Get documents about "The impact of fraud and poor internal controls on
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Published by the SC Municipal Insurance Trust and the SC Municipal Insurance and Risk Financing Fund
The impact of fraud and poor internal
controls on municipal finances
by Heather Ricard McBride, CFO for Risk Management Services
FAll Over the last few months, I have saved several An incentive provides a reason to commit fraud.
clippings from daily news articles. To provide Personal problems, such as bankruptcy, personality
2008 anonymity, I have left out names of cities and towns. disorders, drug or alcohol dependency, or a gambling
See if you can guess what the following headlines addiction could be an incentive. An opportunity
have in common. occurs when an individual finds a way to commit the
theft. For example, lack of good internal controls or
• Former …mayor pleads guilty, gets probation
collusion among individuals provides an opportunity to
• Embezzler given home detention commit fraud. Finally, rationalization occurs when an
individual feels entitled to whatever he steals.
• …officials in court soon
To protect your city or town against such acts
• …chief steps down of dishonesty, it is important to purchase public
• 3 ex…officials in jail; town in ‘a mess’ official bonds. A public official bond “guarantees the
honesty and faithful performance of a public official’s
That is right. All of the headlines concern duties as prescribed by law or regulation, including
stories about an employee or public officials’ crime the honest accounting of all monies entrusted to the
or dishonesty. Local papers throughout the state official according to the law.” Further, the South
printed these headlines during a two-month period. Carolina Code of Laws advises municipalities to
Unfortunately, cities and towns are not immune purchase suitable surety bonds for appropriate
from fraudulent activities. While an outside source officials and employees conditioned for the faithful
may perpetrate these types of activities against the performance of their duties.
government, fraudulent activity often occurs from Securing crime coverage is another option for
within, orchestrated by a previously trusted and often municipalities. Crime coverage involves many things,
respected employee or elected official. While most
cities and towns would like to think this could never The impact of fraud continued on page 2
happen to them, as the headlines demonstrate, it can
What’s Inside
happen to any city or town - large or small.
Municipal
Association The Small Business Administration reported, “as
of SC many as 30 percent of employees pilfer and 60 percent
will steal if given enough motive and opportunity.”
Ultraviolet radiation burns 3
.O.
P Box 12109
Columbia, SC Individuals may have a variety of reasons for engaging
29211 in some type of crime or dishonesty against a city or
Workers’ compensation ruling 4
803.799.9574 town. The American Institute of CPA’s Statement on
FAX Auditing Standards Number 99 defines fraud as “an Safety requirements 8
803.933.1283 intentional act that results in a material misstatement
www.masc. in financial statements.” The AICPA further defines Fundamentals of surety 10
sc/rms a fraud triangle where incentive, opportunity and
rationalization come together as an inducement of theft. SCMIRF coverage enhancements 15
Risk Letter 2
Director’s Thoughts
SCMIT and SCMIRF anticipate good renewals
Staff has received preliminary actuarial (rate A great benefit is the addition of an “in-house
analysis) reports and shared them with the SCMIT underwriting staff. We now have much better
and SCMIRF boards of trustees. Based on the findings management and control of the property and equipment
and recommendations, members can expect favorable schedules. This will allow us to do a better job of
program renewals for 2009. pricing the exposures we have. In addition, staff has
integrated the underwriting function with the overall
The boards cannot give final approvals until
administration, risk management and claims functions.
staff receives all renewal applications, including 2009
Everyone is communicating on a day-to-day basis.
estimated payroll numbers for SCMIT. Nevertheless,
when comparing the recommended contributions The SCMIT and SCMIRF boards will meet
(premiums) needed for 2009 with those billed for 2008, this fall to finalize the 2009 renewals. We will share
we are hopeful neither program will have an overall information with you as soon as possible. We will hold
rate increase. This is good news for everyone given the the SCMIT and SCMIRF annual members’ meetings on
current state of our economy and the demands being November 20. You will hear more about this later, but
placed on local government budgets. please put this important date on your calendar.
Remember, there is a “multi-program discount” SCMIT and SCMIRF are in their best financial
for local governments that participate in both SCMIT shape ever. We also have the best staff ever to help you
and SCMIRF. Last year, the discount was 2 percent. manage your workers’ compensation and property/liability
While this may not appear to be a lot, it represents more programs. I can assure you, the boards of trustees and staff
than a $500,000 savings for members in both programs. are committed to providing you the very best programs
possible at the least cost. That is our promise to you!
