FIDELITY AND SURETY: THE MAGNA CARTA WAS A SURETY BOND
From The Visiting Fireman, Vol. 12, No. 2, Pages 2-3, February 6, 1978.
Branch Fidelity and Surety managers nationwide gathered for the first time at a departmental meeting in San Francisco in December. The purpose of the meeting was to give the branch and Home Office managers a chance to get to know each other and to discuss departmental policy. The meeting followed the recent reorganization and consolidation of the department, from a two-part operation with regional offices in San Francisco and Parsippany to a single operation with all branches reporting directly to the Home Office.
"We called the meeting because we felt it was the best way to communicate," explains Vice President William W. Lauber, Fidelity and Surety Department manager. "The reorganization of our department at the end of September was massive, and we figured that by early December we would have worked at it long enough to have found the bugs in it. We felt that the best and most rapid way to work those bugs out was to get everybody together to discuss it."
The department was consolidated in order to improve its effectiveness in terms of production, underwriting, administration, and staff development. Most of the other company departments were consolidated three years ago, but the Fidelity and Surety Department chose to maintain its divisional offices at that time because, as Lauber explains: "We're a specialty line, and we have to adjust our total structure to fit the nature of the business. Two-thirds of our business is in surety, which tends to track the general economy - especially construction - rather than the insurance economy. We decided that 1974 wasn't the right time for us to make the change."
However, now, Lauber believes, "we're in a different era - the nature of the marketplace is very different. The rate of change in our business has increased several fold in the past few years. From 1973 to 1975, we experienced a rapid inflationary rate, and in 1974 we also went into a severe recession. Those are economic factors that strongly influence our business, and we must be capable of adjusting rapidly to them. We've found it difficult to make those adjustments with divisional offices, and we believe that we will be more effective with a single unit." As Assistant Vice President William T. Perry, assistant to Lauber, explains: "We can adjust our departmental policy more quickly and implement those changes more easily, when the senior Fidelity and Surety people are all in one place."
Six senior staff members were moved from the east coast to the Home Office when the department was consolidated, and two new people were hired to fill vacancies created by staff members who were unable to transfer. Lauber believes that having all his senior staff in one place will also "make us more effective in maintaining staff capabilities, primarily through enhanced and enlarged training programs.
The job of the Fidelity and Surety Department is to underwrite fidelity and surety bonds, which are agreements by Fireman's Fund to take financial responsibility in case of loss resulting from another party's dishonesty or failure to fulfill certain obligations. In a suretyship contract, Fireman's Fund guarantees that the principal will keep his promise to perform certain tasks for the obligee. For example, a contractor (the principal) buys a construction bond from Fireman's Fund, promising the party for whom the building is being constructed (the obligee) to have the building completed according to specifications and by an agreed-upon date. If the contractor defaults, Fireman's Fund must indemnify the obligee.
"The bond business is an old, old business," says Lauber. "The Magna Carta was essentially a surety bond: King John agreed to do and not do certain things, and the Magna Carta guaranteed that promise.
Since 1215, when the English barons forced King John to sign their charter of liberties, many other types of surety bonds have come into being. "There are literally thousands of different kinds of surety bonds," says Perry. "They're all written because they're required by a third party - and county or district can create the need for a surety bond." The most common surety bonds are construction bonds, but others include fiduciary bonds, which guarantee that the administrator of an estate will fully perform the duties required by law; license bonds, which guarantee that the business will comply with the terms of its license; and public-official bonds, which guarantee that the official will properly perform his duties.
One of the more unusual kinds of surety bond is an admiralty bond, which is required for an ocean-going vessel that has been in a collision. Once the damaged vessel is in port, it must remain there until the bond is filed to guarantee payment of any judgment that may be made against the ship or its owners. Another interesting bond is the countervailing bond, which is required for foreign firms that have been accused of "dumping" their merchandise in the United States at cost or less, in order to establish a market. Dumping, which is currently a problem in the steel, textile, and auto industries, is contrary to public policy because it makes it hard for United States companies to compete. Since it takes a long time to determine if a company is dumping, the U.S. Customs Department makes the accused company put up a countervailing bond to guarantee that, if it is found guilty, it will pay damages to the injured parties.
One of the largest surety bonds written by Fireman's Fund is a construction bond for a jet engine test facility being built for the U.S. Air Force. The cost of construction will be $300 million. Fireman's Fund is also the largest writer in the country of bail and arrest bonds for members of major travel clubs, such as AAA (American Automobile Association). Members of AAA who are arrested for traffic violations can use their membership cards in lieu of up to $5000 in bail, and the bonds guarantee that they will appear in court at the time of trial.
A fidelity bond, rather than guaranteeing that the principal will perform some task, simply guarantees the principal's honesty. For example, employers buy fidelity coverage to protect them against losses resulting from dishonest or fraudulent acts of employees. Another common fidelity bond is the forgery bond, which protects against loss by forgery of a check or other written order to pay money. The largest fidelity bonds are for financial institutions, such as bans and stock brokerages, which purchase bonds to indemnify them for theft of money or valuables. Fireman's Fund writes fidelity bonds for the Crocker, Wells Fargo, and Chase Manhattan banks, and for the Pacific Stock Exchange.
Fidelity and surety bonds are often extremely difficult to underwrite, since the underwriter must evaluate intangibles people's integrity and their ability to do what they say they will. "We deal entirely with people, with what people do," says Perry. "Can you imagine anything more difficult to guarantee than someone's performance? How can I look into your mind and know what you will do in ten years?" To determine if the principal has the means to fulfill his promise, the surety underwriter investigates his experience and financial standing. For fidelity risks, the underwriter is concerned with the loss exposure and loss history of the risk. Although a great deal of judgment is involved in both cases, Perry believes that the department has found "some underwriting techniques that are reasonably successful."
Perry thinks that the consolidation of the Fidelity and Surety Department will make underwriting practices even more successful: "The new organizational structure should have a very favorable effect on the future of our department. We believe it will improve our operating results." Lauber concurs: "We're going to be more effective in terms of achieving our profit objectives and growing in tomorrow's marketplace."
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