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Secrets of Bonding #150: Surety Bonds Are Exactly Like Insurance

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Surety Bonds are exactly the same as Insurance.  They are like… twins!

If you are a follower of the Secrets blog, this statement may surprise you.

Go all the way back, way back to article #1 in this series published in February 2014.  It was titled “Bonds Are Not Insurance.” OK, if you read it, so when did they start being like insurance?

Question: Does this sound familiar?

Your contractor client calls up and tells you they have just won a new contract and are ready to sign. “We need to provide an Insurance Certificate.”

What would be your very next comment? Would you say “I’ll transfer the call to Bertha who issues our certificates!” Or would you ask for a copy of the insurance specification and the new contract so you can review them?

You’d probably do the latter. You need this to determine if there are any special requirements, onerous clauses and to determine the coverage levels needed.  Before issuing the certificate, you may need to modify their program to be compliant.

Let’s compare this to Surety Bonds. When an agent colleague sends over a bond request form (or bond app), we always ask for the written bonding requirements, any mandatory bond forms and a copy of the contract if it is available.

We do this for exactly the same reason as with insurance. We want to understand what the customer needs, and be sure what we provide fulfills the requirements. It’s just good business.

Admittedly, bonds are still very different from insurance – except for this common underwriting step. You agree?

Now let’s go a step deeper.  If we will always review these supporting documents to accompany each bond request, what are we looking for when we get them?  What are the hot buttons?

Bond Forms

It is important to note if bond forms are included in the specification.  If they are, you must determine if they are mandatory to use, or if equivalent or standard forms may also be accepted.

In contract surety, all bid bonds are pretty much the same.  However, Performance and Payment bonds can vary great depending on the obligee (protected party).

For example, on all federal projects, the bond forms are the same, and using them is mandatory.

The American Institute of Architects (AIA) has developed a standard set of bond forms that are well accepted by all parties and commonly used in construction.  You may find these are stipulated.

When it comes to private contracts, such as a subcontractor working for a general contractor, the bond forms can be anything.  It might say AIA forms, or they might invent their own P&P bond form that is mandatory. You need to know!

Surety Credentials

The standard for the bonding company could be as simple as “the surety must be acceptable to the obligee.”

However, there can also be licensing and rating requirements that must be adhered to.  A license issued by the local state insurance department could be required “a bonding company authorized to do business in New Jersey.”

A minimum size and strength rating from a rating bureau like A.M. Best could be indicated.

Along similar lines, a surety listed on Circular 570 (a federal approval list) is not uncommon.

Conclusion

There is no way to assure your client has exactly what they need other than to review the requirements. Failure to provide exactly what a client needs can lead to embarrassment, loss of a contract and one disappointed “former” customer. 

Bonds are NOT the twin of insurance, but the underwriting has some common elements, namely the need for certainly when providing the correct coverage issued by an appropriate carrier.  Get the supporting documents and read them. Discussion with the client and underwriter may be appropriate. 

In both bonds and insurance, this procedure protects your E&O, assures your professional performance and leads to stronger client relations.

Insurance Agents and Contractors: Love the “Secrets” articles? You’ll really love it when we solve your tough bonding problem! We have the markets and the know-how to succeed even when others have failed.  Call us with your next surety bond need.  We guarantee a same day response.  856-304-7348

Not available in all states.

Secrets of Bonding #149: Be A Surety Bond Fixer

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Being a problem solver is a great way to deliver value for your customers.  When it comes to surety bond problems, do you have any creative solutions?  Are there tricks up your sleeve that make your clients say “Mr. / Ms. Bond Fixer, I’m sure glad I called you today!

Well try your hand at solving these surety bond problems.  They may have more than one good solution, but I will give at least one for each at the end.