There are several opportunities for SCMIT and
SCMIRF members to save money. RMS provides If at any time you have questions, please do not
grants to help purchase soft body armor, tasers, in-car hesitate to call any of the staff identified on the back page
video cameras and safety apparatus for firefighters. of this RiskLetter. We are here to serve you. If you are
Risk management and safety training is generally currently not a member, please give us a call so we can
provided at no cost (if someone registers for the class assist you in becoming a member of these great programs.
and does not attend, there is a nominal fee). Attendance
at our training sessions has been at or near capacity.
Sometimes we have to turn people away due to limited
space. The programs can provide deductible credits
to reduce up-front costs if the member is willing to
share in the cost when a claim arises. In addition, the
Harvey Mathias
programs can provide credits when members have a
Director of Risk Management
good, active safety program.
The impact of fraud
continued from page 1
including employee dishonesty, employee theft, forgery, While a public official bond or crime coverage
alteration and computer fraud. Because the perils covered cannot prevent fraudulent activities from occurring, it is
are somewhat limited compared to those addressed with important to consider purchasing these instruments for
public official bonds, higher limits are often available. those employees or public officials with regular access
Furthermore, blanket coverage is written on all employees to cash and investments. For more information, contact
(unless excluded) instead of individual employees. Leigh Polhill, lpolhill@masc.sc, 803.354.4752 or Jeff
Thompson, jthompson@masc.sc, 803.933.1216.
Risk Letter 3
Ultraviolet radiation burns from
high-intensity discharge lamps remain
a public health concern
Broken and unshielded high intensity metal halide inspect both the light bulb and the fixture on a regular
and mercury vapor light bulbs continue to cause eye and basis to ensure that they are not broken.
skin injuries. This type of lighting is common for most
With the light fixture turned off,
indoor recreational facilities, gymnasiums, auditoriums,
• check the light fixture, and replace any damaged
large garages and repair facilities.
fixture. Damaged, open fixtures or fixtures
Over the last several years, there has been a growing with wire guards do not protect the bulb from
concern about the safety of this type of lighting. One of the breaking and will not protect the public from
largest incidents occurred in September 2005 when more UV radiation.
than 100 people were exposed to short-wave UV radiation
• check the bulbs. Replace any missing, broken or
from a broken mercury vapor light bulb at a high school
punctured light bulbs.
gym in Tennessee. Eighteen people went to the hospital
with severe eye and skin burns. Personnel investigating the • ensure light bulbs are installed in appropriate
event confirmed that a broken, non self-extinguishing “R” fixtures.
type metal halide bulb caused the injuries.
• those responsible for the maintenance of these
Types of halide and mercury vapor light bulbs sold lighting systems should fully understand the
in the U.S.: manufacturer’s warnings on product packaging,
as well as federal, state and local guidelines to
• “T” type light bulbs with a self-extinguishing
reduce the risks associated with these products.
feature that shuts off the light within 15 minutes
after the outer bulb is broken. “T” type light If a metal halide or mercury vapor light bulb is
bulbs may be used in either open fixtures or broken during use,
enclosed fixtures. • turn off the light immediately.
• “R” type light bulbs are not self-extinguishing. • move people out of the area as quickly as possible.
Only install “R” type light bulbs in light fixtures
fully enclosed by a glass or plastic lens to shield • advise people exposed to the damaged bulb to
people from the UV radiation or in areas where see a doctor if symptoms of skin burns or eye
people will not be exposed to UV radiation if the irritation occur.
outer bulb breaks. • report injuries to the bulb manufacturer, the
The 2005 National Electrical Code addresses high state health department and the nearest Federal
intensity metal halide and mercury vapor light bulbs Drug Administration’s district office.
installed in newly constructed or renovated indoor • check to make sure the light fixture is turned off
sports or all-purpose facilities. Because the bulbs in before replacing the damaged light bulb. It is
such areas are subject to physical damage, install the important to retain the broken bulb to identify
bulbs in fixtures fully enclosed by a glass or plastic the bulb type and manufacturer and to assist
lens to protect the bulb from breaking. The best way with any post-incident investigation.
to reduce the risk of burns is to use fully enclosed
fixtures or self-extinguishing “T” type mercury For information on care and maintenance of high
vapor light bulbs in facilities where the public can intensity metal halide and mercury vapor lamps used
be exposed to the ultraviolet (UV) radiation from a in schools, visit www.nema.org/stds/halide-schools.
