What Are Surety Bonds?

Surety bonds are a form of protection that dates back to Babylonian times.  Such bonds are a key piece of many public and private sector transactions.  U.S. Customs, for example, requires importers to carry bonds to ensure compliance with rules and regulations.  Courts require bail bonds to release criminal case defendants.  Property or project owners require contractors to carry performance bonds.  The Airline Reporting Corporation requires travel agents to meet certain requirements when carrying airline ticket stock, and an ARC Bond meets those requirements.

In the U.S., suretyship is considered a form of insurance and is regulated accordingly.  This is something of a misnomer since insurance is typically a two party transaction, while surety bonds are a three party transaction.  The three parties to a surety contract are:

·        The Principal:  The party that takes out the bond as a guarantee against a stated obligation. 

·        The Obligee:  The party to whom the guarantee is made by the surety on behalf of the principal. In the above examples, a property owner, U.S. Customs, and the Airline Reporting Corporation are potential obligees.

·        The Surety:  The entity that steps in and pays the obligee in the event of a specific failure to perform or meet an obligation on the part of the principal.

There are two primary categories of surety bonds. Contract Surety Bonds and Commercial Surety Bonds. Contract Surety Bonds provide financial security and construction assurance on building and construction projects by assuring the project owner (obligee) that the contractor (principal) will perform the work and pay subcontractors, laborers, and material suppliers.

Contract surety bonds include:

·        Bid bonds – financial assurance that the bid has been submitted in good faith.

·        Performance bonds – protection for the owner from financial loss should the contractor fail to perform the contract in accord with its terms and conditions.

·        Payment bonds – guarantee that the contractor will pay certain subcontractors, laborers, and material suppliers associated with the project.

·        Maintenance bonds – guarantee against defective workmanship or materials for a specified period.

·        Subdivision bonds – guarantee to a city, county, or state that the principal will finance and construct certain property and infrastructure improvements.

Commercial Surety Bonds guarantee performance by the principal of the obligation or undertaking described in the bond.

Commercial surety includes:

·        License and permit bonds – required by state law or local regulations to get a license or permit to engage in a particular business. 

·        Judicial and probate bonds, also known as fiduciary bonds – secure the performance on fiduciaries’ duties and compliance with court order.

·        Public official bonds – guarantee the performance of duty by a public official.

·        Federal (non-contract) bonds – those required by the federal government, e.g. Medicare and Medicaid providers, customs, immigrants, excise, and alcoholic beverage.

·        Miscellaneous bonds, e.g. to guarantee employer contributions for Union benefits, and workers’ compensation for self-insurers.

One of the main differences between an insurance and surety contract is that an insurance premium is usually based on a certain expectation of losses.  Surety contracts are designed to prevent loss, according to the Surety Information Organization (www.sio.org).  In this model the underwriting process involves pre-qualification and the bond is underwritten with little expectation of loss.  The premium is mainly a fee for pre-qualification services.  In some cases a surety company will require indemnity of the owners of a closely held corporation. The two main reasons for this requirement are that the surety company requires all personal/business assets to back the guarantee and that there is less chance a principal will avoid stated responsibilities if personal/business assets are at stake. If an underwriter is unable to approve a bond request based on the qualifications given by the principal, the company may suggest depositing some form of collateral as an inducement to write the bond. In practice, many bonds are written on this basis, particularly ones that are considered financial guarantees.  

Obtaining a surety bond is like opening a line of credit.  And similar to a banking experience, developing a long-term relationship with a surety company can be an important step for you or your business.   Call us for further details on surety bonds and how they apply to your business.

Hiring a Nanny – Know and Manage Your Risks

Many working parents have had their various issues and complaints with daycare and childcare centers. As an alternative to these forms of childcare, more and more parents are choosing to hire their own nanny or share one with another parent. However, many parents aren’t fully aware of the many financial risks involved with bringing a nanny into their home.