  1. The company owner is willing to give personal indemnity, but the spouse refuses. Your solution?
  2. The underwriter has approved a performance bond but collateral is required (money the contractor lets the surety hold as a security deposit against possible bond claims.) The contractor doesn’t have the cash to put up. Your solution?
  3. The subcontractor is required to provide a P&P bond, but no surety will support it. Your solution?
  4. In order to support a Performance Bond, the underwriter requires a CPA Reviewed financial statement. The client didn’t anticipate this and only produced a Compilation (lower quality) report at their last year-end. Your solution?
  5. A property owner has awarded a project to the contractor, but he is being required to issue a performance bond to the local township. The underwriter declines this stating “there is no contract for the performance bond to cover.” Your solution?
  6. Company Working Capital is too low. Main problem is that Accounts Receivable were overdue at fiscal year-end. Your solution?
  7. An old line excavation contractor can’t get bonded because their Net Worth is too low and the Debt to Equity ratio is too high! Your solution?

 

Feel free to post your ideas on how to fix these bond problems.

 

Possible Solutions:

  1. Indemnity – Get the spouse to sign a “non-transfer agreement” prohibiting the indemnitors assets from being moved over. Other possibilities: Spouse indemnity that excludes certain assets, capped indemnity with a maximum dollar value or trigger indemnity that is active only under special circumstances.
  2. Collateral – Can another party put up the money? Could be in the form of a loan to the company owner. Maybe an interested subcontractor or supplier will put it up so the contract can proceed (and they get the work.) How about using Funds Control with a hold back that collects the collateral account from the contract funds as the work progresses?
  3. No subcontract bond – The general contractor could add a retainage clause to the contract, or increase it in lieu of the bond (hold back some money until completion as a security deposit.) On a short term subcontract, make a single payment for the full contract amount at the end when the work is satisfactorily completed.
  4. Compilation FS – Have the CPA go back and do the additional work to upgrade the report. Sometimes, if it is late in the fiscal year, the underwriter may proceed with bond issuance based on proof that the next CPA statement will be a Review. Get a copy of the engagement letter with the CPA.
  5. No contract – The underwriter is correct. There is no contract with the township, it is with the property owner.  A bond on the property owners contract would be for the wrong amount in any event.  A Site or Subdivision bond is the correct way to protect the interests of the municipality.  It would guarantee the construction of the “public improvements” such as roads, sidewalks, sewers, etc. Caution: The property owner should be the applicant for this bond (not the contractor!) or they should at least be an indemnitor.
  6. Slow Receivables – Slow receivables are disallowed by analysts based on the expectation that they will never be collected. Obtain a current update on the collections of the A/R list from the financial statement date. If they have subsequently been collected, they are included in the Working Capital analysis despite being old on the FS date.
  7. Low NW – After years of operation, depreciation can wipe out the asset value of heavy equipment on the Balance Sheet. Document the current value to re-capture these dollars for the financial analysis. Get a copy of the equipment floater and a current appraisal to determine the current “forced sale” value.
  8. Other problems – Think we listed all the possible bonding problems in this article? No, we left out a few million! When you get tough bond problems, or just want the help of experts, give us a call. That’s all we do!  We have the markets and the expertise.

Insurance Agents and Contractors: Love the “Secrets” articles? You’ll really love it when we solve your tough bonding problem! We have the markets and the know-how to succeed even when others have failed.  Call us with your next surety bond need.  We guarantee a same day response.  856-304-7348

Not available in all states.

Secrets of Bonding #148: The Greatest Impediment to Bonding

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Surety bonds are hard to get. Contractors and their insurance agents know that underwriters are conservative. They ask lots of questions. Then they ask more questions. Then they say they can’t help you. It’s a fun-filled process.

Some contractors can’t get bonded because they have a poor credit history. Others have weak or insufficient financial statements. There are plenty of reasons for an unhappy ending, but what is the single biggest reason – and what can you do about it?

Crappy credit: This is a very common problem. The company may be struggling to get enough work, resulting in a weak credit report. So they decide to move into public work for additional revenues – but the bad credit report makes this impossible. Sometimes the report can be improved by correcting errors and updating the info. This is not the greatest impediment contractors and their agents face.

Weak or insufficient financial statement: There are innumerable potential problems. No financial statement, only an internal statement, only a compilation, an interim FS, a net loss, no working capital – the pitfalls are endless! It’s not the biggest impediment though.

Unsavory circumstances: Excessive bid spreads, inadequate prior experience, bad bond forms, harsh contract terms, too much other work. They are all bad, but they are not the king.