broken bulb. cfm#download. For best practices concerning metal
halide lighting systems, visit www.nema.org/stds/
Precautions for facilities that use metal halide and LSD25.cfm. For additional information concerning high
mercury vapor lighting intensity mercury vapor lighting, visit the FDA’s Web
All schools and other indoor, all-purpose facilities site at www.fda.gov/cdrh/radhealth/products/mercury-
using metal halide and mercury vapor lighting should vapor.html
Risk Letter 4
Workers’ compensation ruling
addresses unauthorized deviation
On August 23, 2003, Jesse Houston was injured Workers’ Compensation Commission heard an appeal of
in a motor vehicle accident while riding as a passenger the decision. The appellate panel issued a split decision
in a commercial dump truck owned by his employer, but decided Houston’s act in allowing an unauthorized
Deloach & Deloach. His employer denied the claim, person to drive his employer’s truck constituted an
arguing that Houston was outside the scope of his impermissible deviation from his duties. The panel
employment at the time of the accident. ruled the accident did not arise out of the course and
scope of his duties. Because the injuries did not occur in
On the morning of August 23, Houston picked up
the course and scope of employment, Houston was not
Leslie Brown. Brown was not trained to drive a dump
entitled to benefits under the South Carolina Workers’
truck, but she was allowed to drive the truck that was
Compensation Act.
fully loaded with asphalt that day. Although the dump
truck had only two seats in its cab, Houston and Brown In June, the Court of Appeals affirmed the circuit
picked up another unauthorized passenger, Kimberly court’s order affirming the Workers’ Compensation
Blake, at some point during the day. Neither Brown nor Commission’s denial of benefits to Houston. By allowing
Blake were Deloach employees. Brown subsequently an unauthorized individual to drive a loaded dump truck,
wrecked the truck, injuring Houston. Houston deviated from his assigned task. The deviation
resulted in his injuries; therefore, the injuries did not arise
When the case went to a hearing, the Workers’
out of and in the course of his employment.
Compensation Commission determined Houston
suffered compensable injuries within the course and To see the full text of this case, visit www.judicial.
scope of his employment. The appellate panel of the state.sc.us/opinions/HTMLFiles/COA/4408.htm
Drug-free workplace kit available South Carolina Municipal Insurance
A new kit from the Substance Abuse and and Risk Financing Fund
Mental Health Services Administration offers Employment and labor Hotline
advice on developing and implementing a
workplace drug policy. SCMIRF members have access to the
Employment and Labor Hotline as a free member
The kit contains nine pullout brochures, 13 service. The service helps members prepare for
fact sheets, a bumper sticker and posters. potential claims and suits related to such issues
Topics addressed by the kit include as wrongful termination; age, racial and sexual
discrimination; and other employment-related matters.
• components of a drug-free workplace
Each member has 10 free hours per year with
• conducting a needs assessment the designated Labor Hotline attorney.
• training your supervisors Hotline issues covered include, but are not
• educating your employees limited to, labor, employment, wage and hour,
workplace safety and health, and immigration.
• creating an employee assistance program
For additional information, contact Cindy
The kit is available at www.workplace. Martellini, claims manager, at cmartellini@masc.sc,
samhsa.gov/WPWorkit/index.html. Order up to five 803.933.1235 or 877.825.0544 ext. 1235 (toll free).
free copies at ncadistore.samhsa.gov/catalog/ or by
calling 877-SAMHSA-7. Hotline Number: 1.866.800.0118
Risk Letter 5
RMS Welcomes Top driving mistakes
New Staff Member that cause crashes
Kelly Benson recently left Companion Third Party
Administrators to pursue other career opportunities.
She served SCMIT members well, and we wish her the
best in her future endeavors. We are pleased to welcome
Lisa Branham to the SCMIT adjusting staff to fill that
opening. Lisa comes to us with a wealth of experience
and is a great addition to our team. Welcome Lisa!
lisa Branham
Professional Designations:
Working on Associate in
Claims (AIC)
Professional Experience:
Companion P&C for more
than 17 years
Hometown: Born in
Milwaukee, WI, but raised in
1. Multi-tasking While Driving
Columbia, SC
Driving Tip: When you turn the car on, turn the
Hobbies and Interests: Shopping, Traveling, Spending gadgets off. No matter how busy your day is, when
Time with Family you are on the road, focus only on driving. Catch up on
other activities later, and avoid unnecessary accidents.