When you hire a nanny, you’ve basically just become an employer. Did you know that your new nanny could cause you IRS problems if you improperly pay him/her and not withhold payroll taxes? Even if you withhold payroll taxes, you can still find yourself facing some costly penalties and fines if they aren’t calculated correctly and submitted on time. One way to eliminate this risk is by hiring a payroll provider to appropriately handle the taxes, just as any other employer would do.

Another financial risk is being sued by your nanny following an injury on the job. This risk of injury is why it’s prudent to purchase worker’s compensation. Otherwise, you’d be responsible for paying all the benefits that your nanny would’ve received under such a policy and any penalties or fines that your state might impose. Before you falsely assume that your nanny’s injury would be covered by your umbrella liability policy or homeowner’s policy, it won’t. These policies typically exclude any injury where workers’ compensation would normally be due to the injured party.

However, you will need an umbrella policy that includes excess employer’s liability coverage beyond that provided by worker’s compensation coverage. Your nanny’s spouse, children, or other family members could initiate a lawsuit for loss of his/her services if your nanny is injured on the job. Employer’s liability coverage is provided under workers’ compensation coverage, but lawsuits of this nature can easily exceed the limits.

One final concern would be from another parent’s child being injured while under the care of a nanny at your home. Even if the parent was involved in the vetting and hiring process of the shared nanny, you could still be sued by them for the child’s injury. If you share a nanny with another family, then you’ll want to ensure that your personal umbrella limits are high enough to adequately protect your assets.

If you want to avoid all the liabilities and insurance concerns, but still have the benefit of a personal nanny, then you might consider using an agency nanny. When you hire a nanny through a service or agency, the nanny is their employee, not yours. This puts the responsibility of payroll taxes, insurance coverage, background and reference checks, and so forth on their shoulders, not yours. Some agencies will even have added perks, such as having an equally qualified nanny on standby for times when your regular nanny isn’t available. Considering that you can avoid the countless hours interviewing nannies, potential liability risks, and the need for various costly insurance policies, the additional fees associated with a nanny service may be well worth it to you in the long run.

What Factors Influence Malpractice Premiums?

According to a November 2005 article published in the Insurance Journal entitled, “How to Write the Diverse Business of Lawyers Professional Liability,” between $1.5 and $2 billion is spent annually on Professional Liability coverage. With numbers such as these, it is important that any firm in the market for this insurance understand the factors affecting coverage rates.

Determining premium rates is a complex matter based on a combination of factors. However, there are two main factors insurers review when underwriting an insurance application. The first is your geographic location, because each state has a different risk assumption.  The level of risk is measured by the number of suits brought against other lawyers in your area. The second important factor is your practice area(s). You can expect to pay more for coverage if you specialize in high-risk areas such as securities, banking and/or real estate.

Other factors that insurers consider include:

·                                Liability limits and deductibles selected

·                                Breadth of coverage desired (prior acts, extended reporting, etc.)

·                                Number of attorneys covered

·                                Personal claims history of your firm’s attorneys

·                                Length of time covered attorneys have been associated with your firm

·                                Number of malpractice prevention controls utilized by your firm

The length of time covered attorneys have been associated with your firm is important, because insurers typically use step rates to calculate premiums for a new attorney.  Risk exposure increases during the initial years that an attorney practices as the number of potential plaintiffs increases with every new case. After a certain point, this risk flattens out.  So premium rates on a new attorney will automatically increase in set steps until the risk exposure matures.

It is also important to realize the significance reinsurance holds in determining premiums. Insurance is a way of transferring risk. You transfer risks to an insurance carrier, and the carrier will often transfer some of that risk to another company. By reinsuring, a carrier increases its capacity to underwrite more policies.  When reinsurance rates rise, the increased cost can be transferred to you in the form of higher rates.

Sport Utility Vehicles Improving Rollover Safety Record

According to Newsweek, one in four automobiles sold in the United States is a sports utility vehicle. Every SUV purchase nets an average of $15,000, according to Forbes magazine, in profit for the vehicle’s maker. Because of this high demand and lucrative sales potential, the makers of SUVs have been accused of ignoring safety when it comes to the design and production of their products. The biggest safety complaint about the SUV is its high rollover record.

