What is a Surety Bond?

To fully understand why surety companies examine a principal’s moral character, you first need to understand the nature of suretyship. A surety bond is a three party contract between the principal (your customer), the surety company, and the obligee. The obligee requires the principal to purchase a bond, usually as a prerequisite to obtaining a business license or permit, and the surety company assumes liability in the event a claim is made against the bond. Surety bonds protect the obligee from financial harm in the event that the principal violates the provisions set forth in the bond form.

Why Do Surety Companies Examine The Principal’s Moral Character?

Surety companies examine the principal’s moral character to assess the likelihood of a claim being made against the bond. As mentioned above, surety bonds protect the obligee in the event the principal violates the bond provisions. Each surety bond has its own specific provisions, but the purpose will always remain the same; To ensure the obligee does not suffer financial harm if the principal acts unethically. For example, auto dealer bonds protect the general public in the event the dealer engages in any acts of fraud or fails to pay taxes and fees. So when determining a dealer’s eligibility for an auto dealer bond, surety companies must assess the likelihood the dealer will act unethically.

How Do Surety Companies Examine The Principal’s Moral Character?

So now we know why surety companies examine moral character, but how do they make their determination? Well for starters, surety companies will examine the principal’s history of having legitimate bond claims made against them. If your customer has had bond claims made against them in the past, then in the eyes of the surety company, they are considered far more likely to violate the provisions of the bond being applied for. Additionally, the surety will request information on prior convictions and if the principal has had any legitimate complaints made against their business license (if applicable).

When do Surety Companies Examine a Principal’s Moral Character?

Surety companies won’t always consider the principal’s moral character during the underwriting process. For bonds that are considered low risk enough, surety companies will forgo this requirement. But what makes a bond low risk? Essentially, bonds with a historically low rate of claims and a relatively low limit (think below $10,000) will not be subject to underwriting requirements and are issued to all buyers at the same rate. However, if your customer’s bond is subject to underwriting criteria then surety companies will always consider the buyer’s moral character.

How Important is the Principal’s Moral Character to the Underwriting Process?

The principal’s moral character isn’t the end all be all of the underwriting process, as surety companies will also consider a myriad of other factors. As with other types of insurance, the underwriting process is all about analyzing risk criteria to assess the likelihood of a claim occurring. Additionally, surety bonds are subject to indemnification, which means that the principal is legally required to repay the surety company for all claims made against the bond, as well as any claims handling expenses (legal fees, investigative fees, etc). So while the moral character of the principal is important, it is still just one of many factors that underwriters will consider. In summary, surety companies examine both the likelihood of a claim being made against a bond, and the principal’s ability to repay them were a claim to occur.