Last Book You Read: “The Battle Belongs to the
Lord” by Joyce Meyer 2. Following Too Closely
Driving Tip: One thousand one … one thousand
Favorite Book: Anything by Stephen Covey
two… Leave a two-second cushion between you and
Favorite Song: Any song by Air Supply or Journey the vehicle ahead. It could save your bumper and your
life. Make sure to double or triple that time when the
Last Movie You Saw: “Fool’s Gold” weather is bad or the pavement is slick.
Favorite Movie: “Pride and Prejudice” 3. Failure to Yield on a Left-Hand Turn
Other Interesting Facts: I’m a Green Bay Packer fan. Driving Tip: Check the flow before you go. Look
at the street you are turning into to make sure that no
vehicles or pedestrians are in your path.
4. Incorrect Merging
Welcome New Member Driving Tip: Yellow is for yield. Accidents often
occur when you are stuck behind a driver who interprets
RMS is pleased to welcome the yield as stop. Do not be the guilty party. Use the ramp
as a means for merging into traffic not causing it.
City of Landrum
5. Backing Up
to SCMIT and SCMIRF. Driving Tip: Look over your shoulder. Objects
We look forward to in the mirror are closer than they appear. Your mirrors
have a margin of error; do not rely on them alone. Look
working with you. over your shoulder before backing up.
Source: GMAC
Risk Letter 6
He did what?
Another absurd claim
A California man sued the City of Lodi, California, things are just ridiculous,” stated Steve Schwabauer, an
for damages incurred to his vehicle when a city-owned attorney for the city, in denying the claim. “This is just
dump truck backed into his car. The court dismissed one of those things where you go, no. The citizens of
the suit because the car’s owner was the city employee Lodi are not going to pay for his error.”
driving the truck at the time of the accident.
Gokey’s wife then filed a claim under her name.
Curtis Gokey, a public Schwabauer said the claim also lacked merit because
works employee, admitted Rhonda Gokey cannot sue her own husband. “You can
he was at fault but sue your spouse for divorce, but you can’t sue your
still sued the city spouse for negligence,” Schwabauer said. “They’re
in an attempt to a married couple under California law. They are one
recover entity. It’s damage to community property.”
$3,600 for
Her claim is for a larger amount ($4800) because,
the cost
she says, “I’m not as nice as my husband is.”
of repairs.
“Some
CPSC updates handbook for
public playground safety
Each year, hospital emergency rooms treat about • Purchase playground equipment that meets the
200,000 children for injuries related to playground latest safety standards.
equipment. To promote awareness of this issue, the
• Maintain at least nine inches of protective
Consumer Product Safety Commission updated its
surfacing, including shredded/recycled rubber,
popular “Handbook for Public Playground Safety,”
wood chips, wood mulch (non-CCA treated),
which contains guidance for childcare personnel,
sand or pea gravel under and around playground
school officials, designers, inspectors, parents and
equipment to cushion children from falls.
school groups on building safer playgrounds. Many
municipalities have incorporated the guidelines, • Check that protective surfacing extends at least
considered by many to be the model of playground six feet in all directions from play equipment.
safety, into local and state building codes. For swings, extend protective surfacing in front
and back of the swing, twice the height of the
The handbook provides specifications for creating
suspending bar.
safer play zones and avoiding hazards with equipment
such as sharp points, entrapments and entanglements. • Repair sharp points or edges on equipment.
It contains new guidelines from CPSC staff for Replace missing hardware and close “S” hooks
playground equipment for children as young as six that can cause injuries.
months old, track and log rolls for older children,
and playground surfacing, as well as suggestions on • Never attach ropes, jump ropes, clotheslines, pet
protecting children from sun exposure on playgrounds. leashes or cords of any kind to play equipment
due to the strangulation hazard.
Tips to help prevent injuries and other hazards on
public and home playgrounds: To order free copies of the handbook (CPSC-325),
• Always supervise children on play equipment to e-mail the CPSC at info@cpsc.gov. Download CPSC
make sure they are safe. publications at www.cpsc.gov
Risk Letter 7
loss control tip –
tree trimming cuts down on claims
The American National Standards
Institute and the International Society of
Arboriculture publish tree pruning and
safety standards, known as ANSI A300
(Part 1) Pruning Standard. Follow these
standard practices whenever possible.
Careful pruning to reduce branch weight
may reduce the risk of branch failures
associated with drought stress.
• Prune when trees are dormant.
