A contractor’s license bond can be valid for as little as one year or as many as five years depending on the surety. California contractors with good credit usually have an opportunity to purchase a license bond with a term of several years, while those with poor or marginal credit generally are not offered bond terms greater than one year. It’s important to note that whether a bond has a term of one year or several years, all contractors must re-qualify for a new bond when their current bond expires. When this occurs, contractors often experience large premium fluctuations both up and down as compared to their prior bond due to changes in their credit profile or other rating factors. This raises the question as to when it’s most advantageous for a contractor to purchase a bond for a single year, or opt for a multi-year option if available. Below is a short summary of the pros and cons of each option.
When to Purchase a License Bond for Multiple Years?
One of the best reasons to purchase a license bond with a term of several years is that multi-year bonds offer significant discounts over a single year alternative. Generally each additional year of a bond term offers an increasing discount that can reach as high as 20% or more compared to a single year option, depending on the surety.
Reduces Premium Fluctuation Risk
Multi-year license bonds offer contractors the ability to lock in low bond rates for several years at a time, which is especially beneficial if a contractor’s credit happens to deteriorate in the future due to unforeseen circumstances. Assuming a contractor qualifies for premier bond rates today, it’s unlikely the same contractor will be able to obtain significantly lower bond premiums in the near future as average bond premiums tend to rise over time; however, their rates could increase 15 times or more if they’re forced to re-qualify for a new bond with poor credit. Purchasing a low priced bond for several years reduces premium fluctuation risk. There is a caveat however. Sureties often retain the right to cancel a bond mid term should they experience adverse underwriting results.
Closing Shop Prior To a Bonds Expiration
Many contractors will close shop prior to the expiration of their bond term, which is increasingly likely when a contractor purchases a bond for several years. When this occurs, a contractor may not get back their full bond premium as a certain percentage of each bond premium is generally considered fully earned. While this is not a significant issue for most contractors as multi-year license bonds are relatively inexpensive in general, it is an additional factor that should be considered.
Opportunity Costs if Lower Bond Rates Become Available in The Future
Contractors that purchase a bond for several years with credit that is below premier standards, but above marginal standards could run the risk of locking in a higher bond rate than they may qualify for in the future should their credit improve. While this is not a common scenario, it is something contractors should consider if they are considering the option of purchasing a multi-year bond with a premium of several hundred dollars per year or more.
The best course of action for contractors is to evaluate their future business plans and purchase their bond accordingly. For contractors with good credit that plan to stay in business for several years, a multi-year bond has substantial benefits with very little downside. While the definition of “good credit” will vary amongst all surety’s, generally a credit score of around 680 or better with a clean license history will qualify a contractor for premier bond rates of under $100 per year on average. For contractors unsure about which bonding option makes the most sense given their circumstances, please feel free to contact our agency and we’d be more than happy to review your options with you free of charge.
By Jeremy Schaedler