This lax attitude toward safety, however, is an item of the past. The National Highway Traffic Safety Administration (NHTSA) recently released new rollover results for 2006 and 39 SUVs earned four-star ratings, which was the highest rating earned by the vehicles tested. No SUV earned the top ranking of five-stars. Under this ratings system, a vehicle rated at five-stars has a rollover risk of less than 10%. A four-star vehicle has a 10% to 20% risk, and a three-star vehicle has a 20% to 30% risk.

Newly tested SUVs that received four stars included: the Chevrolet HHR, Honda Pilot, Toyota RAV4, Subaru B9 Tribeca, Hyundai Tucson, Mercedes-Benz ML Class, Suzuki Grand Vitara and four-wheel drive versions of the Chevrolet TrailBlazer.

Among top-scoring SUVs, the HHR had a 14% chance of rollover and four-wheel drive versions of the Pilot had a 15% chance.

The four-wheel drive version of the Nissan XTerra had a 25% percent chance of rollover, the highest percentage among the new SUVs tested. The two-wheel drive version of the XTerra, the two-wheel drive Chevrolet Tahoe and Hummer H3 each had a 24% chance of rollover, and all received three stars.

The new statistics also reveal that SUVs have shown consistent improvements in the area of safety. Only two-dozen SUVs received four stars last year, and just one SUV earned the ranking in 2001. In addition, the agency noted that 7 in 10 new SUVs are equipped with electronic stability control. This feature is an anti-rollover system that automatically applies the brakes if the vehicle begins to skid, which helps to stabilize the vehicle. Government studies have found stability control reduces single-vehicle sport utility crashes by 67% compared with the same models sold in previous years without the feature.

Since 2004, NHTSA has asked auto manufacturers to voluntarily install electronic stability control because of its proven potential for saving lives.  As a result, nearly all automakers now offer electronic stability control as standard equipment on a total of 57 SUV models, and on 6 SUVs as an available option. This is up from 20 standard and 14 optional in 2003. NHTSA is expected to issue a new proposal later this year specifying a performance criterion for stability control.

Protect Your Home from Power Surges This Summer with Surge Protectors

The arrival of summer can mean several welcome events: a return to outdoors living, an opportunity for vacation, and more time with the family. One of the issues people may not associate with summer are the power surges that often occur due to the tremendous demand for energy, especially to cool homes. A power surge is a brief spike in electrical power. While on the surface it may not seem like much to be concerned about, power surges can cause serious damage by burning up electrical circuits inside appliances. They can also damage electrical outlets, light switches, light bulbs, air conditioner components, and even garage door openers.

You can protect your valuable electrical appliances from the damaging effects of power surges. The most cost effective way is by purchasing surge protection strips. You can plug in your television, DVD player, and stereo into the strip and it should provide adequate protection against most surges. It’s a good idea to pick up a surge protection strip for the kitchen counter so that you can protect small electrics like the toaster, blender, food processor etc. You can also find surge protectors that fit into electrical outlets that will protect your phone and answering machine. You can buy most types of surge protectors in any local hardware store.

When it comes to your PC, however, you will have to be a bit more selective about protection, because of the delicacy of its internal components. Back-up power packs that are specifically designed to protect your hardware can be found in stores that sell computer accessories as well as in many electronics chain stores. They can be somewhat expensive, but are certainly less expensive than replacing your entire system.

Before you purchase any surge protector, there are certain features you need to look for. The first feature to look for is a surge protector that is labeled with the Underwriters Laboratories (UL) logo. The UL logo tells you that the unit has been tested to determine if it meets certain standards. Any product that is UL tested will be labeled as a “transient voltage surge protector,” which means that it meets or exceeds the minimum standards required to be an effective deterrent against power surges.

A surge protector’s performance is rated in three ways. The first is clamping voltage, which is the level of voltage surge that has to occur before the surge protector kicks in and diverts excess voltage from the item being protected. You want to find a surge protector that has a low voltage number so that it takes less of a surge to activate it. Look for a protector with a clamping voltage of less than 400 volts.

