The Development of Bad Credit Surety Bond Programs
High Risk = Higher Premium: Before there were high risk bond programs, underwriters of surety bonds would only write bonds for customers (or principals) that presented little to no risk of having a claim arise against them. In other words, they went after a “0% loss ratio”, and the bond companies were in a position to do so. With Bad Credit Surety Bond Programs, the underwriters of bonds are able and willing to write bonds for principals that are higher risk (of having a claim), and can do this by approving them at higher premiums. Similar to insurance companies, surety bond underwriters can approve a wider array of customers, but approval for those more likely of having a claim is obviously comes at a cost to the principal… higher rates.
Collateral vs. Increased Premiums: Early on in the process, Bad Credit Surety Bond Programs brought about a need for bond companies to require collateral from principals. This tends to be a cumbersome, time-consuming process that involves a lot of administrative effort, and therefore many bond companies decided to avoid the collateral requirement by offering higher premium rates to their principals. Customer preference depended on the specific principal’s financial situation. Typically, however, the bond programs that offered higher premiums vice collateral were less expensive for the first year of the bond, but over time those that required collateral proved to be less expensive. This was due to the fact that the collateral would eventually be returned to the customer (roughly a year after the bond’s release) if no claims arose.
Knowing Your Options: It is important for principals with bad credit to understand what all of their options are. While many Bad Credit Surety Bond Programs are designed to meet the needs of customers with poor credit, and often times prove to be the most cost-effective option, they are the only option available. For example, an Irrevocable Line of Credit (ILOC) is an alternative whereby the bank will freeze liquid assets of a principal in an amount equal to the total amount of the surety bond they would need to purchase. This would only be more preferable for principals with enough liquid assets to comfortably have the amount of the ILOC frozen by a bank. For customers that truly value their liquidity, and ability to quickly have cash on hand, an ILOC is probably not a viable option. While ILOCs have traditionally had services of around 1% the cost of the line of credit, the money market rate will have an impact on that as well, and can significantly raise the annual rate of the ILOC for the customer. For example, if the money market rate is 5%, and the service fee for the LOC is just 1%, the actual annual rate the principal pays for the ILOC is 6%. Customers must understand the choices available to them, and should choose the option that best fits their specific needs.
Outlook: High Risk Surety Bond Programs have been around for more than 5 years now, and it does not appear that they are going anywhere in the foreseeable future. More and more companies are willing to write surety bonds for principals with bad credits, and those that carry some sort of risk of having a claim arise. While increased premiums are part of what makes bonding companies willing to do this, the increasing number of bonding companies writing high risk has created competition. Competition is obviously a good thing for the customers, in this case the principals with bad credit, because it will eventually drive premium rates down, making Bad Credit Surety Bonds more affordable.