Years ago when I started as a cub reporter for the Daily Planet, I mean surety underwriter, I ran into a strange situation that was recently repeated. In this article we will present the scenario and ask you to use your underwriting judgement. The question is “What’s wrong with this picture?”
Originally this came up on a Lost Instrument bond. The applicant claimed a negotiable instrument (anyone holding it could potentially cash it in) had been inadvertently destroyed. He was a young adult in his 20s who had inherited the asset. His financial statement showed little other than the asset in question, which was a problem because the underwriters do not want to feel that the person has a reason to fraudulently convert the “lost” asset and it’s replacement.
We wrote back and expressed the underwriting concern, that the applicants financial position was inadequate. In response we received a novel proposal: When the replacement instrument is issued, it will be conveyed directly to the surety who can hold it as full collateral against their exposure, until the bond is released (years!) “There will be no risk to the surety.” Sounds pretty good?
In my infantile underwriting mind I thought this sounded intriguing, but it also made me uncomfortable. Why had I never heard of doing this before? Maybe I was on the verge of creating an entirely new underwriting procedure. Will they name it after me?
What was wrong with this picture?
In the more recent situation, the surety was being asked to support a multi-million dollar purchase transaction. The applicant (a person) was a foreigner, an accomplished business person, who was not familiar with surety underwriting requirements. They were not accustomed to providing personal financial info or involving the spouse in business obligations.
As a way of supporting the transaction, and maybe dodging the indemnity requirements, it was suggested that title to the purchased property would be conveyed directly to the surety (sound familiar?). After the financial transaction (which was the subject of the surety guarantee) is completed, the surety will be released, the title will be transferred to the buyer, and “the surety will never be in a position of risk.” Boom! Let’s do it!
What’s wrong with this picture?
Here is good advice. If your underwriting brain feels like something is wrong, it probably is!
The problem with both these scenarios is the timing.
Bonding companies ALWAYS secure their position before assuming an obligation. It is incumbent on the underwriters to protect their company assets and its owners by doing so.
Think about bank lending practices, which are not unlike surety underwriting. Would a bank make a building loan relying solely on the future value of the project? No, they require being secured with sufficient assets in advance such as the company and personal net worth of the applicant and possibly other collateral.
Financial obligations always require that the credit grantor be secured in advance. Prudent decision making requires this.
So the next time you see something that doesn’t feel right, trust your gut. Check it out before you leap.
Steve Golia is an experienced provider of bid and performance bonds for contractors. For more than 30 years he has specialized in solving bond problems for contractors, and helping them when others failed.