Performance bonds and payment bonds costs vary depending on a number of factors. Many websites will just say 1%-3% and leave it at that without giving contractors insight to improve their rates. This article is a deeper dive into the costs of contract surety bonds including performance, payment and maintenance bonds. Let’s examine the factors that go into these rates and give contractors some ideas so they can obtain better surety bond rates.
Surety Bond Rating Agency
The Surety and Fidelity Association of America is an organization that collects data from most surety bond companies across America. In fact, 98% of the surety premium is written by SFAA members. The SFAA develops loss costs and rating rules that can be filed county wide. Most surety bond companies follow these rules. They give guidance on what sureties should charge for different obligations and different classes of business. Sureties then have to file their rates with each state.
Contractor’s Class of Business
Most contractors are familiar with class rating because of their casualty insurance. However, surety bond companies use classes as well. Class B work includes things like General Construction. Class A includes things like Roofing, Bridgework, Curb and Gutter, ect. There is also a Class A-1 which includes trades such as asphalt paving. Each class includes tiers such as “Standard”, “Preferred” and “Merit” rates. Most bond companies have a number of filings for each class of business. Let’s look at an example:
Class B General Construction
First $100,000 of Contract Price $25/$1,000
Next $400,000 of Contract Price $15/$1,000
Next $2,000,000 of Contract Price $10/$1,000
This is a standard Class B rate. Like most surety rates, the standard rate drops as the project gets larger. The contractor is charged $25 per $1,000 (2.5%) for the first $100,000 of contract price. To say it another way, if the contract is $100,000 or less, the rate would simply be 2.5%. What if the contract is $500,000? We calculate that as follows:
$100,000/$1,000 = 100 x $25 = $2,500
$400,000/$1,000 = 400 x $15 = $6,000
Our total premium on this project would be $8,500 (2,500 + 6,000).
For contactors not wanting to do these calculations, we provide a free bond premium calculator here on our website.
Surety Bond Debit and Credits
Most underwriters also have the ability to “debit” and “credit” rates by 20% – 30%. This gives the underwriter and agent some flexibility to get to the rates they need. In our example above, they might be willing to credit the Standard Rate by 20%. This would make the rate:
First $100,000 of Contract Price $20/$1,000
Next $400,000 of Contract Price $12/$1,000
Next $2,000,000 of Contract Price $8/$1,000
Hazardous Classes of Contract Surety Business
Some classes of business are considered more risky and will generally carry higher bond rates. Some examples of contractors performing hazardous work include abatement contractors and demolition contractors. Some bond companies simply have one rate for any contractors performing this type of work while others have filed tiers depending on their merit. It’s also common to have flat rates for this type of work. That means the cost remains the same even as the project gets bigger.
In Design-Build contracts, the contractor assumes part or all of the design risk. This brings more risk to the contractor and bond company. Most surety bond companies have a design build surcharge for these projects. That is usually anywhere from 20% – 50% of the premium. Let’s assume your Design Build Surcharge is 20% and our class B premium is $8,500. Under a Design Build project, that same project would now cost $10,200. It’s important to know that most surety bond companies will charge this even if you sub out the design work. If your contract says Design Build, you will likely be surcharged. You can read more about design-build surety bond considerations here.
Many construction contracts contain a warranty or maintenance provision. This can be anywhere from 12 months after project completion to much longer. Each bond company has different rules for warranties. Some include 12 months at no cost with a performance and payment bond. Others include up to 24 months after project completion for now cost. After some period of time, you will be charged for additional time though. This additional premium will factor into your total bond cost. Maintenance costs are calculated the same way we calculated regular bond costs. Each bond company has their own maintenance rates but a rate scale may look something like this:
First $100,000 of Contract Price $2.50/$1,000
Next $400,000 of Contract Price $2.00/$1,000
Next $2,000,000 of Contract Price $1.50/$1,000
Again, if our contract was $500,000, we would need to add the following for EACH additional year of maintenance:
First $100,000 of Contract Price $2.50/$1,000 = $250
Next $400,000 of Contract Price $2.00/$1,000 = $200
Total Premium for Each Additional Year of Maintenance = $450
Time Completion Surcharge
In addition to other premium factors, we have to consider completion time for some projects. Most surety bond companies give you 12 months to complete a project without a time surcharge. However, any project that requires more than 12 months to complete is usually subject to an additional bond cost. Often, this is 1% a month after the first 12 months. Let’s look at an example. Suppose there is a 1% surcharge after 12 months. Our project is 18 months and the regular premium is $8,500 from our example above. The time surcharge premium would be 18 months minus 12 months = 6 months. 6 months x 1% per month = 6%. Therefore we take our $8,500 premium and multiply it times 0.06 = $510. Our time completion surcharge is $510 in this scenario. We add that to the regular premium to get a total of $9,010.