The second way to rate a surge protector’s performance is response time: the amount of time it takes for the surge protector to respond to the surge. You should look for a unit with a response time of one nanosecond or less.

Just like any other appliance in your home, your surge protector will eventually wear out. The third performance-rating factor is energy absorption, or how much energy the unit will absorb before it fails. For the longest lasting performance, look for a unit rated between 300 and 600 joules. Remember, the higher the number, the longer the life of the surge protector.

Buckle Up- It’s the Law

Many people invent reasons not to wear their seat belt.  Some just don’t bother and others think – “nothing will happen to me.” The statistics show that this statement is definitely untrue. From 1992 through 2001, roadway crashes were the leading cause of occupational fatalities in the U.S., accounting for 13,337 civilian worker deaths (22% of all injury-related deaths), an average of 4 deaths each day.  Between 1997 and 2002, 28% of fatally injured workers were wearing a seat belt; 56% were unbelted or had no seat belt available. Belt use was unknown for the remaining 16%.

Seat belts are effective in preventing fatalities, 50% more effective in preventing moderate to critical injuries, and 10% more effective in preventing minor injuries, according to the National Highway Traffic Administration.  What is most surprising is that by 1992 over 40 states had enacted seat belt use laws and still only 55% of the people traveling in cars were wearing them.

In addition to seat belts we are even more fortunate in that cars are now equipped with supplemental restraint systems (SRS), more commonly known as air bags.  What is not commonly known is that the air bag will only fully protect the passenger if they are wearing their seat belt.  This is another good reason to buckle up.  Insist all passengers in your car do the same and make every trip a safe one.

Occupational fatality data
*Census of Fatal Occupational Injuries (CFOI), 1992-2001 (special research file prepared for NIOSH by the Bureau of Labor Statistics; excludes New York City).

†Fatality Analysis Reporting System (FARS), 1997-2002; National Highway Traffic Safety Administration (NHTSA) (public-use microdata files).

Above Average Hurricane Activity Expected This Year – Check Your Insurance Coverages Now

According to the latest forecast from researchers at Colorado State University, the U.S. coastline has an above-average chance of getting hit by at least one major hurricane this season. Researchers estimated the likelihood of at least one hurricane with a category of 3, 4 or 5 making landfall this season at 63%, above the average for the last century of 52%.

The official Atlantic hurricane season runs June 1st through November 30th. Once a storm is within range of land it is too late to change or add coverage. Therefore, it is imperative that homeowners review their insurance policies now.

Make sure your homeowners’ policy reflects your needs in the following areas related to hurricane coverage:

Hurricane Deductible – Some states have implemented separate deductibles for hurricanes based on a percentage of the home’s insured value. Note that wind damage caused by non-hurricane storms is subject to your policy’s general deductible not the hurricane deductible.

Flood Insurance – Flood damage is not covered under a standard homeowners’ policy, but flood insurance is essential in high risk areas.

Replacement Cost vs. Actual Cash Value – Replacement Cost policies cover the amount needed to replace or repair a home without a deduction for depreciation. These policies generally cost about 10 percent more, but they provide much more comprehensive coverage than Actual Cash Value policies.

Guaranteed or Extended Replacement Cost – Provides additional coverage if widespread damage inflates the cost of building materials and labor.

Inflation Guard – Automatically adjusts policy limits to reflect changes in construction costs so you do not have to increase your limits each year.

Building Code Upgrades – If your home is severely damaged, it will need to be rebuilt to comply with current building code standards that could add increased building costs. Law and ordinance coverage ensures these extra costs are covered.

Additional Living Expenses – Covers the costs of living elsewhere while your home is being rebuilt or repaired.

To protect your assets in the event of a hurricane, also:

  • Inventory, photograph or video tape all household items. Keep receipts, inventory lists, copies of your insurance policy and insurance company contacts in a safe place that can be accessed in the event of a storm.
  • To minimize losses, take steps to protect your property when a hurricane is imminent, such as covering your windows with shutters, siding or plywood.
  • Keep materials such as plywood and plastic on hand in case you need to make temporary repairs after a storm. Keep receipts as repairs are made, as they may be reimbursable by your insurance company.