The Greatest Impediment

Picture how the process starts. When the contractor decides to go after bonding, a list of information is requested. The underwriter wants business and personal financial statements. A current work in process schedule is needed. Prior tax returns, resumes of key people and a bank reference letter are desired.

The contractor wants to pursue this, but MAN, that’s a lot of stuff!

He has not needed to make company financial statements, so how to come up with them now?

The company owner never needed to make a resume, always been self-employed. How do I write that up?

The WIP schedule: I don’t have that info available. I know where I am on all my jobs. Why would I take the time to fill out a bunch of forms anyway?

I can get the bank reference letter completed and make copies of prior tax returns (they want the WHOLE THING?!) But if I do that, who’s gonna do the estimating so we don’t run out of work? And I have to visit the projects or everything will grind to a halt. The workers want to milk every job like it’s their last. They’ll suck the profits out of everything if I give them the chance.

Conclusion 

The greatest impediment is the applicant themselves! In my 40+ years of surety bond underwriting, I have concluded that MOST contractors deserve to be bonded, but many fail to acquire surety support. It is because they stop trying, or never really start.

People must make choices. They have to put bread on the table. If they can succeed by doing what they know, why try some experiment that may fail? Sometimes it’s just easier to keep doing the same thing – even if you are discontent.

Our observation is that bonding takes perseverance and patience. It is a journey, a path with unexpected twists. There can be obstacles, but we have solutions! If contractors or agents expect it to be fast and easy… they may be disappointed.

Applicants for bonding must plan to devote some time and energy to achieve a goal they know is worthy. It says a lot to have a surety backing you. They are vouching for your ability, and putting up their own money to prove it. It’s a big deal and not always easy, but always worth it in the end.

Insurance Agents and Contractors: Love the “Secrets” articles? You’ll really love it when we solve your tough bonding problem! We have the markets and the know-how to succeed even when others have failed.  Call us with your next surety bond need.  We guarantee a same day response.  856-304-7348

Not available in all states.

Secrets of Bonding #147: Surety Challenge Question “If It Quacks Like a Duck…”

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Up for a challenge?  Here is the scenario:

A Performance and Payment Bond has been approved on a project. The lender (funding the contract) is requiring it.

There is a discussion regarding the procedures that will be used to control disbursement of the contract funds – they are extensive.

A licensed architect is being used and they will oversee the processing of each monthly payment to the contractor.  To protect the lenders interests, they will not only review the paperwork that is submitted (called a Pay Requisition), they will also conduct a physical inspection of the site.  The point of this is to assure that the contractor is only paid for work actually in place.

If approved by the architect, the pay requisition then goes to the lender for their review and handling.  Finally, the money is paid to the general contractor (GC) who then pays subcontractors and suppliers.

The GC has additional controls in place.  They monitor the status of all their subcontractors and suppliers.  Each month lien releases are obtained which is a guarantee that all the people downstream are being properly paid.  This step prevents future claims against the contractor, project owner or surety for non-payment.

Everything is checked and double checked. Each month these controls assure that the funds are handled properly. 

So here is the Surety Challenge Question:

The bond underwriter has required “Funds Control” as a condition of the bond approval. Do the multiple procedures we described satisfy this requirement?  If it quacks like a duck, is it a duck?

Answer: No!

It seems hard to believe, because no one would deny those controls are all good – and highly beneficial. But actually there is a missing piece we must add to have true “funds control.” It comes at the end of the money handling, the disbursement.

From a surety viewpoint, the funds administrator must be the Paymaster for the contract. It pays everyone, including the general contractor.  The problem with our example scenario is that the GC is paying all the subs and suppliers.  This is just what the surety does not want.

True “funds control” aka “funds administration” gives the underwriter confidence that the money will stay in the project and not get diverted to the contractor’s other work.  It also prevents claims against the Payment Bond by assuring that suppliers of labor and material are paid properly and timely.

Funds Control is a specialized process conducted by a party separate from the surety company. When utilized, applicants must be prepared to pay an additional fee for these “back room” services, and follow the required procedures for prompt money handling each month.

Learn the difference between Funds Control and Tripartite Agreements: Click!

Insurance Agents and Contractors: Love the “Secrets” articles? You’ll really love it when we solve your tough bonding problem! We have the markets and the know-how to succeed even when others have failed.  Call us with your next surety bond need.  We guarantee a same day response.  856-304-7348

Not available in all states.