Account Rating or Class Rating
In addition to class of business, there are a lot of factors that contribute to how much you pay for performance and payment bonds. Experience, credit score, financial strength and quality of financial presentation are just a few. However, some surety bond underwriters have a lot of flexibility in what rate they can give you and some don’t. In general most bond companies fall into one of two categories. They either use account rating or class rating.
- Account Rating – Bond companies that use account rating tend to have more rate flexibility. They rely on their local underwriters to make decisions on the rates they give each account based on the merits of the account and that underwriter’s experience with local market conditions. Usually regional and specialty bond companies are more likely to use account rating.
- Class Rating – On the other hand, many larger bond companies use class rating. This means contractors are given rates depending on what categories they fall into. For example, all contractors performing Class A-1 asphalt paving with a CPA Reviewed Statement and tangible net worth from $1,000,000 – $2,000,000 will receive the same rate. The thought process is that all similar accounts are on a level playing field when it comes to their surety bond rates and costs. Under this scenario, a contractor would only be able to improve their bond rates by making a fundamental change such as increasing their tangible net worth or upgrading their CPA statement to an Audit.
It’s important for contractors to understand these things so they can make appropriate decisions. Let’s look at an example for a small contractor. Let’s assume he needs performance and payment bonds on a $1,500,000 project. The contractor doesn’t need bonds often and has decided to have a CPA Compilation statement. The contractor qualifies for a better rate from a financial standpoint but because the scope of his statement is a CPA Compilation, the bond company’s best Class Rate is a 1.5% flat rate. The cost for the performance and payment bonds would be $30,000. Let’s assume that the bond company would give that contractor a $25 sliding rate if they upgraded to a CPA Reviewed financial statement. Would this be worthwhile? The bond premium on a $25 slide would be $18,500. Assuming a quality CPA Review from a construction oriented CPA cost our contractor $10,000, they would be slightly ahead under this scenario. What would happen if that contractor needed another bond during the year of similar size? Instead of saving a couple thousand dollars, the saving would be significant. These are things that contractors should keep in mind when making decisions that could impact their overall bond costs.
Other Factors Affecting the Cost of Performance and Payment Bonds
Performance Bonds are typically issued with Payment Bonds. If so, there is only one charge for both. In essence, the obligee gets double the protection for one price. These bonds can be issued stand alone but there is not a discount for doing so. A stand alone performance bond will cost the same as when it is issued in combination with a payment bond and vica versa. The exception to this rule is a maintenance bond. There is typically no additional charge to issue a maintenance bond if it’s less than 12 months and issued with a performance or payment bond. However, if a maintenance bond is issued by itself, the rules change and it will usually cost more. You can read more about stand alone maintenance bonds here. Bid bonds almost never have a cost. Bond companies and brokers have tried but the current market does not allow for that.
Performance and Payment Bond Overruns and Underruns
It’s important for contractors to understand that their cost for performance and payment bonds are not final until the contract is complete. Performance and payment bonds follow the contract. Therefore change orders that increase the contract price create what is called an overrun. That means that more premium is owed to the bond company by the contractor. As a counter to that, a decrease in contract price creates an underrun and the bond company owes you a return of premium. These overruns and underruns are applied to the end of the contract price. That’s important when you have a sliding rate because any overrun will be charged at the lower cost. Bond companies routinely send out contract status reports to Obligees throughout projects to see how the projects are progressing. Often, overruns and underrun charges are pulled off of these status reports and sent to the contractor (Principal) on the bond. Bond underwriters may also use a contractor’s Completed Contract report on their CPA prepared year end statement to get these amounts.
By having an understanding of how performance bond and payment bond rates are calculated, contractors can make improvements to their company to qualify for lower surety bond costs. We love to educate contractors and anyone interested in surety. Please contact our surety experts at MG Surety Bonds anytime if you want to discuss how we can make your bond program better and easier.