“What Is Good to Buy Right Now? Municipals? Or Corporate Bonds?”
“What Is Good to Buy Right Now? Municipals? Or Corporate Bonds?”
Usually when I tell someone that I work for an insurance agency and that my product is bonds, the response from them is the question above. I’ve received that question so many times that I have a canned response, “The bonds I deal with are not something you want to buy. They are something someone makes you buy.”
So what is a bond? Simply put, it is a credit guarantee whereby a third party, usually an insurance company, guarantees an obligation from one party, the principal, to another, the obligee. The potential obligations cover contractual obligations for construction of bridges, buildings, roads, etc. to an obligation of a public official to faithfully perform the duties of their office.
The types of bonds can be broken down into three large categories:
Fidelity bonds are more like your typical insurance product. They protect an employer from embezzlement by employees. While some of these are written as a stand-alone product, today most fidelity coverage is written as a product of a company’s property coverage.
Contract bonds, or performance and payment bonds, guarantee that a construction contractor will complete a construction project according to the contract between the contractor and the project owner, and that they will pay all of the bills related to that project for labor, materials and subcontractors.
The largest category, and the one with the most variety, is commercial bonds. There are literally thousands of different types of commercial bonds and these are the types that most of our clients are required to obtain. This category contains everything from bonds on public officials guaranteeing their faithful performance, to simple compliance bonds which guarantee that a company will comply with the terms of a license or permit. When you have seen the trucks of an electrician, plumber, air conditioning contractor, roofer, etc. and they have the words “licensed, bonded and insured” on the side, usually all that means is they have posted a $5,000 to $10,000 bond required to obtain a license or permit to operate in a certain city or county.
This has been a basic introduction to bonds. Over the next several weeks we plan to explore in more detail the different types of bonds, what information is required to obtain them and how they are underwritten by the insurance company.
The reality of the construction industry is that contractors have to sign contracts to work. And they usually don’t have much in the way of negotiating leverage. This can put contractors into a financially dangerous risk management position if their insurance agents aren’t looking at their contracts and comparing them against their insurance policies.
One of our insureds (the Subcontractor) had the wording paraphrased below contained in one of their construction agreements:
Subcontractor will defend, indemnify, and save harmless Contractor from any and all claims which are caused in whole or in part, which arise from or occur in connection with work undertaken or to be performed by the Subcontractor, or which arise from or occur in connection with any other act or omission relating to the Subcontractor.
The key piece of this indemnity that could cause trouble is “which arise from or occur in connection with work undertaken or to be performed by the Subcontractor.” This statement makes the subcontractor responsible for all claims that are connected to its work; it doesn’t require that the subcontractor’s negligence or actions contribute to the loss. The mere presence of the subcontractor at a jobsite makes anything that happens to one of its employees “in connection” with the subcontractor’s work.
In our example scenario Capitol Plumbing has been hired by ABC General Contracting for a new office building. One morning Capitol Plumbing’s employee Joe is getting his equipment ready at the jobsite and the sheetrock supplier hired by ABC backs his truck over Joe causing serious injuries that require tens of thousands of dollars’ worth of surgeries and a lot of lost work time for Joe.
Of course Joe has his medical bills taken care of by Capitol’s workers’ compensation policy along with a portion of his lost wages. But Joe wants the rest of his lost wages and he wants someone to pay him for his suffering now that he can’t go out on the Reservoir every weekend in his boat and enjoy fishing the way he used to. So Joe sues ABC General Contracting for negligently hiring a sheetrock contractor with incompetent drivers who don’t know how to follow proper safety protocols at the jobsite.
As soon as ABC gets this claim, they pull the contract they have with Capitol and remind them that they agreed to defend and indemnify ABC from any claims that occurred in connection with Capitol’s work for ABC. Joe would not have been at the jobsite if it weren’t for Capitol’s work. So the claim bounces back to Capitol who is contractually obligated to take it. An unendorsed general liability policy would cover this as a contractual liability claim because Capitol’s contract with ABC is an “insured contract” and the workers’ compensation and employers’ liability exclusions wouldn’t apply because of an exception for this specific circumstance (an action over claim). Unfortunately, Capitol’s general liability carrier had just added an endorsement stating that insured contract coverage didn’t apply unless Capitol’s negligence was at least partially responsible for the loss. They also had an additional insured endorsement that required Capitol’s partial negligence to kick in. So Capitol has to take on this claim without any insurance to help pay for it.
At the end of the day, Capitol could have avoided this financial exposure by sending its contract to its insurance agent. We would have recommended that they add a statement to the indemnity explicitly exempting Capitol Plumbing for any liability associated with ABC’s (or its other subcontractors’) sole negligence. Most contractors will agree to this if it is negotiated in advance and it could have saved everyone in this scenario a lot of grief.
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