Be wary of rushing into a contract or placing a hefty deposit with a company for repairs. Unfortunately, fraudulent contractors often flock to natural disaster sites, so it is important to consult your insurance agent before hiring anyone.

Understanding a Builder’s Risk Coinsurance Clause, Common Mistakes, and Penalties

Coinsurance clauses are commonly found in a builder’s risk completed value policy. As one might deduce merely from the name, a coinsurance clause involves the policyholder becoming a co-insurer of the risk of loss with the insurer. In other words, certain conditions would result in the insurance company not paying the total amount of loss, thereby leaving the policyholder to bear the remainder of the loss amount. The insured and the insurer jointly assume the risk.

Those unfamiliar with such a clause are probably wondering why any policyholder would even consider a coinsurance clause. The benefit of buying an insurance policy with such a clause is that the policyholder will usually have relatively low premiums compared to other similar policies that don’t contain a coinsurance clause. That said, anyone considering a coinsurance clause should understand what it entails and requires, so that they aren’t taken by surprise with penalties if a loss should occur.

A typical coinsurance clause found in a builder’s risk completed value policy will say that the insurer will not pay more for any loss than the proportion that the limit of insurance bears to the value of the structure described in the declarations as of the structure’s date of completion.

The way a coinsurance clause works with the policy limit is often a source of confusion for policyholders. Take a loss of $20,000 with a policy limit of $100,000 for instance. It would superficially appear as though the insurer would be responsible for the total loss. However, once the coinsurance clause is figured into the equation, the insurer might not be responsible for paying the total loss amount. This will depend on the policyholder maintaining enough insurance to avoid the coinsurance penalty.

If the coinsurance is applied, it might look something like this:

Still using the $100,000 policy and $20,000 worth of damage from above, the completed value of the project will be determined as $120,000 at the time of loss. The value of the $100,000 policy is only 80% of the $120,000 actual value of the project. So, the insurer is only responsible to pay $16,000, which is 80% of the 20,000 dollars worth of damage.

Anytime the policyholder receives a lesser sum than what the full value of the claim is because of a shortfall between the completed value of the project and the policy limit, it’s termed a coinsurance penalty. The discrepancy between the two numbers can be the result of a number of mistakes made by the policyholder.

Policyholders often make the mistake of failing to report when expected costs are surpassed. Any increased completed value must be shown in the policy limit when costs overrun original figures. The best way to make sure the policy limit is updated is by keeping your insurance agent apprised to the overruns so that the appropriate changes can be made.

All too often a policyholder makes the mistake of setting their limit of insurance based on the amount of the construction loan for the structure. Most of the time, the completed value of the project is greater than the amount of the construction loan. An example would be a significant portion of a building project being funded by cash, but not computing the cash amount when totaling the completed value. If the insurance is only for the financed amount, then the policyholder will suffer a coinsurance penalty for any losses.

Another common mistake occurs when the policyholder doesn’t include profit and overhead in the completed value. These are generally figured at 10% for each. If not accounted for, this can cause a substantial coinsurance penalty.

Sometimes, it’s what shouldn’t be included that may lead to problems. Land value, excavations, and underground work, for example, shouldn’t be included in the completed value. These aren’t covered losses on typical policy forms. So, the policyholder would just be paying additional costs for items that wouldn’t be covered during loss.

What Coverage Limits Do You Need for Homeowner’s and Auto Insurance?

Most people avoid thinking about scenarios that would cause an insurance claim – our homes damaged by fire or tornado, someone injured on our property, or family members hurt in an auto accident.  However, it is necessary to give some thought to these upsetting possibilities to ensure that you are adequately prepared and protected in the event of a catastrophe.  Reviewing your insurance coverage will also clarify if there’s a need for an additional umbrella policy for extra protection.  So, let’s try to summarize some of the basics on coverage limits.

Homeowner’s Insurance

Homeowner’s insurance covers three areas:  damage to the home, damage to the contents of the home (personal property), and your liability for injuries to others.

