By Elisabeth Boone, CPCU
Richard Savage (left) and son John share CEO duties for the Amwest Group.
If you're an agent who finds the world of contract surety bonding complex and baffling, you're not alone. With its seemingly alien terms such as "obligor" and "obligee," and its strict requirements for detailed financial information on prospects, to many independent producers the contract surety business is more than a little intimidating.
To the Amwest Insurance Group, the fears of agents who aren't familiar with the contract surety market are easily understandable. In fact, at Amwest Surety Insurance Company, the Amwest Group's lead carrier, a recently formed brokerage caters exclusively to independent agents who aren't experts or specialists in contract surety bonding. In this category are agents who are new to contract surety, those who need a bond only occasionally, and those whose clients are start-up contractors and thus are unable to meet the underwriting requirements of standard surety companies such as Amwest Surety.
In this article we'll learn about the key factors that differentiate suretyship from insurance underwriting, and we'll find out how Amwest has structured its operation to allow it to serve both veteran and neophyte surety agents. First, let's look at the structure of the Amwest Insurance Group and meet the father and son team who run the organization.
A family affair
Amwest was founded by Richard Savage in 1970. Six years later, fresh out of college, his son John came on board. "I was a December 1975 graduate," John says, "and I went to work for Dad in January 1976. I think I got a total of three weeks' vacation--not exactly the post-college sabbatical I had planned!" John's first job at Amwest was in the bail bond department; and from there he moved into branch office and home office underwriting, learning the many complex aspects of the surety business from seasoned veterans. Today father and son share CEO duties; Richard is chairman of the company, and John is president and chief operating officer. The field organization, a nationwide network of regional and branch offices, reports to John, while Richard has responsibility for other departments.
In addition to Amwest Surety, other members of the Amwest Group are Far West Insurance Company, an underwriter of specialty surety bonds; Condor Insurance Company, which provides property and casualty coverages to specialized segments of the trucking industry in California and Arizona, private passenger auto coverages in Arizona, and homeowners insurance in California; Raven Claims Services, Inc., Southern California Bonding Service, Inc., and its newest subsidiary, Far West Bonding Services, which we'll be learning more about later in the article.
Amwest is licensed to do business in all 50 states, the District of Columbia, Puerto Rico, and Guam; Far West Insurance operates primarily in the western states. The group's new home office is in Calabasas, California, in the Los Angeles area. For this article we spoke with John Savage, who's closely involved with all aspects of the group's surety operations.
One market, two kinds of agents
As the 11th largest surety bond underwriter in the United States, Savage explains, Amwest Surety transacts most of its business with agents who specialize in surety. "Professional surety bond producers probably account for 70% to 80% of our business," he says. "This is what we call our 'relationship' business, because a key factor in writing profitable contract surety bond business is the quality of the surety's relationship with its producers." Agents in this category have a contract with the company, just as with property/casualty insurers; they also have the opportunity to earn higher commissions on the business they produce.
Serving a diversity of needs
It's also possible, Savage notes, to write profitable business with agents who don't specialize in contract surety but who from time to time may need to arrange a bond to accommodate a client, or whose contractor clients are small or new operations that need special underwriting consideration. It's the occasional, or so-called "transactional," business that constitutes 20% to 30% of Amwest Group's total premium, that's handled through Far West Bond Services (FWBS). The majority of this business is placed with another Amwest Group subsidiary, Far West Insurance Company, which specializes in providing bonds for higher risk contractors. In fact, the Amwest Group is the nation's leading producer of specialty, or nonstandard, surety bonds. (As we'll see later, however, the line that distinguishes standard from specialty surety business is beginning to show some signs of blurring.)
Amwest Surety was chartered as an insurer in 1976; before that, it wrote contract surety bonds as a general agent, Savage explains. "In those early years, we wrote most of our business--as much as 90%--with agents who didn't do much surety," Savage says. "As we grew, we became able to provide capacity for contractors who could qualify for more favorable rates." So, while by no means turning its back on agents who didn't specialize in surety, Amwest found itself writing less "transactional" business as it became more involved with the "relationship" business generated by professional surety bond producers.
The business from nonspecialist agents "was always good business, always profitable," Savage observes. "We wanted to keep that business, and we wanted to create a structure that would allow us to serve the special needs of that market." That commitment led to the formation of Far West Bond Services (FWBS), which offers an array of services specifically designed to help agents with "transactional" business, and their contractor clients, move smoothly through the detailed and complex procedures involved in arranging a surety bond.