Secrets of Bonding #146: Financial Statement Sniff Test

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Brokers protected.  Contractors welcomed.

Here is a list of my business and accounting courses in college:

  1. _______
  2. _______
  3. _______

I was an Education Major (teaching), so I didn’t get anything on financial statements “FSs”.  When I started as a surety bond underwriting trainee, I realized that I had no idea what a Balance Sheet was – but I learned. 

If your first reaction when you look a FS is “Duh,” we will fix that right now.  Keep reading! This will be a view from 30,000 feet.  Big picture but it will help.

To be complete, every financial statement must include at the minimum:

  • Balance Sheet
  • Profit and Loss Statement

The Balance Sheet

This document is a one-day snap shot of the funds in the company (Assets) and who owns them (Liabilities).  The assets and liabilities are equal “balance” because every dollar in the company is shown from two points of view: the Asset side and who owns it, the Liability side. 

The Balance Sheet has three important parts we can review initially.  Let’s identify them based on their functionality.

Current Assets: This line item is a subtotal found near the middle of the Asset column. It represents those assets readily convertible to cash within the coming fiscal year (such as Accounts Receivable).

Current Liabilities: Found near the middle of the Liabilities column, these are debts to be paid in the coming fiscal year (such as Accounts Payable).

Total Stockholders Equity, aka Net Worth: Usually the last subsection near the end of the Liabilities column. This is the company’s Net Worth that would remain if they shut down and liquidated everything.

The Profit and Loss Statement

This is a historical summary of all the money taken in (Sales aka Revenues) and money spent (Expenses) during the preceding period, usually one year. At the bottom of the column is the Net Profit, which is the money the company “made” for the year after paying all the related bills and taxes.

Now that you can pick out a couple of strategic numbers on any FS, what shall we do with them?

Calculate Working Capital

This is a primary measure of financial strength used by all analysts, including sureties, banks and other credit grantors.  It is found by subtracting the Current Liabilities from the Current Assets. It is an indicator of expected cash flow in the coming year. 

Here is a quick, simplified Sniff Test to use when considering a particular bid or performance bond.  The evaluation is made based on the expected contract (not bond) amount. This is an instant indication of the adequacy of the finances in regard to the upcoming project.

Part One – The Working Capital target amount is 15% of the contract amount.  For example, if the contract amount is $1,000,000, sureties hope to see Working Capital of at least $150,000.

Part Two – The Net Worth target amount is 20% of the contract amount or about $200,000 in our example.

Certainly there is more to surety underwriting than this simple analysis.  However, by using this method, you can get a quick idea of whether the financial statement easily supports the bond, or may be a stretch.  If your analysis reveals negative numbers, which are shown in parenthesis on financial reports, that’s obviously a bad sign.

Also keep in mind, applicants that do not meet these criteria may still qualify for bonds based on other factors – and the reverse is also true. Surety underwriting takes many factors into consideration.  In this article we are offering a very simplified version of the process although it is valid as a quick review. This procedure will enable you to make a fast financial evaluation, and relate it to the upcoming surety exposure.

Summary

This article doesn’t make you a bond underwriter, but now when you get a new FS instead of “Duh!” you can say “Let me analyze this!”

Running a quick analysis plus the Sniff Test will indicate the likelihood of obtaining surety support. You learned a lot in three minutes, but when you have a bond that fails the Sniff Test, that’s where our expertise and market access comes in.  Call us!

Insurance Agents and Contractors: Love the “Secrets” articles? You’ll really love it when we solve your tough bonding problem! We have the markets and the know-how to succeed even when others have failed.  Call us with your next surety bond need.  We guarantee a same day response.  856-304-7348

Not available in all states.

Secrets of Bonding # 142: Make Bid Bonds Great Again!

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Need a bond?  Talk to the Pros!  856-304-7348  www.BondingPros.com

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You used to love them.  They were so easy.  Now they are in dollar amounts and percentages, sometimes with a limited maximum value.  They can be electronic or digital.  Sometimes a letter is required instead.  Sometimes nothing is required instead! There may be a single or annual charge for it or maybe it is free! It’s outta control…

So here is your chance to catch up with everybody’s favorite: The fun and fascinating world of Bid Bonds.