Prior to obtaining homeowner’s insurance, it’s a good idea to stop and consider exactly what you want the insurance to cover.  You may want coverage just to pay off the mortgage in the event you can no longer occupy your home.  It’s more likely you’ll want to continue living in your home after a claim or sell it at market value, so you will want your insurance to pay for repairs caused by wind, fire or some other covered peril.  In most cases, reconstruction means you will need insurance that actually covers more than the home’s market value.

Replacement value, which is the cost to reconstruct a damaged home, is typically higher than the cost of buying a similar home on the market due to the specialized nature of reconstruction as opposed to new construction.  For example, in reconstruction there is an initial cost of debris cleanup.  New construction starts at the bottom and builds up, but with reconstruction it is often necessary to take off the roof and build down, which is more expensive.  Additionally, after a natural disaster, construction costs may rise due to increased demand.  Keep in mind that your insurance can cover not only the costs to rebuild, but also the costs for you to live elsewhere, if necessary, while the home reconstruction is completed.  An experienced insurance agent can help you assess your coverage needs as well as determine available coverage based on the age and condition of your home. 

Also, you will need to consider whether you want replacement coverage for clothing, furniture, appliances, and other personal property inside your home.  Without replacement coverage, your coverage for personal property is depreciated by the age and wear of the items lost.  Due to depreciation, the computer you paid $500 for three years ago may be valued at only $150 or $200, which is all the insurance company would pay if you don’t have replacement coverage.

Some insureds will need more coverage for personal property (contents) than their policy provides. The amount of personal property coverage is usually limited to 70% of the coverage limit for the structure.  For instance, if you have an art collection, antique furniture, jewelry, or other valuable possessions, talk to your agent about supplemental coverages, such as fine arts or scheduled property endorsements, to adequately protect your investment in these items. The cost is modest for the extra protection.

Liability limits generally start at about $100,000; however, some experts recommend that you purchase at least $300,000 worth of protection, which covers personal liability for damage to property or personal injury caused to others.  The additional coverage also help to protect your assets in the event you are found liable in a personal injury lawsuit.  Additionally, you may want to consider purchasing a separate liability umbrella policy (discussed below).       

Auto Insurance

There are six different types of auto insurance coverage.  Three relate to liability, two for damage to your vehicle, and one provides specific coverage for accidents involving you and an uninsured or underinsured driver.

Collision coverage covers the costs of damage to your vehicle caused by collisions with other cars or objects; comprehensive coverage covers theft or damage to the vehicle caused by events other than a collision with another car or object.  The amount of coverage you need depends on the value of your vehicle.

Auto liability insurance is required in most, if not all, states, but the liability limits that drivers are required may not be enough to protect your assets.  Even one serious injury caused by an accident for which you are liable could cost into the six figures, or more in extreme cases, just for medical expenses.  And the amount only increases if there are more injured people.  It’s easy to see that the $50,000 of per accident liability coverage required in many states would not be enough to pay all the costs of property damage and bodily injury.  Auto insurance companies recommend that you have $100,000 of bodily injury protection per person and $300,000 per accident. If your personal net worth is more than $300,000, consider buying additional liability auto insurance.

What About an Umbrella Policy?

Unfortunately, even with our best intentions and efforts, accidents may happen for which we are legally at fault.  Medical costs can skyrocket.  If someone were permanently disabled by an accident, the expenses of lifetime care could be astronomical.  If someone killed left behind survivors who were depending on that person for support, you could be liable for damages to the survivors.  Be aware that any costs not covered by insurance will come out of your pocket.  Hence, you could be forced to sell property or to turn over part of your earnings for years to come, perhaps the rest of your working life, to an injured party.

There are limits on the amount of liability coverage available as part of your homeowner’s and auto insurance policies.  If you have total assets valued at more than these limits – including, say, your vacation home, investments, rental property, boats and vehicles — or if you have a high income, an umbrella policy offers a great deal of protection for a relatively low premium.  