Operating through Amwest's nationwide network of regional and branch offices, Savage explains, FWBS underwriting and marketing specialists often are able to help agents qualify their clients for more favorable rates and for placement with Amwest Surety. What's more, he adds, as they become familiar with the bonding process, agents who previously avoided the contract surety market, or approached it with trepidation, can use the experience they gain with Far West Bonding Services as the basis for creating a profitable niche in today's highly competitive market. Because FWBS acts as a brokerage for Amwest Surety and Far West Insurance, no agent contract is necessary; nor are minimum volume requirements imposed--both of which serve to create a flexible, no-pressure environment for an agent who's new to the contract bond business.
Surety vs. insurance: What's the difference?
The principles of suretyship differ markedly from those that govern property/casualty insurance, Savage explains. "First of all, unlike insurance, which is a two-party contract, surety is a three-party obligation. The three parties are the principal (the contractor), the obligee (the owner of the construction project), and the obligor (the surety)." Unlike an insurance policy, a contract bond doesn't cover specific risks or exposures. Rather, in issuing the bond, the surety is guaranteeing that the contractor will fulfill the obligations set forth in the contract between the contractor and the owner. The language of the bond, therefore, is the language of the contract it guarantees--not wording devised by the insurer.
"That's why," Savage points out, "the underwriting requirements for surety bonds are so stringent. Because we're undertaking this major obligation, often on projects that take a year or more to complete, we need extremely detailed information on all aspects of the contractor's operation: financial statements, credit history, record of experience and performance--every factor that could affect the contractor's ability to complete the project."
Another extremely important but perhaps less well-known difference between suretyship and insurance is that a surety, unlike an insurer, does not establish reserves for expected losses. In theory at least, the surety expects no losses--and, should a contractor default on the contract, Savage explains, "we can go after the contractor, because he/she indemnifies the surety." It's for this reason that Amwest and other sureties expend considerable time and effort to ensure that the contractors for whom they issue bonds are fully funded and qualified to execute the contract. Yet another reason for the surety's meticulous up-front underwriting is that in most cases, a bond cannot legally be canceled except for good cause.
The underwriting process
For all the reasons outlined above, the process of underwriting a surety bond is considerably different from insurance underwriting. Savage suggests a good way to understand the difference: "A surety is more like a bank than an insurance company," he explains. "The process of arranging a bond is similar to applying for a bank loan. We require three years of detailed financial statements, plus a credit history, and we need verification from suppliers and subcontractors that the contractor has paid them on a timely basis." (As noted earlier, Amwest can accommodate start-up contractors who don't have three years' worth of financial statements or who otherwise don't meet standard underwriting requirements.)
"The agent is responsible for collecting all this information from the contractor," Savage emphasizes. "That means the agent must be able to read and understand financial statements. Professional surety producers know how to do this. Most agents who only occasionally need a contract bond don't know how, and this is an area where Far West Bonding Services can help." FWBS underwriters will guide an agent through the information-gathering process, he notes, and can even provide simplified application forms.
Reaching out through regionalization
To a much greater extent and in a much different way from insurance policyholders, contractors are affected by economic and business conditions in the locality or region where they operate. Even given the surety's exacting, fine-tooth-comb approach to underwriting, Savage comments, processing every bond through the home office may not be the best approach to writing quality business. In recognition of this reality, Amwest has reorganized its contract surety underwriting operation to give more authority to its regional managers. "We're putting the decision-making process more in the field and less in the home office," Savage explains. "This way, agents get answers faster."
Over the last two years Amwest has increased the number of its regional offices nationwide from three to five, and has significantly expanded the authority of regional managers. "Regional managers have more familiarity with larger accounts than the home office," Savage points out. "Now they're closer to our agents, so they can underwrite better and make decisions faster."
In another change, each of the five regional managers (one of whom is based in the company's Los Angeles-area home office) now has underwriting authority such that "only the largest bonds go to the home office," Savage says. "Our home office underwriting staff has been reduced from twenty employees to five, and most of those employees are now in the field."