The Basics
These instruments accompany a contractor’s proposal during the acquisition process for a new project.  This is routine on public work, such as federal state and local municipal contracts.  The procedure may also be used on private projects at the contract owner’s discretion.

The bond guarantees that, if awarded, the bidder will sign the contract, furnish the required Performance and Payment Bond, and commence with the work – or – pay the difference between their bid and the next higher bidder (subject to the maximum dollar value of the bid bond.)

Cost
Usually free although the surety is entitled to charge for them.  Typical charges could be an annual bid bond service fee or a per bond charge.

Underwriting
The decision to issue the bid bond is based on the underwriter’s willingness to provide the related P&P bond, because that is the real money transaction. The decision is NOT based on the dollar value of the bid bond.  Rely on the fact that the underwriter will not provide the bid bond if they do not feel they can support the final bond.

Bid Spreads
If the bidder is more than 10% below the next bidder without a plausible explanation (we have a special machine,  already have materials, are already working next door, we’re super fabulous, etc.) the surety could decline the final bond, resulting in a bid bond claim.

Alternative Forms of Security
In addition to a bid bond, proposals may also be secured using a cashier’s check or irrevocable letter of credit, depending on what the project owner (Obligee) is willing to accept.

Percentages
The Invitation or Bid Solicitation describes the proposal requirements.  It will state if a bid bond is required and the amount.

The bond value is often expressed as a percentage. Example “20% of the attached proposal amount.”  This is convenient because the underwriter doesn’t want to know the actual bid amount (to preserve the bid confidentiality).  It is the best way to express the exactly correct amount when typing the bond in advance.

Capped
Because the percentage bond actually has an unknown dollar value at the moment it is executed, language is sometimes added establishing the most it can be worth (to prevent a wildly high amount the underwriter didn’t expect).  Example, “10% of the attached bid, not to exceed $100,000.”

Fixed Penalty
“Bond Penalty” is the term used to express the bond dollar value.  A fixed penalty bond has a stipulated amount, regardless of the bid.  Example, “Maximum bid bond amount required: $20,000.”

Surety Letter
Some owners choose to require a letter from the bonding company, but no bond. Federal projects are handled this way at times.  The letter talks about how much they love the client and the contracts they are willing to bond.

Consent of Surety
This letter is the surety’s written promise to issue the P&P bond if the contract is awarded.

Electronic
A scanned copy (pdf) of the executed bond may be acceptable for an online bid.

Digital
Some state departments of transportation use this.  The surety registers with the obligee in advance and the bid bond is “filed” online using a unique identification number.

No Free Lunch
If you default (cause a bond claim), the surety will come after the contractor, it’s owners and spouses for recovery.  Remember: Bonds are not insurance.

Funky Land
Now some of the weird stuff:

  • You may encounter a bid bond requirement, but no final bond (P&P bond) to follow
  • Can also have the opposite: No bid security required but a final bond is needed
  • No! You are not required to use the same surety for the bid and final bonds – although the bid bond provider fully expects to write the final bond and may hunt you down and kill you. (Just kidding!!!)
  • Yes! If you obtain a bid bond under the promise to provide collateral, you are allowed to get the final bond from a different surety that is not demanding collateral. (But you face the hunt and kill thing again)
  • When you acquire a project using a Consent provided by ABC Surety (their promise to provide the bond upon award of the contract), you are not prohibited from taking the final bond from XYZ Surety. However, good protocol dictates that you remain loyal to those who enabled you to acquire the job (meaning ABC).

Make Bid Bonds Great Again
So there you have it.  These instruments are fussy and sometimes complicated.  It is imperative that they be executed correctly and filed on time or it can cause the bid to be thrown out (loss of contract.)  This always makes people very crabby (Read: LAWSUIT).

The key is to review the written bonding requirements as described in the bid advertisement. Use any mandatory bond forms that are stipulated and double check the correct execution and typing of the document including name spelling, job description, project identification details and the correct bid bond amount.

Now that you know, you can start to love bid bonds again!

