How Do Surety Bonds Affect the Public Energy and Utility Sectors?

Posted on August 20th, 2012 by
   

It’s no secret that various government agencies regulate the public energy and utility sectors in many different ways. Regulations are typically put in place to protect consumers from large corporations that might try to take advantage of them. But large corporations sometimes need protection from their clients as well.

What do I mean by this, and what does it have to do with the energy industry?

Utility companies provide a great deal of energy to numerous clients every month. As you know, clients are billed for the amount of energy they use, which means they pay for services only after they’ve used them. So how do utility companies ensure that they’ll be paid for the energy provided to clients? They do so by requiring clients to purchase surety bonds that guarantee payment.

Before we go much further, let’s review how surety bond insurance works.

Although it’s a common risk mitigation tool used to reinforce regulations in a number of industries, few people have heard of surety bond insurance before being told they have to purchase it. Unlike traditional insurance policies where a company provides coverage to a policyholder, surety bond insurance involves three entities.

When it comes to surety bonds for utility companies, the three entities involved are a utility company, a client and an insurance company. The utility company requires a bond to ensure the client pays utility bills in full and on time, which makes it the bond’s obligee. The client purchases a bond as a financial guarantee that it will pay utility bills, which makes it the bond’s principal. The insurance company backs the bond with a financial guarantee in case the client fails to make a payment, which makes it the bond’s surety.

Utility bonds, which are insurance policies and not financial investment tools, are typically only required of clients that will consume thousands of dollars of energy each month. Some businesses, such as manufacturing plants, are obvious candidates whereas others — such as restaurants, bars and campgrounds — might be more surprising. Clients typically have to file the bond with the utility company before power will be turned on.

If a client does fail to make a payment, the utility company can make a claim on the bond to ensure proper compensation. If the claim is found the be valid, the surety that backed the bond will be required to repay the utility company up to the bond’s full amount. Surety bond insurance is not like other insurance policies that require the underwriter to assume the financial loss; if this were the case, it would be all too easy for clients to default on payment under the assumption that the surety must foot the bill.

Instead, when it comes to surety bond guarantees, the insurance company will expect to be reimbursed by the client. Bond forms include an indemnification clause that plainly states the principal is legally required to repay the surety if a claim is ever paid out. Of course, claims made against surety bonds are rare, so this is rarely an issue.

One reason bonds claims are rare is because surety providers take great care when reviewing applicants. If they determine an applicant lacks the financial stability to make utility payments on time and in full, the surety will simply choose not to issue the utility bond. Without the bond, the client will be unable to work with the utility company. Or, in some situations, surety providers will issue the bond to applicants perceived to be risky, but they’ll charge a much higher fee to do so.

Fortunately, in most situations claims rarely have to be made against utility bonds. However, if a situation arises where a client fails to pay for the energy consumed, utility companies can avoid losing money by taking advantage of these valuable insurance tools. Without the financial guarantee of surety bond insurance in place, utility companies could lose a great deal of money due to nonpayment.

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

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