• Hire only licensed tree care businesses
and experienced professionals to prune
and maintain trees. Arborists and tree
workers certified by the International
Society of Arboriculture must pass
a written test of basic arboricultural
knowledge and attend continuing
education courses to maintain their
If some members did not have trees, they would certification.
not have any claims. Downed trees and flying limbs
have caused property damage to vehicles, fences and • If municipal workers must perform this task, they
buildings. Bodily injury claims and even deaths have must always wear personal protective equipment,
resulted from falling limbs. including safety glasses, helmet, ear protection
and gloves. Require chainsaw chaps if the
South Carolina’s current drought situation is employee will use a chainsaw on the ground.
harming trees. Drought causes primary and secondary
physical damage as well as physiological changes in • Always perform a hazard assessment of the work
trees. The primary physical effect is direct damage to area prior to starting the work.
the roots and root death. When roots dry, shrivel and • Trained and experienced line-clearance tree
become nonfunctional, a water deficit develops because trimmers should perform all tree trimming or
the roots cannot provide water to the top of the plant. removal work within ten feet of a power line.
Another drought effect is weakened trees, which then
become vulnerable to insects and diseases. Long-term • Do not allow trees to be topped. This decreases
drought symptoms include dieback of branches and tree health, safety, longevity, aesthetics and other
death as the plant’s capacity to absorb water is damaged. benefits provided.
Tree maintenance, routine care given to a tree
throughout its life to preserve or improve its health, The benefits of regular and
function and safety, begins with regular inspections to
determine if a tree needs pruning, mulching, fertilizing,
correct tree pruning
irrigating or pest management. • proper tree form, improved health and
structural integrity
Pruning is the deliberate removal of tree branches • removal of decaying and diseased wood
and limbs to achieve a specific objective. Every tree • decrease in overall risk of limb failure and
maintenance program should include regular inspections liability
to determine a tree’s pruning needs. • reduced maintenance needs in the future
Risk Letter 8
New safety requirements
for highway and emergency workers
New federal worker visibility regulations will rule. This means law enforcement are still required to
become effective on November 24. wear the appropriate level of reflective garments when
directing traffic, investigating crashes, and handling
Because of a 2006 rule (23 CFR 634) by the
lane closures, obstructed roadways and disasters.
Federal Highway Administration, all workers and most
public safety officers working in the right-of-way of a Currently no such exception exists for firefighters.
federal-aid highway must wear certified high-visibility Fire service personnel have expressed concern about
safety apparel. The rule is intended to increase worker adding a layer of potentially flammable material
visibility and reduce worker fatalities due to traffic between their turnout gear and self-contained breathing
accidents. The high-visibility clothing must meet ANSI/ apparatus while battling car fires or performing
ISEA 107-2004 Class 2 or 3 requirements to ensure both extrications. Because the fire personnel did not express
day and nighttime visibility. their concerns during the comment period of 23 CFR
634, no exceptions or interpretations for fire service
The rule does provide an exception for police
operations were published along with the rule. Turnout
officers who are “engaged in law enforcement activities,
gear alone does not meet the visibility requirement.
such as traffic stops and pursuit and apprehension of
In fact, no turnout gear currently manufactured meets
suspects.” However, “all persons at a traffic incident
the color requirement for the fluorescent background
scene or within a traffic control zone, including, but
material of these high-visibility garments.
not limited to, police, fire, EMS, utility, media, and tow
operators exposed to risks of moving roadway traffic To view the rule, visit edocket.access.gpo.
or construction equipment” must comply with the gov/2006/pdf/E6-19910.pdf.
USFA and FHA release firefighter guide
for highway response
The U.S. Fire Administration and the U.S. implementation of TIMS and the IMS Consortium
Department of Transportation’s Federal Highway Guide. It examined technologies and practices such
Administration, working in partnership with the as effective distance for placing roadway warning
International Fire Service Training Association, signs; correct amount and type of emergency vehicle
developed technical guidance and training programs warning lighting (e.g., intensity, color, etc.); and
in traffic incident management for fire and emergency training, placement, and protective equipment for
service providers. “Traffic Incident Management “flaggers.” It includes case studies of roadway
Systems” guides local-level fire incidents that have taken the lives of firefighters,
departments on complying with highway scene safety survival
the DOT’s “Manual of basics, incident command for
Uniform Traffic Control roadway incidents and examples
Devices” and the of effective TIMS programs.
National Fire Service
Find additional information
Incident Management System
about this study on the USFA
Consortium’s “Model Procedures
Web site at http://www.usfa.