Amwest operates 30 branch offices nationwide, with locations in most major cities. "We have one of the most extensive branch networks in the country," Savage says. This structure "gives us closer contact with both agents and contractors than that enjoyed by companies that write business through general agents," he adds. "At Amwest, we believe that, to do business in a city, we need a presence there."
In the surety business, Savage emphasizes, there's more to evaluating a prospect or client than reviewing financial information. "Visiting accounts in person--especially larger accounts--is key to profitable underwriting. It's still important to be able to look a prospect in the eye and assess the quality of his or her character," he declares.
It's equally important to have well-qualified people in the field: "Amwest strives to recruit and retain better-quality managers who have the ability to both sell and underwrite," Savage says. In the case of smaller contractors, he notes, the manager must work harder to produce each dollar of premium than in the standard market. "Experience and aggressiveness in sales are two key factors we think differentiate Amwest from its competitors," he asserts.
View from the field
Speaking of the field, how does Savage assess agents' perception of Amwest, with its distinctive two-tiered surety bond marketing approach and its hands-on regional and branch office network?
"Amwest producers see Amwest as a market with good, experienced, knowledgeable people," Savage responds. "Agent relationships are key in the surety business. Independent agents can go to the Far West Bonding specialists in every branch and get answers about surety when they have no knowledge or experience. Many standard companies shun this business, because they don't want to deal with these agents, who have low volume and lack knowledge of surety. That's the market where we got started. We welcome this business, and we're going after it."
Cycles and market status
Surety bonding, like insurance, experiences underwriting cycles--but not in the same way, Savage explains. "The underwriting cycle in surety is completely different from that in insurance--different factors, different timing," he says. What's more, because sureties traditionally expend more effort than insurers on stringent, up-front underwriting, their loss ratios run dramatically lower than those of insurers.
For example, "throughout the recession that ran from the late 1980s to the early '90s, surety results were great--the recession never hit contractors. The loss ratio didn't go above the high 30s." In the mid-1980s, however, "for three years in a row the loss ratio went to the 50s, even the 60s--and that's incredibly high for the surety market." Looking at 1997, Savage sees what may be "one of surety's best years ever, with the loss ratio only in the high 20s."
What's the status of the contract surety market today? "The market is soft right now," Savage responds, "with a lot of overcapacity. If you can't get a bond today, you simply don't qualify," Savage declares. "It's easier to get a bond today than it was over the last 50 years."
What factors led up to this capacity glut? "Sureties charged more for premiums in the past five years than they did over the previous 50," Savage explains. "There are some rate cuts, and in some cases agents may relinquish their first-year commission and not take a commission until the second year."
What does Savage see for the surety bond market over the near term? "I don't see an end to the current capacity/pricing situation," he replies. "Over the last year I've been hearing of more companies having problems with their underwriting results, but I still don't see much hardening in the market." In fact, Savage says, Amwest, as the leading writer of specialty surety bonds, is beginning to experience competitive challenges from standard markets that previously declined to write smaller, newer contractors.
"They see Amwest making money with higher-risk, higher-rate business, and they want a piece of it themselves," he says. "Some of our competitors are starting to set up their own subsidiaries or departments to handle specialty bonds."
A mega-merger
A recent development that is bound to have a major impact on the surety market for 1998 and the future, Savage observes, is the merger of USF&G with St. Paul Insurance. The new entity, by combining its two large surety departments, "is now number one in surety, more than double the size of number two," and, Savage believes, the industry will be watching to see what results from the marriage of the traditionally conservative St. Paul and the more liberal USF&G, which, he notes, "has been very aggressive over the last several years, doing things not traditionally done in surety."
In a current program, Savage comments, the company grants underwriting authority of up to $1 million to agents who qualify their clients. "Very few Amwest branch managers have $1 million in underwriting authority."
Amwest looks ahead
Agent response to the regionalization of surety bond underwriting has been overwhelmingly favorable, Savage says; and producers who arrange bonds through Far West Bonding Service are delighted to have a facility that caters to their needs and those of their clients. With its variety of subsidiaries and its commitment to service its chosen market segments competently, Savage says, Amwest has a strong sense of its own identity. "We're not trying to compete with the big companies," he says. "All our markets are niche markets where we think we can be profitable."
By not trying to be all things to all agents, Amwest clearly aims to succeed by being a major force with the producers it serves, in the markets where its expertise gives it the leading edge. *
©COPYRIGHT: The Rough Notes Magazine, 1998