In addition to the assets you want to protect, you may want to consider your risk of being sued.  Do you live in a state that is particularly friendly to plaintiffs?  Do you have frequent guests on your property?  Do you have a swimming pool, trampoline, swing set, or other sports equipment in your yard?  Do you have a dog that is overly protective of your property?  Are you or any of your household members aggressive, fast, or careless drivers?  If so, your risk is greater that someone may be injured, perhaps very seriously, and you would be legally at fault.  In fact, any situation that could result in serious injury, long-term physical impairment, psychological damage or death could put your financial well-being at risk.

Once the liability limits are exhausted on your home or auto policy, your umbrella policy takes over and provides another layer of liability protection.  Policies typically start at $1 million with coverage available up to $10 million.  Premiums start at around $300 a year – less than a dollar a day for a great deal of protection.

The best way to determine whether you need an umbrella policy is to discuss your financial status, lifestyle, and current and future assets with your insurance agent.   Ask him or her to review the liability limits in your current policies and suggest the best strategy to ensure protection of your assets in the event of an injury for which you are legally liable.

Cut-Throughs to the Rescue

Whenever A.M. Best, Standard & Poor’s, Moody’s or Fitch drop an insurance company’s rating below an A, businesses become worried that an insurance company might not have enough capital to pay their claims. To reassure the risk managers of these businesses, insurers often seek cut-throughs from their reinsurers.

A cut-through is an endorsement to a reinsurance agreement that requires the reinsurer, in the event of the ceding company’s insolvency, to pay a loss covered under the reinsurance agreement directly to the insured or its beneficiary. The endorsement gets its name because reinsurance claim payments “cut through” the usual route of payment from reinsured company-to-policyholder, substituting instead payment of reinsurer-to-policyholder. A cut-through affects the payment only, and does not increase the risk to the reinsurer. Most cut-throughs are provided only for property, almost never for casualty, unless the cut-through can be limited to claims on a yearly basis.

Those insurance companies that get a cut-through from reinsurers are borrowing the size and rating of their reinsurers. A cut-through permits the insured or its beneficiary to collect insurance proceeds directly from the reinsurer if the insurer becomes insolvent. The insured does not have to wait for the liquidator of the insolvent insurer to pay claims, usually paid at a discount, which could take years.

A cut-through can be written on a blanket basis, where the reinsurer assumes liability for a complete line, or for specific policies. The fee or surcharge paid to the reinsurer can vary considerably, depending on how urgent the primary insurance company needs the cut-through and how willing the reinsurer is to consent to the plea.

Because of the continuing hard insurance market, obtaining a cut-through is difficult for a downgraded insurer. One reason for the difficulty is in the event of an insurer insolvency, the reinsurer has to become involved with adjusting claims. Because reinsurers don’t handle claims directly, they would have to hire a third party.

Further complicating the cut-through provision is determining which policies have the cut-through and which do not in the event of insolvency. Sometimes, records of the insolvent insurer can be incomplete or missing, and the reinsurer has to spend considerable expense to determine which claims are to be paid to the receiver and which to the beneficiary of a cut-through. If the accounting is not carefully fulfilled, the reinsurer may pay the same claim twice.

State insurance regulators are opposed to cut-throughs, arguing they give an unfair preference to sophisticated insurers and third parties at the expense of consumers and should not be enforced. The officials contend that reinsurers have a statutory obligation to pay reinsurance proceeds to the receiver of an insolvent insurance company.

Almost every state requires that reinsurance contracts contain an “insolvency clause” if the cedent is to receive financial statement credit for the reinsurance. An insolvency clause obligates the reinsurer to pay claims to the receiver of the cedent without diminution due to the insolvency of the cedent. A guiding principle of receiverships of insolvent insurers is that all creditors of the same class are treated equally. Ordinarily, this means all policyholders and loss payees would be paid the same proportion of their allowed losses.

But in some states, the “insolvency clause” contains language allowing payment of reinsurance proceeds directly to the insured if there are cut-through provisions. This difference can cause conflicts between contractual cut-throughs and receivership policy and case law on the other.