Insurance Agents and Contractors: Love the “Secrets” articles? You’ll really love it when we solve your tough bonding problem! We have the markets and the know-how to succeed even when others have failed.  Call us with your next surety bond need.  We guarantee a same day response.  856-304-7348

Not available in all states.

Secrets of Bonding # 141: Surety Bonds and Zombies

Brought to you by…Secrets of Bonding is brought to you by Bonding Pros

Need a bond?  Talk to the Pros!  856-304-7348  www.BondingPros.com

Brokers protected.  Contractors welcomed.

Zombies are bad.  They eat your flesh and brains.  Who wants THAT?!

Same goes for your construction business.  There are zombies that can ruin your bonding and eat up your business – destroy profits and your credit rating.  But the worst part is… it’s preventable!   

Does the zombie have a name? Yes, accountants call it “Fixed Overhead.”  This is a controllable expense that, if left unattended, can eat your flesh and brains (figuratively.) Let’s define the monster:

Fixed Overhead – Construction companies incur common fixed overhead costs. These are costs that do not vary with the level of the company’s output such as: accounting fees, advertising, insurance, interest, legal fees, labor burden, rent, office expenses, salaries, repairs, supplies, taxes, telephone bills, travel expenditures, and utilities. 

Now consider Variable Overhead – These costs vary in proportion to the amount of production. Variable overhead mostly relates to hourly indirect labor costs, supplies and utilities such as electricity, gas and telecommunications expenses.

The danger of fixed overhead is that, during times of reduced volume / revenues, the expense does not automatically go down. This means when sales are weak, your expenses do not diminish proportionately.  These bills keep rolling in relentlessly.  They just don’t care!

The only hope construction managers have is to be cautious when incurring such expenses, and always work to reduce them so the company can survive the inevitable troughs that come between the peaks of activity.

Here are 40 ideas that may help reduce / eliminate fixed overhead:

  1. Lease-purchase options for vehicles and equipment
  2. Employ part-time mechanics and administrative staff
  3. Pay employees for use of their vehicles
  4. Keep equipment longer
  5. In unprofitable years, slow down depreciation schedule
  6. Overhaul facilities and equipment instead of purchasing new
  7. Review / quote insurance annually. Consider self-insurance or association captives. 
  8. Eliminate overlapping insurance coverages
  9. Improve safety program
  10. Examine Workers Compensation classifications
  11. Consider increasing deductibles
  12. Eliminate over insurance, such as reducing inventories
  13. Deactivate, de-register and uninsure unused vehicles
  14. Challenge property valuations (taxes)
  15. Avoid the expense of audited financial statements if possible
  16. Reduce accounting fees by assisting your CPA
  17. Consider using a local CPA rather than a national firm
  18. Lease unused space
  19. Consider a smaller building
  20. Consider high density stacking and storage systems
  21. Renegotiate rent or move
  22. Get indefinite lease with 6-month cancellation rather than fixed term
  23. Pay moderate salaries with bonuses for exceptional performance
  24. Reduce number of management staff
  25. Reward managers with stock instead of cash
  26. Trim fringe benefits (deferred compensation, automobiles, club memberships, etc.)
  27. Cut managers first
  28. Pay bonuses to field staff first
  29. Pay raises based on merit, not cost of living
  30. Cross train office staff to eliminate temporary employees
  31. No vacations during “busy season”
  32. When hiring, seek individuals whose employment qualifies for tax credits
  33. Four day work week
  34. Charge employees for replacement tools
  35. Put company ID on tools, keep records
  36. Centralize tool storage with check in / out system
  37. Close dormant companies
  38. Consider solar panels and solar water heat
  39. Monitor unemployment claims
  40. Consider an office maintenance service instead of employing a janitor, or use a part-time after hours person

Conclusion

Companies can achieve better financial performance, support their bonding and banking and survive the weak years by controlling these relentless expenses. 

Remember: You can’t kill a zombie because technically they’re already dead.  And you can’t entirely eliminate fixed overhead either – but good managers work to control it.

Insurance Agents and Contractors: Love the “Secrets” articles? You’ll really love it when we solve your tough bonding problem! We have the markets and the know-how to succeed even when others have failed.  Call us with your next surety bond need.  We guarantee a same day response.  856-304-7348

Not available in all states.