Will the fidelity market experience the one-two punch of lower premium volume and increased claims activity in what has traditionally been a low-risk, and growing, category? While concerned about fidelity bond customer demand in the near term..
Utility Deposit Bonds: As Restaurants Go Dark, Claims Will Light Up
Author: Suretypedia Team
Posted On: 03-27-2020
Social distancing is creating unprecedented upheaval in the economy that we believe could lead to substantial higher loss ratios for a number of types of surety bonds. Stay-at-Home and similar orders prevent many businesses from continuing operations in hopes of slowing the spread of Coronavirus (COVID-19), making this an uncertain time for small businesses, particularly retailers and restaurants.
While the federal government is attempting to alleviate the pain with its $2.2 trillion rescue bill, a record 3.28 million Americans filed for unemployment benefits in the week ended March 21, 2020, five times the highest weekly job loss on record. Goldman Sachs is predicting a 24% drop in Gross Domestic Product (GDP) for the second quarter, which begins April 1st and Morgan Stanley expects a 30% drop. With the Trump administration extending its guidelines for social distancing through at least April 30th, the real economy will continue experiencing more acute stress than at any point during the Great Recession of 2007-09.
Our recent article “Stay-at-Home”: List of Essential Services Matters Greatly to the Surety Industry uncovered which businesses are exempt from stay-at-home orders, and our follow up examined the impact on Contractor Bonds. This article unearths the more obscure world of Utility Deposit Bonds, where many principals are deemed non-essential businesses, and therefore dramatically impacted by social distancing orders. Suretypedia expects Utility Deposit Bonds to be one of the first surety lines to experience elevated losses.
Why Could Utility Bonds Be Impacted So Badly?
Prior to activating service, more than 300 utilities across the U.S. require new businesses such as hotels, laundromats, restaurants, motor vehicle dealers, retail shops, and those with delinquent payments to secure their first few months of estimated utility payments with some form of deposit, the most popular of which is a Utility Deposit Bond. Utility Deposit Bonds give financial protection to the utility company (the obligee) when a business (principal) defaults on their utility bill. The utility can file a claim on the business’s surety bond to be compensated for their financial losses.
A 2018 survey compiled by Womply shows that more than 20% of small businesses said they would not be able to survive zero sales for 30 days and another 34% said they could only survive one to three months. A 2016 study conducted by the JPMorgan Chase Institute found that the median retailer maintained a cash buffer of only 19 days of expenses while the median restaurant could last only 16 days. We’re now operating in a time that was previously treated as a hypothetical. For small businesses running out of cash because they’re shut down, paying last month’s utility bill will take a back seat to basic living expenses.
According to industry sources, losses for Utility Deposit Bonds average approximately 15-20% long term, with the majority of losses happening during the 2007-2009 recession. Surety companies should expect greater losses for existing businesses from the economic downturn that is currently playing out.
Can Enhanced Underwriting Help in this Environment?
Considering different underwriting criteria is important for new businesses requiring Utility Deposit Bonds during this crisis, especially in locations where social distancing regulations have not been enforced. Writing surety bonds for non-essential businesses without collateral should be avoided during COVID-19 in most jurisdictions; if a Utility Deposit Bond is necessary, surety companies should carefully scrutinize the Utility’s bond form, the principal’s business and credit profile, and the local regulations and orders prior to writing the bond.
As detailed in Suretypedia’s Guide to Bond Forms, some bonds contain more adverse language for the Surety than others. Utility Deposit Bond forms are no exception.
Sureties often maintain the right to get off risk at their discretion; however, some bond forms contain provisions requiring much longer notice periods during which the Surety remains liable for the indebtedness of the principal, or even fixed bond terms. As a relatively extreme example, Consolidated Edison (ConEd) Utility Deposit Bond form:
This bond shall remain in effect for three (3) years. Neither the SURETY nor the PRINCIPAL shall have the right to terminate their liability until 3 years from the effective date of this bond.”
At the end of 3 years, the Surety may request bond cancellation in writing with Con Edison. Upon receipt of the notice the bond remains on file for 30 days.
