accessibility trend between surety bond issuance and contractors has proven to help the SMBs as well. In a 2022 Economic Value Of Surety Bonds report, “75% of owners/developers surveyed reported that surety bonding reduces contractor pricing,” and “unbonded construction projects on which the contractor defaults were found to have a cost of completion 85% higher than projects protected by surety bonds."

Insurtech brought innovations

Insurtech has improved the accessibility for SMBs to acquire bonds. It’s no longer only for the large companies with the deepest pockets. Rutledge says, “It’s never been easier for small businesses to procure surety bonds thanks to improvements in both technology and competition among surety companies. It used to be that small businesses were subject to substantially the same procedures to apply for bonds as larger companies, making smaller companies at a disadvantage for an underwriter’s time and attention. However, most surety companies are now eager to solicit those [smaller companies’] risks to balance out the larger, potentially catastrophic risks they assume on larger companies.”

Additionally, technology has made the application process more efficient. Perschy added, “Much of the routine surety needs for small companies are now ‘instant issue’ in the surety world, meaning the carriers will request very little information to approve a bond.”

How agents can help SMBs with surety bonds

There are three key ways agents can help SMBs with surety bonds:

Stay current and educate yourself

Surety bonds can be complicated, especially if you are new to commercial insurance. Even experienced agents can benefit from many great continuing education opportunities, such as from the National Association of Surety Bond Producers, to feel confident about all things surety bonds. Agents should also stay current on regulatory changes mandated by local, state, or federal authorities. 

Once an agent has taken the time to educate themselves, pass that knowledge on to your customer via interactive platforms such as webinars, video tutorials, and podcasts to disseminate information. Perschy continued, “Agents should take the time to thoroughly explain the different types of bonds and their specific purposes. Providing real-life examples and scenarios relevant to the small business's industry can help them grasp the significance of each bond type.”

Demystify the costs

Small businesses may not even inquire about surety bonds due to perceived costs. Rutledge further explains that both parties will benefit from breaking down this misconception by “explaining how they are calculated and highlighting the potential cost savings in the long run. Providing customized quotes and flexible payment options may make bonding more accessible to small businesses.” 

Additionally, there are ways agents can guide their customers to obtain more favorable terms. Rutledge continues “[Agents should also] present ways to present the business in the best possible light to bond underwriters by showcasing its strengths and mitigating perceived risks.”  Customers could engage the help of financial professionals to help build a stronger financial profile (i.e., manage cash flow, reduce debt, and demonstrate profitability) and enhance creditworthiness. When possible, agents could also advise clients to diversify their business into industries with lower risk profiles. This can make the business more appealing to bond investors.

Stay accessible and communicate effectively

Successful agent/customer interaction is based on effective communication and strong relationships built on credibility. As a trusted advisor, take the time to break down complex concepts in the surety bond landscape and use relatable examples that highlight the fact that surety bonds are indispensable, and sometimes required, tools for mitigating risk and ensuring contractual compliance. Talk them through the process and answer any questions they might have concisely and quickly.

A final word on surety bonds for SMB risk mitigation

Surety bonds are indispensable risk mitigation tools for contractual compliance. Various small business industries are becoming increasingly reliant on them, in addition to other commercial products, to protect their business’ reputation and investments.  

If your customers do not understand the differences outlined above, they may end up with a gap in coverage. You have a unique opportunity to empower them by providing comprehensive solutions to their needs. By understanding the nuances of surety bonds, seizing cross-selling opportunities, staying abreast of industry trends, dispelling misconceptions, and offering personalized guidance, you can solidify yourself as an invaluable partner in your clients' success journeys.