Guide for Highway Incidents.”
dhs.gov/fireservice/research/
The project included safety/roadway.shtm#B
research into emergency services
Risk Letter 9
First responder safety:
hazards involving copper theft
Over the past several months, home explosions outside of the residence. The Lansing Fire Department
across the country have been linked to the theft of recently responded to a gas leak where gas was detected
copper. Home explosions in Lansing, Grand Rapids and 10 feet from the residence.
Flint, Michigan, are suspected to have occurred because
Officers responding to these calls should take
thieves damaged the gas lines inside the residence while
several precautions.
stealing the copper. Nebraska, Minnesota, California,
Iowa and other states report similar stories. With copper • Before approaching the home, begin to check for
theft on the rise in our state, it is only a matter of time the smell of gas.
before we see this.
• If an odor is detected outside or within the
Once the gas lines are damaged, the home begins residence, exit and remove all people and sources
to fill with gas. A small amount of gas can cause a flash of ignition from the area.
fire or explosion to occur. Many radios and flashlights
carried by police departments are not “explosion proof” • Call the local fire department and gas utility
and may ignite the gas within the residence as well as provider for assistance.
SC OSHA Most Cited Standard
Tools you can use for Government Entities,
Before signing on the dotted line with a
contractor, take advantage of OSHA’s online tools
October 2006 - September 2007
to check the company’s safety record. It is a simple 1. 1926.0651 Specific Excavation Requirements
process that is an extra layer of protection for you.
2. 1910.0156 Fire brigades
1.Go to OSHA’s Web site
3. 1910.1200 Hazard Communication
(www.osha.gov/oshstats/index.html).
4. 10012 General Duty Clause
2.Click on “Establishment Search.”
5. 1926.0652 Requirements for protective systems
3.Enter the name of the entity whose safety
record you wish to research. 6. 1910.0157 Portable fire extinguishers
4.Select other criteria – years, location, status 7. 1910.0242 Hand and portable powered tools
of case, etc. and equipment, general
5.Click “Submit,” and you will get a listing 8. 1926.0100 Head protection
of the inspections and any violations found.
Find detailed information concerning the
violation by clicking on the violation ID.
Risk Letter 10
Fundamentals of surety
by Mark Ferraro CPCU, ARM, CRIS
This article was originally published in the July 2008 issue of Public Risk magazine
and is reprinted with permission.
Successful risk managers need many skills Basic Surety Terms
to handle the day-to-day requirements of their job A surety issues bonds, a surety may be an
in a public entity environment. A fundamental insurance company, but bonds are not insurance.
understanding of surety is critical to the survival of Bonds are a three-party contract composed of a surety,
the risk manager and the adequate protection of the a contractor and your entity. In a bond, your entity is
entity. For this article, we will use both the terms the owner of the project and is described in the bond
bonding and surety, as their once distinct meanings as the “Obligee.” The contractor that you hire is the
have faded over time and usage. This discussion will “Principal” and the company that issues the bond is
also be limited to three types of surety: bid bonds, the “Surety.”
payment bonds and performance bonds. These are the
most common forms of surety that the public entity Surety is as old as insurance, with historical
risk manager encounters. As they are used in capital references going back as far as 2,750 BC. Modern
improvement projects, they represent some of the surety for construction was codified in the United States
largest risks faced by a public entity. beginning in 1893 when surety became a requirement
for federal construction projects. The Miller Act of 1935
(40 U.S.C. Section 270 a-d) finally put construction
surety into the category of standard operating procedure
and through individual states adopting what is referred
to as Little Miller Acts, every jurisdiction now has some
form of mandatory surety for construction contracts
funded by public funds.
Surety provides the following benefits to the
public entity:
• Guarantee the terms and price in the bid/contract
• Assures that laborers, suppliers and
subcontractors will be paid
• Relieves the public entity (as owner) of liens
• Smooth transition from construction to
permanent financing
• Reduces probability of contractor diverting funds
• Intermediary to whom owner can complain
• Lowers costs by facilitating competitive bids
More than any other reason, contractor failure
is a driving force behind the requirements that public
entities use surety to protect public funds. Construction
trade contractors fail at an alarming rate. Industry trade
journals suggest that 20 to 25 percent of all contractors
go out of business each year. The Surety Association
of America released a study in 2002 that indicated that
contractors failed for the following reasons:
Risk Letter 11
Unrealistic Growth 37 percent In a performance bond, the end date is a bit more
Performance Issues 36 percent complicated. Most performance bonds cease coverage
Character/Personal Issues 29 percent when the project is accepted by the owner, there is
Accounting Issues 29 percent no activity for two years, the warranty period ends or
Management Issues 29 percent there is specific language in the bond itself that covers
the issue. There may be a conflict with the warranty
Given the obligation that the surety assumes, the
period, as many states require specific warranty periods
underwriting process is critical. While the industry
for public construction projects that may differ with
has over $3 billion in claims each year, actual losses
standard construction practices.
