What is Stacking Liability and Why Does it Matter?

Author: Suretypedia Team

6-23-2020

Many insurance executives think of surety bonds as relatively simple risks, often one-page contracts with no variability amongst carriers, but surety veterans understand that nuance of adverse bond form language that is often overlooked. One such underappreciated risk is Stacking Liability. As we explained in our deep dive into different bond classes, there is room for concern when it comes to adverse bond form language. The potential for elevated claims caused by society’s response to COVID-19 makes Stacking Liability all the more dangerous and worthy of additional attention. This article is designed to raise awareness and understanding for surety agents and carriers, including both underwriters and claims handling departments, and highlight ways the industry can potentially avoid unintentional Stacking Liability.

What is Stacking Liability and Why Does it Matter? 

The bond limit, also referred to as the bond penal sum or simply the bond amount, is one of the most important factors determining how surety underwriters will approach eligibility and rating of a surety bond – the larger the bond limit, the greater the contingent credit extended to the bond principal, and therefore the more scrutiny applied to the application. More often than not, the total potential liability faced by the carrier cannot exceed the bond limit, irrespective of the size of any claim, number of claims or number of claimants.  One major exception are bonds subject to, and carrier issuance practices that result in, cumulative liability, also referred to as “Stacking Liability,” which can arise from specific language in a bond (i.e. a Stacking Liability provision) or unintentional actions taken by a surety when writing bonds. 

What is a Stacking Liability provision?

Some bond forms contain an explicit Stacking Liability provision. This most often occurs when an obligee requires a specific bonding period and the penal sum applies to each bonding period. Each renewal, or extension of the bond for additional bonding periods, carries a new penalty for each bonding period. Therefore, a Surety writing the bond is not just exposed to a single penal sum over the life of the bond. Instead, they are subject to the aggregate penal sum for the total number of bonding periods. For example, if the Surety writes a bond with a $10,000 penal sum for three terms, the Surety’s aggregate liability for that principal would be $30,000. 

The Maryland Home Improvement Contractor license bond contains such a Stacking Liability provision. Check out the language below directly from Maryland’s bond form:

Each $20,000 bond limit per bonding period can be claimed as long as the alleged grievance occurred during the applicable bonding period. So, should a Maryland Home Improvement Contractor be in their third renewal cycle with the same carrier, the carrier now has $60,000 of total contingent credit extended to the contractor on a bond with a stated $20,000 limit.

Another example of a Stacking Liability provision is found in the Wisconsin Electronic Title and/or Registration Processing bond form. This is particularly noteworthy because the Wisconsin bond is continuous and does not require specific bonding periods like the Maryland bond . Should the Wisconsin bond renew, the penal sum automatically stacks and is available for the benefit of any claimant during each 12 month period the bond is effective. Pay close attention to how the Wisconsin Department of Transportation lays this out:

Based on the above, a new bond doesn’t need to be issued by the carrier at renewal, the bond only needs to pass a 12 month period after a specified beginning date for the Stacking Liability provision to occur. So, should a cancellation notice not be sent 60 days prior (per the cancellation provision) to the renewal date, the Surety could inadvertently be on the hook for an additional $10,000 in liability if activity resulting in a claim occurs prior to the final cancellation date of the bond and after the first 12 months.   

Can a Surety’s liability accumulate without specific Stacking Liability language in the bond form?

Yes, another (and potentially avoidable) way Stacking Liability can occur is when an agent issues a new bond for a principal at the same carrier holding the principal’s existing/prior bond term, typically for a competing agent. The issuance of a new bond (and bond number) creates an additional single and aggregate limit exposure for the new bond, rather than simply renewing the existing bond which would cap the surety company’s liability regardless of how many times the principal renews the bond. This set of circumstances can also result in carriers extending credit to principals far in excess of the stated limit on the bond. 

But can’t the Surety cancel the old bond when it writes the new one?

Yes, but that doesn’t immediately and completely eliminate the liability of the old bond. Depending on the statute of limitations for filing a claim, a party can file a claim on a bond for 3-20 years after the bond is cancelled, depending on the state (see statute of limitations section below), a period known as the statutory liability “tail”. If a new bond is issued for the same principal by the same surety company, a claim on one bond would not reduce or exhaust the available limit on another for as long as the first bond remains in its statutory tail window.

How does Stacking Liability without specific Staking Liability language increase the Surety’s risk on any one principal?

Except for bonds with a specific Stacking Liability provision, such as the Maryland Home Improvement Contractor license bond or the Wisconsin Electronic Title and/or Registration Processing bond discussed above, when a Surety renews a continuous bond, i.e. does not cancel at the end of the term due to receipt of renewal premium, or renews a bond via a continuation certificate, there is a single limit that applies no matter how many years the bond has been outstanding or how many times the bond has been renewed. Coupled with standard aggregate limit language, this means that if a valid claim is filed within the statute of limitations (aka “claims tail” or “statutory tail”) for an incident that occurred during a prior term of the bond, the payment of that claim reduces, and potentially exhausts, the aggregate limit on the current bond. Much like a letter of credit from a bank, the Surety charges a fee (i.e., the premium) to the principal to effectively rent the creditworthiness of the Surety for a period of time up to the limit on the bond.

