Surety Bonds Provide Vital Protection to Utility Companies

–Danielle Rodabaugh, chief editor of the Surety Bond Insider, a publication that tracks developments within the surety industry. As a part of the publication’s educational outreach program, Danielle provides information to help leading industry professionals better understand surety bond intricacies.

Millions of dollars exchange hands within the energy sector every day. So how do energy providers ensure they’re paid for the power and other services they provide? One way utility companies ensure they’re paid in full is by requiring some clients to purchase surety bond insurance. Before discussing how and why surety bonds are used within the energy sector, let’s review how utility surety bonds work. When discussing the role surety bonds play in the energy sector, it’s crucial to recognize how this specific insurance product differs from other types of commercial insurance.

Surety bond insurance does not protect the policyholder, which, in this case, would be the client required to file the bond.[1] Instead, the bond protects the interests of the party requiring the bond, which, in this case, is the utility company.[2] The basic purpose of utility bonds is to ensure that clients who consume large amounts of energy will pay their utility bills in full and on time, which keeps utility companies from losing money.[3] When clients are expected to consume large amounts of energy, utility companies typically require them to file a bond before the utilities will be turned on.[4]

Each surety bond insurance policy that’s issued brings three separate entities together in a legally binding contract to ensure a specific task is completed.[5] When it comes to utility bonds, these three parties are as follows:

• The principal is the client who purchases the bond as a promise that all future utility bills will be paid on time and in full.[6]
• The obligee is the entity that requires the bond as a way to prevent financial loss. Most surety bond types are required by government agencies, but utility bonds are required by utility companies.[7]
• The surety is the insurance company that issues the bond, thus providing a financial guarantee that the client will pay all utility bills.[8]

The exact requirements a client will be expected to fulfill depend on the contractual language that’s used on the surety bond form. Generally though, the bonded principal fails to fulfill the bond’s terms, the underwriter will have to pay for the claim.[9] This means utility bonds are financial guarantee bonds and not compliance bonds, which is why they are risky for insurance companies to underwrite.

Although insurance companies might have to pay out claims, surety bonds do not involve deductibles.[10] In fact, they function in a contrasting way: if a claim is made against the bond and the underwriter pays for it, then the bond’s indemnification clause will require the principal to reimburse the insurance company in full.[11] To put it simply, bonded clients who fail to pay their utility bills must reimburse their surety provider if any claims are paid.[12]

Of course, if bankruptcy on behalf of the client is involved, the insurance company will be forced to assume the loss. To avoid this potential risk, insurance companies are incredibly thorough when reviewing utility bond applications.[13] If a client’s financial credentials do not allow them to qualify for the required surety bond, the utility company will avoid working with the client.[14] Some insurance companies even avoid writing utility bonds altogether, which makes it difficult for some clients — especially those with bad credit — to fulfill their utility company’s bonding requirements.

Preferred citation: Danielle Rodabaugh, Surety Bonds Proide Vital Protection to Utility Companies, LSU J. Energy L. & Res. Currents (September 26, 2012), http://sites.law.lsu.edu/jelrblog/?p=70.