are very much smaller. The majority of the industry’s
expense is the underwriting process itself. In theory, the Performance of the surety is triggered by the
underwriter does not expect to pay any losses. Rather, failure of the principal (the contractor) to perform
they believe that their process identifies contractors that his duties under the contract. The Bid Bond can
can fulfill their obligations. The underwriter looks at be triggered by the failure to obtain surety; the
three issues when evaluating a contractor for a bond: Payment Bond can be triggered by the failure to pay
capital, capacity and character. subcontractors & suppliers; the Performance Bond can
be triggered by the failure to complete project.
Capital – does the contractor have lines of credit
sufficient to carry out their business plan? Discharge: When the contractor, as principal, fails
in their duty to the obligee (public entity), the surety is
Capacity – does the contractor have the human and
required to take action to make the obligee whole again.
machine resources, as well as experience, to do the work?
The three types of construction bonds each have similar
Character – does their word/promise, ethics, business discharge provisions. For a bid bond, the discharge is
behavior mean anything? very simple and straight-forward. The surety simply
forwards the penal sum to the entity.
When a contractor complains that they cannot
secure a bond for your work, one of the three C’s is an Payment bonds have two options, as the surety
issue with the underwriter. Construction is a very small can pay the subcontractors directly to make them
universe and surety underwriters know the players in whole or the surety can do nothing, waiting to see if
their territory intimately. Pricing of bonds is based on the contractor can remedy the situation on their own.
the project amount, the history of the contractor and the Intervention by the surety is not mandatory, as there
scope of the project. As a rule of thumb, you can expect might be legitimate business and legal reasons why the
the price of bonds to be in a range of 0.5 to 2 percent of subcontractors are not being paid.
the contract price.
Discharge of a performance bond is the most
complicated and problematic for the risk manager. A
surety has five options to discharge their obligation.
What Should A Risk Manager Understand The surety could buy the performance bond back from
About A Bond? the entity by payment of the penal sum. Or the surety
Every construction-related bond has four elements: can extend financing to the principal (the contractor)
Purpose: The purpose is defined as binding to complete the project. The surety can find another
the surety and the principal, their heirs, successors, contractor and tender that contractor to the obligee (the
executors, administrators and assigns to the owner for entity) for completion of the project. If the entity refuses
the performance of the construction contract to work with the tendered completion contractor, the
surety, as its option, can contract with the completion
Period: In a bid bond, the period is composed of contractor and take over the project directly. Finally, as
two conditions: If the bid is not selected, the bid bond a fifth option, the surety can elect to do nothing. Again,
expires. When the bid is selected, the bid bond expires as in the payment bond situation, there may be legal
when the payment and performance bonds are issued. and business reasons why the surety has no reason to
In a payment bond, the performance of the bond discharge the obligation.
is usually set to expire one year past last payment on Most public entities are loathe to terminate a
contract. Some forms and state law modify this to the contractor from a project. They would much rather have
last sign of activity. However, there are states that have the surety help the contractor finish the project as planned.
very long performance periods. Maryland has a 12-year
period to submit claims against the bond. Fundamentals of surety continued on page 12
Risk Letter 12
Fundamentals of surety continued from page 11 recourse once a contractor is declared in default on their
contract. In truth, the surety has at least 11 defenses to
More financing or even additional help is preferred rather
discharging a bond. These defenses include:
than going through termination, re-bid and then getting a
new contractor up to speed on the project. Principal Not In Default: If the contractor is not
in default, the surety has no obligation to the public
Bond Forms: Bond forms do matter so be careful
entity. There can be much litigation on this issue alone,
which forms your entity uses. Most states have specific laws
so before you terminate a contractor, make sure you can
and case law that speaks to the issue of what should be in a
prove in court that the contractor is in fact in default.
bond form. As examples, many states have claim settlement
acts and the tort of good faith that help ensure that surety Obligee In Default: This happens more than we
companies discharge the bonds with utmost good faith. realize. Poor project management by the entity can
Don’t allow a bond form to give away something that you result in the entity being in default.
already had under your state law or case law.