Another concern are provisions that demand payment from the Surety within a specified period of time. The limited time required to make payment hinders the Surety’s ability to properly investigate and adjust the claim. The example listed below is taken directly from the Louisville Gas and Electric Company’s bond form:
...All the Surety herein agrees to pay within ten (10) days after written demand for payment by the Louisville Gas and Electric Company, and delinquent gas and/or electric bills rendered by the Louisville Gas and Electric Company to the Principal…”
Longer Tail Periods
The statute of limitations, commonly referred to as the “Liability Tail,” upon which claims can be filed against the bond can extend the Surety’s risk on a single bond. Some Utility Companies specify a certain period during which the bond may be claimed after it is cancelled. Should the bond form not specify a time period, the statute of limitations defers to the State’s requirement. The Yazoo Valley Electric Power Association (EPA) bond has a particularly lengthy liability tail:
...Obligee shall render every assistance, not pecuniary to facilitate the investigation and adjustment of any loss under this bond shall be brought after the expiration of fifteen (15) months from such termination of service.”
Forfeiture clauses are one of the most hazardous provisions that can exist in a bond form. These provisions require the Surety to pay out the full penal sum of the bond should the obligee file a claim, regardless of the size of the claim. Suretypedia has extensively reviewed the utility deposit bond forms in its database, including 265 custom forms required by the various utilities around the country, and fortunately has not found this provision required by any utility companies thus far. However, given the unusual nature of the present crisis, we would not be surprised if utility companies incur large costs collecting delinquent payments that they are unable to offset with current bond forms. Therefore, Suretypedia will be on the lookout for any trends in updated bond forms coming out of this crisis.
Consent to Extensions
Many Utility Deposit Bonds contain a provision maintaining all of the obligations of the Surety even if the utility extends a grace period to the customer, which is highly relevant right now given the number of utility companies that have recently offered to continue providing power to customers that miss payments (more on this below). Such a provision can be in the Peoples Gas System, Inc.’s bond form, which states
Surety shall be deemed to consent to any extension or extensions of time granted to Principal in which to satisfy Principal’s obligations to Obligee, and Surety hereby waives all notice with respect to Principal’s obligations to Obligee including notice of all amounts due and notice of any extension(s) of time for payment.”
Liability in Excess of the Bond Amount
Language in certain bond forms may increase liability to the Surety for litigation costs and attorney’s fees in excess of the bonds penal some. Below is an example from Florida Power & Light Company’s bond form:
Surety shall not be liable there under for a larger amount, in the aggregate, than the amount of this bond, unless suit must be brought for enforcement of the within obligations in which case the Surety will also be liable for all costs in connection therewith and reasonable attorneys’ fees, including costs of and fees for appeals.”
At the end of this article is a list of every Utility Deposit Bond form in the Suretypedia database, organized by the extent of the adverse language found in the form. The table includes the bond’s cancellation period, along with the existence of any demand clause, liability for attorney’s fees, and extended claims liability tail periods. Keep in mind, not every demand clause is made equal, and other important provisions may exist such as a bond automatically being reinstated if a preferential payment to the utility is made prior to a principal filing for bankruptcy protection. Therefore, it is imperative for Sureties to review any bond forms in detail where they have a particular concentration.
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How Are Grace Periods Impacting Utility Deposit Bonds?
Businesses have been forced to close their doors to the public for undetermined amounts of time. Some restaurants are able to stay open but only offer carry out; retailers can offer online-only sales. The reduction of revenue can place a strain on many small business owners, potentially leading to non-payment of utility bills. The utility industry is trying to help mitigate some of the pain. The Energy and Policy Institute has a complete list of utility companies voluntarily suspending shutoffs and the governing bodies who have imposed the suspension of disconnections. In at least 20 states, government entities have mandated statewide utility disconnection suspensions while many other states, counties and cities have urged utilities to avoid disconnection of services for nonpayment.
While these measures may come as welcome relief to many struggling businesses, most Utility Deposit Bond forms specifically state that any extension of time for payment does not relieve the Surety of its obligations under the bond. In fact, a grace period where the utility does not shut off power to businesses that do not pay their bills could be the worst thing for the Sureties with Utility Deposit Bond exposures as some costs will continue to accrue to the Obligee.
Here are the details for a few major utilities:
*This is not a comprehensive list - there are many additional companies who have agreed to delay shutoffs during COVID-19.
Even though Utilities are relaxing policy on the disconnection of services and late payments, they are urging businesses to pay as they can so bills don't become overwhelming leading to nonpayment. Companies that continue nonpayment will likely result in surety claims.