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The trouble with setting surety bond amounts

A lot more goes into developing surety laws than the public might be aware of. Difficulties can arise at any point during the bonding process. The basic flow works like this:

  • Legislators use their discretion to write surety bond laws
  • Companies/individuals apply for bonds they’re required to purchase and hope they’re qualified
  • Surety providers decide which applicants to financially back with a bond

A lot of people don’t realize that when issues arise during the bonding process, they almost always stem from the same place: the surety bond amounts. Determining what any given surety bond amount (technically called a “penal sum”) should be is complicated. Recognizing the potential implications involved with setting excessive or insufficient bonding amounts can help legislators, business owners and surety providers alike better understand their roles in the process.

Legislators pass laws that require surety bonds in a certain amount. Sometimes this is done without proper consideration for what amount is in the best interest of the industry versus what’s in the best interest of the consumer. Sometimes the bond’s penal sum might be too low to actually provide adequate consumer protection. Conversely, if the amount is too high, certain individuals might not be able to qualify for the bond and/or pay for its premium.

Herein lies the problem in determining what the most effective bond amount is. The following examples represent the two major concerns with setting surety bond amounts.

Case study: the insufficient freight broker bond amount

The Fighting Fraud in Transportation Act of 2011 proposes the surety bond amount required of freight brokers be increased from just $10,000 to $100,000. The change was contrived because trucking companies continue to go out of business after being unable to collect due payments on brokered loads. These companies are currently unable to collect their due payments by making surety bond claims because the funds have already been depleted from previous claims. Increasing the bond amount from $10,000 to $100,000 would provide an additional financial cushion for such companies and allow them to stay in business.

However, some people have argued that increasing the bonding amount would discriminate against smaller transport companies that wouldn’t be able to afford the much larger bonds. When applicants have bad credit, surety providers typically require them to post collateral for the full bond amount before issuing them a freight broker bond. Continuing this practice with a $100,000 bonding amount would obviously keep some individuals from working in the industry. Supporters of the bill, though, point out that the new restriction would be completely understandable given the increased instances of industry fraud in recent years. To date, the bill is still under review.

Case study: the excessive appraisal management company bond amount

Within the past two years, 10 states have established regulations that mandate appraisal management companies to post surety bonds. Similar to other bonding requirements, these regulations encourage the faithful performance of a company’s obligations. The appraisal management bond amount can be used to benefit claims against the company if necessary, and consumer claims are given priority in recovering the bond.

So far 9 of the 10 states with new appraisal management company bonds have set the required bond amount at $30,000 or less. However, the Kentucky appraisal management bond amount is currently $500,000, which is obviously significantly higher. Such a high bonding amount will likely keep a great deal of appraisal management companies from getting licensed to work in the state. Kentucky’s Legislative Research Commission is scheduled to review the regulation on October 27, which could potentially result in a lower surety bond amount.

How do high surety bond amounts affect applicants?

Although the primary objective of surety bonds is to provide harmed consumers with a guaranteed way to recover losses, this is not the only purpose they serve. They’re also used to keep financially unstable individuals from accessing a profession through which they might harm consumers. As such, surety providers act as a neutral third party that evaluates whether applicants have the financial credentials necessary to maintain a surety bond.

As a general rule, the higher bonding amount is, the stricter the surety is when evaluating whether to write the bond for any applicant. Problems related to the bonding amount emerge again. Some bonds are historically more risky to underwrite, such as telemarketing bonds or contract bonds. Surety providers might decide not to issue risky bonds with high penal sums to applicants that have poor financial credentials such as bankruptcies or unpaid child support.

When all is said and done, establishing any surety bond amount begs the consideration of three key questions that continue to plague the surety industry:

  • How do we set bonding amounts that don’t keep out too many individuals while still providing adequate financial coverage to consumers?
  • How can we reinforce the integrity of an industry while possibly setting expectations that are too high for business owners to meet?
  • What’s more valuable, keeping a financially unstable business from potentially taking advantage of their customers or keeping small businesses out of the market because they can’t qualify/pay for bonds with large penal sums?

With all of these considerations coming into play now more than ever, surety bond regulations in a number of industries could see an overhaul within the next few years. Stay on top of these regulations by visiting SuretyBonds.com.