However, when a Surety company writes a new bond for a subsequent term for the same principal, the Surety takes in the same premium as in the above scenario but now has two bonds outstanding that the public can file claims against, and therefore double the potential payout. Surety bonds are “occurrence”, as opposed to “claims made”, contracts so this doesn’t mean that a claimant harmed in one period can file a claim on a bond effective for a different period even if the statute of limitations on that bond remains current. What it does mean is that a claim filed against a principal during the statutory tail period for an incident that occurred during a prior bond term does not reduce the limit of the current bond or other bond terms for that principal whose statutory tail period has yet to expire. For a familiar example, we’ll reference the $50,000 Oregon Motor Vehicle Dealer bond. Let’s review an excerpt directly from the bond form:

This can be a little dense, but Suretypedia has determined that should the Oregon Motor Vehicle Dealer Bond, and other bonds with similar language, be renewed normally by the issuing carrier, the Surety’s exposure is limited to the penal sum of the bond and liability does not stack. However, should the dealer “renew” the bond with a different carrier, or if the principal moves their book of business to a new agent that writes a bond with the same carrier without a broker of record letter, both bonds can be claimed against if each claim is filed respective to the period each bond is in effect. 

Are there ways to avoid Stacking Liability? 

If a Stacking Liability provision is built into the bond form, the only way to avoid this condition is to not renew the bond. Alternatively, if a carrier is worried about duplicate bonds being submitted for a single principal, they can require their producers to take the following precautions. 

1. Ask the principal if they have been bonded in the past and by what carrier(s)
2. If the bond is filed electronically, check the obligee’s website, if available, to confirm the carrier of record. Some obligees even show a principal’s bonding history
3. If the bond principal is already bonded with the carrier, require a broker of record letter for new agents to take over the existing bond rather than issuing a new bond for the principal.

How Could Stacking Liability Impact Underwriting?

Underwriters should gauge their total potential exposure when underwriting bonds with a Stacking Liability provision, which will be driven by the number of years the principal has been bonded and the statute of limitations for filing claims in the state in which the bond was issued. Bonds with this provision should be reviewed with a bit more scrutiny because, if the bond renews, the Surety can be liable for more than the penal sum of the bond.

This is tricky because while a bond with a Stacking Liability provision increases the exposure of the Surety periodically, a principal’s surety risk is typically deemed to decrease the longer they have been in business. While most carriers provide underwriting credit to bond principals for establishing a history of operating their business, surety underwriters should categorize bonds with Stacking Liability provisions differently and certainly re-underwrite these bonds before offering renewal terms. 

Keep in mind that the increase in risk is not linear with the increase in aggregate exposure due to the stacking of liability. First, a surety’s exposure is always contingent on a claim being filed and the probability of multiple claims being filed for different periods during the statutory tail period is certainly lower than the likelihood of one claim being filed. Moreover, while a 20-year statute of limitations may look daunting, the probability of a surety claim being filed on account of an incident that occurred 15 years ago is pretty low.

How Should Claims Handlers Address Stacking Liability?

Claim handlers need to familiarize themselves with the bond form and statutes dictating the bond’s guarantee. Claims professionals will need to be aware that claim payments can be assessed (and paid out on) during the term of each bond with a Stacking Liability provision that has been filed undiminished by claims from prior periods. As discussed above, a Maryland Home Improvement Contractor operating for 6 years posts three $20,000 bonds for each of their two-year license terms. Claims can be filed on each bond for work performed within each bond’s term subjecting the surety to up to $60,000 in potential liability.

In addition to understanding that the limit for a bond with stacked liability will not be reduced or exhausted by claim payments related to prior bond terms, claims handlers must be prepared for claimants, especially those represented by attorneys, to attempt to file claims against multiple bonds. While one or more of their claims may be invalid due to the date of the incident, this can be murky in the case of complex claims and can increase loss adjustment expenses.

What is the statute of limitations for claims that can be filed on bonds?

We’ve established that the presence of a claims tail, the period of time during which a claim can be filed following the cancellation of any specific bond, is a necessary condition for Stacking Liability to occur. The claims tail is established by the bond language, statutes relating to the bond and/or the general contractual statute of limitations in the state in which the bond is issued. Suretypedia has compiled the following list of general contractual statute of limitations by state that would govern bonds that do not have specific statutes or language in the bond form. It is worth reiterating that the underlying incident giving rise to the grievance must have occurred during the term of the bond for a claim to be valid.