Surety Bond Collateral Requirements
Surety Bond Collateral Requirements
In order to qualify for surety bond coverage, individuals or firms may need to put up collateral. Many people may be surprised to find that collateral can become a vital part of the surety bond process. Bonding companies often require collateral they can secure against the provided services. But what is considered acceptable as collateral under a bond? How much collateral is required? And is collateral required in addition to a fee? We’re here to help answer these questions and others you may have regarding collateral on surety bonds.
Here, The ProSure Group discusses the requirements of surety bond collateral, the purpose of collateral, and what may qualify as acceptable or unacceptable forms of collateral, among other details. Contact our surety company today to request a complimentary quote and for additional information.
Why Is Collateral Needed On Surety Bonds?
Collateral isn’t used too often, but it may be required in certain circumstances. A common misconception is that collateral is only needed for individuals or firms in financial distress. One of the reasons collateral may be required may be that bond types are at high risk to receive claims against their bond. For instance, defendants’ court bonds or appellate bonds, tax lien bonds, or release of lien bonds are a few types of bonds with a high claims frequency, so it makes good business sense for the surety to collect the money in advance. Collateral is used to support the applicant’s indemnity or agreement to repay the surety if the surety has to pay a claim. As a surety bond isn’t insurance, the applicant/principal must pay the surety back.
Poor credit is another, more obvious reason why someone would need to post collateral, but another less obvious reason is for someone with good credit to post collateral. Some applicants may have good credit and a lot of experience but do not have the financial strength in relation to the size of the bond, requiring them to supply collateral. In many cases, collateral may be needed because it’s a beneficial business decision made by the surety, so they know they will get paid back if there are any claims.
How Much Will I Have To Pay In Collateral?
The amount of the collateral depends on the surety, and the amount fluctuates with each instance. Therefore, the bond amount is a significant factor in determining the amount of collateral required.
Why Do I Have To Pay A Fee AND Pay Collateral?
Upon purchasing a surety bond, the fee required is only a small percentage of the bond, and the amount doesn’t go towards the collateral. Instead, the premium paid to purchase the bond is the sale of the bond itself towards services, etc.
How Long Is Collateral Held?
A surety bond company often holds collateral past the cancellation or release date of the bond because the obligee can still claim the bond up to a year or more after the bond is canceled. The collateral can be held up to 180 days but typically is returned within 90 days of the cancellation or release date of the bond.
Why Should I Get A Surety Bond Instead Of Just Posting An Irrevocable Letter Of Credit?
When there is an option to use an ILOC instead of getting a surety bond, why wouldn’t someone do that instead? The reason is quite simple. If only an ILOC is provided to the obligee without the placement of a surety bond, anyone can make a claim against you, and you will be required to pay it. With a surety bond, the surety performs research to determine whether or not the claim is valid.
What Is An Acceptable Form Of Collateral?
Generally, the only forms of collateral accepted are cash and an irrevocable letter of credit. An irrevocable letter of credit (ILOC) is a written guarantee by a financial institution that the necessary funds are available and cannot be touched for as long as the bond is active. For the entire period that the surety bond is active, the ILOC cannot be canceled or modified in any way unless there is an explicit agreement made by all parties involved. In brief, an ILOC serves as a promise that the bank will pay the surety if needed.
What Is Not An Acceptable Form Of Collateral?
Collateral cannot be a certificate of deposit (CD), government securities, or physical assets. Certificates of deposit are typically not accepted because their maturity dates rarely coincide with the bond term. The mismatched dates cause the collateral to liquidate prematurely, which will cause penalties or the collateral being held longer than it is needed.A CD is provided by a financial institution and is backed by the Federal Deposit Insurance Corporation. The CD allows the bank to retain the money for a certain amount of time, during which time the bank gains interest on the return, while they guarantee repayment once the term is complete. Government securities include blue-chip stocks and bonds and gold and silver bullion. These were accepted in the past for collateral, but since the market fluctuates, they are considered unreliable security for sureties. Physical assets are also not considered to be reliable collateral. Physical assets include items such as cars, boats, etc. However, some sureties will accept real estate and other fixed assets as collateral.