Although we at KOG (www.kogbonds.com) frequently get questions about bond rates and premiums
from customers, as well as prospective customers, many factors determine what a contractor or
business owner pays for his/her bonds. This blog addresses primarily construction bond premium rates.
A little background is appropriate to mention. Bonding companies generally, but not exclusively, use
premium rates which are suggested by the Surety & Fidelity Association of America Rate Manual, which
classifies bond premium rates based on Class of Construction. So, for example, General Construction is
listed in a more expensive category, while Roofing is listed in a less expensive category. There are many
categories too numerous to mention here. In theory, the categories are organized and suggested
according the amount of time and effort that goes into underwriting the bond request/application, and
are not related necessarily to the RISK of that particular class of construction. Virtually every category of
construction is listed in the SFAA Rate Manual.
Bond rates based on risk factors?
Historically, loss experience was not factored into premium rates, as the rates were intended primarily
as service fees to underwrite the contractor customer. This was unlike insurance premium rates, which
are based substantially on loss experience for a particular industry or activity. Deviated (discounted)
bond premium rates were available for customers based on premium volume, stronger balance sheets
as well as length of relationships between contractor and bonding company. In other words, the best
customers were able to secure the lowest rates.
Federal legislation many years ago forced bonding companies to justify their rates based on their own
actual loss history, and most all of them did. The resulting rate structures maintained the general
breakdowns by construction classification but also added options for the company underwriters to
discount or surcharge the “base” premiums by factors which were deemed to either mitigate or increase
the overall risk. Thus, in theory, bond rates were changed to reflect decision factors based more on
actual (or perceived) risk. Also, underwriters became more flexible in their application of rates for
specific accounts, which had the effect of increasing competition among bonding companies.
How are rates calculated?
Rates are quoted as a percentage of the contract price. The contract price is considered to be the
bonding company’s “exposure”. So, for example, a $100,000 contract with a quoted rate of 2.5% (or,
$25.00 per thousand of contract price) would generate an initial premium of $2,500.00. Contractors
need to be aware that as contracts increase, usually by change order, the bonding company reserves the
right to charge additional premium based on the increase in contract price. Conversely, if the contract
price decreases, contractors are entitled to a return premium due to the decreased exposure.
Bond premium rates can be either “scaled”, or flat. Scaled rate structures are applied in tiers as the
contract price increases. So, for example, a $500,000 contract might be billed at 2.5% for the first
$100,000 of price and 1.5% for the remaining $400,000 of contract price. Accordingly, the overall
percentage of bond premium for a $500,000 contract would be 1.7%. As the contract price increases
even more, the tiers continue and the overall percentage of bond premium to contract price can tend to
drop even further. As logic would suggest, “flat” rates are applied to the original contract price and
remain fixed even as the contract price increases – there are no distinct rate tiers.
Contractors need to be specifically aware of how bond premiums are charged so they can properly
account for them in change orders.
So then, how are bond premium rates determined? The above suggests a variety of factors can come
- Types of business
- Class of construction
- Financial strength of the customer
- Amount/frequency of usage (total billed premiums)
- Quality of information supplied-greater sophistication in financial presentation can equate to lower perceived risk and accordingly, lower premiums
- Length of relationship between bonding company and contractor customer
- Credit –better credit usually means more competitive rates
- Compliance with individual State laws, local ordinances, etc. (Some State requirements are very specific as to what a bonding company can charge).
- Opportunity cost- the bonding company might charge a higher percentage rate for an infrequent customer, as opposed to one who uses bonds more regularly.
Do you have a question about your bond premium rate? Bond premium rates in general? If so, please give us a call! Contact the experts at KOG International, Inc.! Philadelphia PA Regional Office – (610) 399-4080, Central PA Regional Office – (717)-732-9066, DE Regional Office- (302) 382-7489 www.kogbonds.com
Our next topic will address bond capacity, what it means, how it’s calculated, etc. Something to think
about: Which is more important to you, lower rates, or increased capacity?