Surety: a brief introduction
Surety bonds guarantee the performance of a variety of obligations, from construction or service contracts, to licensing, to commercial undertakings. Almost any sale, service or compliance agreement can be secured by a surety bond.

Surety has been around almost as long as business contracts. The earliest surviving surety contract dates back to 2750 BC, which guaranteed the performance of a farming contract. The first surety law dates back to 1750 BC. Over the centuries the product has adapted to new needs although the essence of the surety contract remains the same.

Bonds and guarantees are normally required under the terms of a construction or engineering contract, or in accordance with mandatory legal requirements, to secure the obligations of the principal debtor (generally known as the principal).

A surety bond provides the security to protect the creditor against the default or insolvency of the principal up to the limit of the bond. For example, the failure of a contractor to complete a contract in accordance with its terms and specifications or the failure of an enterprise to pay taxes or customs duties to a government or department.

They play a vital part in domestic and international trade and in particular protect taxpayers against the loss of public funds.

Although in many countries originally banks mainly issued bonds, the security provided by an insurer has proven equally acceptable. This has enabled many enterprises to set up separate lines of credit and bonds with surety or insurance companies. In doing so, they protect their lines of credit with banks, which might otherwise be blocked at such time when this working capital was needed. Banks usually prefer to issue so-called “on demand” bonds and must therefore treat them as un-presented letters of credit.

Unlike traditional insurance, sureties do not undertake to spread risk but rather to pre-qualify and rigorously select their principals.

Surety bonds are especially useful in the construction of public works. The vetting of a contractor’s ability to complete a given project is often far too cumbersome or expensive a task for government agencies. The surety industry has facilitated countless government works projects, delivery contracts, public private financing initiatives and build-own-operate-transfer arrangements, while at the same protecting the taxpayer’s money. Other types of surety bonds include customs or tax bonds, bonds concerning concessions or licenses, judicial bonds, bonds concerning leases and bonds concerning the delivery of goods or services.

Surety took a hard hit with the collapse of Enron, which saw the industry pay over US$ 500 million in claims. This high level of claims not only demonstrates the fact that surety companies honour their obligations; it also shows that surety remains a reliable business as it has been during the past century.
One consequence is that surety underwriters have gone “back to basics”. In fact, sureties have gone back to do what they do best: discerning the safest principals from among the crowd and standing behind them to make them even safer yet.

The most notable developments are the industry’s return to growth and an adjustment of the premium rates. The present period of consolidation in the sector is likely to be followed by a new period of growth and renewed vigour. For decades, the industry has suffered from structurally low premium rates. It is realistic for the market to expect a long-overdue adjustment. There are no other clear trends, although some developments are worth mentioning.
In Europe there are movements towards surety bonds with a higher percentage than traditionally available. Traditional percentages in Europe have been between 5 and 50%, depending on the product and the country involved.
Increased e-commerce practices have forced the industry to look into electronic delivery mechanisms. Electronic bonding, for example, reproduces the traditional bonding process via the internet. The success of this approach will depend on the legal status of electronic signatures and delivery.

Any development should be seen, however, within the context of stiffer underwriting practices. Although the premium remains an important element to indicate risk, good underwriting is far more important. High premium rates cannot compensate for poor underwriting. Surety underwriters have adopted stricter rules for use of their capital and are more likely to rigorously assess the risk-return profile before writing a particular bond. Rather than being a new development, this should be seen as a move towards the traditional way of underwriting.