Factors That Insurance Agents Consider During a Bond Risk Assessment

Securing a surety bond is more than just a regulatory step for construction firms and government contractors—it’s about building trust and ensuring accountability.

Surety bonds involve three parties: a principal (the person who is responsible for fulfilling some obligation or duty), the obligee (the party to whom the obligation is owed), and the surety (which is the surety bond agency). The bond establishes that a specific service or obligation will be fulfilled by a particular time period. If the principal fails to meet that obligation, then the obligee has the right to file a claim, which may lead to the surety paying the obligee and the surety requesting reimbursement from the principal. Needless to say, it can be a messy experience.

When people come to us to obtain a bond, they’re often surprised by how lengthy the process can be. This is for a reason—bonds can be risky, and surety companies are responsible for ensuring they only extend bonds to clients that will uphold their obligations.

The underwriting and risk assessment processes significantly influence the time it takes to obtain a bond.

In this article, we’ll cover some of the factors we consider when we’re performing a bond risk assessment to give you a better understanding of what we (and most insurance agents) prioritize.

Financial Stability

As we alluded to earlier, if the principal can’t uphold their obligation, the obligee risks filing a claim with the surety and the surety requesting reimbursement from the principal. Should that situation occur, the surety needs to know that the principal is financially stable and could pay the amount of money owed.

So, financial health and stability is critical. We evaluate health and stability by reviewing:

• Current financial statements, such as balance sheets, income statements, and cash flow statements.
• Credit score and history, focusing on any past defaults, late payments, or bankruptcies. The higher the credit score, the better.
• Cash flow analysis, especially in the construction industry, where cash flow can be unpredictable.
• Debt-to-income ratio to ensure the specific company is not overly reliant on debt.
• Profitability and growth trends.

We essentially want to know if the company is financially capable of meeting their bond obligations. If the company has a history of high debt and late payments or isn’t financially stable, that is a significant risk for us.

Track Record & Credibility

Next, we look at the company’s overall reputation and credibility. We review the company’s claims history, especially any previous claims made against them on bonds, which signals potential issues with fulfilling contractual obligations. We also review the company’s track record of project success (especially with construction) and whether they consistently finished projects on time and within budget. This usually involves talking to previous clients or contacting provided references.

Other factors we review to determine reputation include:

• Awards, certifications, and industry recognition.
• Past legal disputes or compliance issues.
• Ethical violations.
• The experience and stability of the current management team.
• Vendor relationships.

Scope of Project & Operational Capability

Another aspect that can increase the risk of a bond is the project scope. As you probably guessed, the larger or more complex the project is, the higher the risk. We look into the project’s duration, estimated budget, technical requirements, environmental challenges, and logistical challenges to determine complexity, as well as:

• The company’s resources, such as equipment and technology, to determine if they could even complete the requested obligations.
• Availability and qualifications of the staff to see if their current team can meet the project demands or if additional hiring is needed.
• Subcontractors the company may work with and if subcontractors are being overly relied upon.
• The company’s contingency plans for dealing with potential setbacks and disruptions.

If the company seems well-equipped to handle complex projects and has handled complex projects in the past, they are less of a risk.

Market Conditions

Lastly, we look into current market conditions. Market conditions can rapidly change, so it’s important for us to evaluate the overall stability of the region where the project is located and the specific health of the sector, whether it’s construction, manufacturing, or services. We also evaluate competition levels within the sector (high competition can pressure profit margins and potentially impact the financial stability to complete a project), as well as analyze supply chain stability, as instability can result in significant delays and increased project costs.

Does High Risk Mean No Bond?

No. There are some factors, like market conditions, that the company/principal doesn’t have much control over. Although risk assessments are vital for bonds, that doesn’t mean that companies with high-risk projects won’t be able to obtain a bond.

If the surety company truly believes that the principal won’t be able to fulfill the obligations, it’s very likely that the bond application will be rejected. However, if the principal shows financial strength and credibility, but the project is high risk due to scope, market conditions, or other factors, the surety company will likely:

• Charge higher premiums to ensure they can cover potential claims without significant strain.
• Require collateral (cash, letters of credit, etc.).
• Include specific exclusions or riders in the bond form that limit their liability in certain scenarios.
• Require a co-surety or joint venture with another firm.
• Plan to disburse bond amounts in stages based on project milestones and conduct frequent audits.

Still Have Questions? Contact Allied Insurance Managers Today

Surety bonds aren’t like standard insurance. Unlike standard insurance, surety bonds are designed to guarantee the fulfillment of specific obligations or duties, and the risk is never directly transferred to the bonding company. There will be serious financial and legal consequences for the principal if they can’t fulfill their duties. That’s why risk assessments are so crucial to the application process.

If you need to apply for a bond and still have questions, turn to our experts at Allied Insurance Managers. We have over three decades of experience helping construction companies, small businesses, government officials, and service providers apply for surety bonds. Contact us today, and let us know how we can help you.