From the April 2012 issue of American Agent & Broker •Subscribe!

Untangling the Options

Agents play an integral role in reviewing security options. Learn the intricacies of surety bonds and bank letters of credit.

In the wake of the recession’s aftermath, many businesses are seeking greater access to credit. Whether the intended use of credit is to fund acquisitions, retire or refinance high interest rate debt, or to support capital expenditures, certain circumstances call for businesses to take a closer review of potential options before establishing or tapping into their credit facilities. As part of any business’ trusted advisers, agents and brokers play an integral role in reviewing what security solutions are available that won’t tie up credit and allow the client to take advantage of his financial standing and liquidity. 

Clients need to be strategic in their decision making, particularly in an environment when more businesses may be required to post security in the form of a bank letter of credit or surety bond. Educating your clients about alternatives like surety bonds can help them preserve their bank lines of credit for other strategic purposes. 

Read sidebar "Customers You Can Reach."

When comparing a surety bond with a bank letter of credit, consider a variety of factors in addition to cost. Perhaps the most important consideration is how the decision impacts your client’s business from a macro perspective. For example, if your client foresees the need to access his cash reserves to maintain or grow his business, it is important to keep his bank line of credit fully available. Opting for a bank letter of credit in this particular scenario could financially hamstring your client down the road. A surety bond can help clients “check the box” without tying up lines of credit.

Related: Read the article "Surety Capacity Remains Ample and Inexpensive, Despite Construction Downturn" by Dave Lenckus.

Surety bonds offer more favorable terms and conditions—one of the most relevant differences being a facility charge. Explain to clients that an expectation for a certain amount of that line will be used when a bank issues a line of credit. If your client does not use the facility they may be charged a facility fee for the untapped portion of the bank line of credit in addition to non-competitive letter of credit fees for actual use. 

Related: Read another article by Dave Lenckus "Public, Private Sectors Could Unite to Fix U.S. Infrastructure."

Clients opting for a surety bond will not face charges for failing to use the surety program extended to them by their bonding companies. Another area of consideration includes the security or guarantees required by the bank. Is the bank facility unsecured or secured by business assets? While the surety will require the execution of a general contract of indemnity it may not require the same overall security arrangements as the bank. 

Got Cash?

In addition to flexibility and keeping lines of credit available, surety bonds create opportunity for more affordable securitization. An article from The Wall Street Journal (“In Carnage, Cash Comforts”) revealed that many companies are holding more cash now than they were before the recession hit. In fact, non-financial companies held 59 percent more cash in August 2011 than the end of Q3 2008. Clients who are required to post collateral with the surety and happen to have large cash or equivalent reserves on hand can obtain reduced surety costs while retaining the investment income from those collateral deposits. Travelers, for example, has established third-party intermediaries to help keep those funds secure in highly liquid and safe investments. The types of investments are negotiated by the client and the securities intermediary and typically mirror the established conservative investment strategies of the client. 

Read the sidebar "A Tough Time For Small Contractors."

On the other hand, as many companies are trying to keep their financial options open and flexible, a collateral or security requirement can be a tall order. Opting for a surety bond over a letter of credit may give your client the opportunity to obtain a surety bond without putting up collateral or security to a bank. Banks often require assignments or pledges of corporate assets and personal guarantees of business owners and spouse. Depending on the nature of the bonded obligation, surety bonds are an option that can be obtained without requiring the financial assurances required by the banking community.

When it comes to providing clients with the best service and options possible, agents and brokers should review certain considerations. For one, what are your clients’ buying habits? The answer can be surprising and is closely related to how your clients’ treasury, financial reporting, and risk management roles and responsibilities are established. For example, treasury may post letters of credit for obligations that can be easily covered with a surety bond without the knowledge of their risk management team. Once you understand the scope of your client’s security needs, especially for workers’ compensation self-insurance programs, large deductible or retrospectively rated programs, and court appeal bonds, you will be in a better position to coordinate and influence the buying decision. 

Related: Read the article "Surety Insurance Strong Despite First Sealord Struggles" by Arthur D. Postal.

Agents and brokers do more than sell products to clients by serving as consultants and solution providers. While some clients understand they have options when it comes to different risk management techniques, deciphering the benefits of surety bonds versus bank letters of credit can be one of the more confusing hurdles. A key benefit of a surety bond is the knowledge that a strong team of surety claim specialists are available to mediate with the bond obligee to validate the default in the event of a dispute on a bonded obligation. With a letter of credit the beneficiary can merely draw on the funds in accordance with the terms and conditions of the letter of credit. 

Bank letters of credit are an extremely important resource for all businesses, particularly in this economy, but need not be the best choice when other options like surety bonds may offer greater flexibility and valued services.

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