Defective Plans and Specifications: If the plans
While surety companies are regulated by the call for 25 foot pilings and it is later determined that
states’ departments of insurance, the bond forms 65 foot pilings should have been used, the contractor is
themselves are unregulated. In fact, it is much like not at fault for following your plans. Should they have
a bond form jamboree when you start looking for known? Could they have known? These are issues that
standardized bond forms. From the federal government often can only be resolved through legal action.
on down to local entities, from trade associations
Obligee’s Fraud/Concealment: The public entity, as
to public entity pools, everybody seems to have a
the owner of the project, has the obligation to conduct its
bond form. There is nothing wrong with this, but just
affairs with utmost good faith. There is some wiggle room
remember two things when selecting a bond form.
for differences between passive and active concealment.
Bonds are contracts; the words mean exactly what
But not much. As a city attorney once said, “If we are
they say. Surety litigation is brutal and expensive, so
having this conversation, we have to disclose it.”
understand the bonds meaning before you accept it.
Second, since the bond forms are unregulated, model Principal’s Fraud/Concealment: The surety can
bond forms tend to benefit the organization that offers void the bond if they can prove that during the underwriting
it. Verify that the bond being offered serves your needs process there were material misstatements or concealment.
first. Your state league or association and your legal
counsel can be of tremendous assistance. Modification of Contract: Bond forms should
be carefully read to assure the entity that change orders
Accepting a Surety or changes of the scope of work don’t void the bond.
Like insurance policies, the public entity has Changes of more than 20 percent usually void the bond.
to decide if a surety is acceptable. Most states have Most underwriters are willing to waive this provision in
established specific guidelines: the surety must be the bond before it is issued.
licensed as a corporate surety, they must be authorized,
Procedural Defenses: The surety has a number of
licensed and admitted to transact business in that procedural defenses that can result in judicial dismissal of a
state and they must be licensed to execute the bond as lawsuit before the public entity can present any facts about
a surety. Many states, by directive, legislative action or the case. These defenses include establishing that the public
common sense, also require that the surety appear as an entity is not a proper claimant; the public entity failed to
acceptable surety in Treasury Circular 570. The Circular follow the notice provisions in the surety instrument; failed
570 is the resource to see not only the financial strength to bring notice or a claim in a timely matter, as required by
of the surety, but the maximum amount of limits that the state statute or contractual terms; seeking judicial action in a
surety can place on any one project. venue that violates the contractual terms of the bond.
Many states penalize a public entity quite severely Obligee’s Overpayments to Principal: Overpayments
if they accept a bond from an unlicensed surety. They limit the surety’s rights to complete the project.
usually void the bond, even if the bond is desperately
needed by the entity. Obligee’s Extension of Time: Extension of time in
some states may void the bond. Some states require due
Surety Defenses
Many public entities believe that a surety has no Fundamentals of surety continued on page 15
Risk Letter 13
Member Spotlight
From time to time, we get word of outstanding safety efforts in our cities and towns. As always, we like to
share information that may benefit our members. If you have any information you would like to share , whether
it is regarding coordinated safety training, a new technique or a new piece of equipment, contact Amy Lindler,
803.933.1271, alindler@masc.sc
Georgetown implements fall protection device to
protect employees
Climbing poles is one of the basic job skills that
every electric utility line technician must possess. Even
though the use of bucket trucks has replaced much
of the climbing that these workers perform, new line
technicians still must master this skill. The learning
process, though, usually includes its share of bump,
bruises and splinters. After a new employee suffered
minor injuries from a fall while climbing, the City of
Georgetown Electric Department learned of a new
climbing system designed to minimize the risk of falling
from a pole while climbing.
pole. If the technician’s gaffs lose contact with the pole,
the technician’s weight is supported and held in place
by the straps, thus avoiding a fall. The technician is
suspended at that point on the pole until he can regain his
footing or until assistance arrives.
The Electric Department decided to purchase one
of these systems and Buckingham provided a training
session for all of the line technicians. The technician
who had recently suffered the fall was given the first
opportunity to climb with the new system. After going
through a learning cycle to gain some proficiency and
comfort, the technician found the system very reliable.
His confidence level has risen substantially after using
the system for a short period. The Electric Department
Climbing a wood utility pole is performed by
subsequently purchased two additional systems for new
using specially designed equipment on the feet and
technicians with limited climbing experience.
around the waist. All of the technician’s weight is
transferred to the pole through two spikes, or ‘gaffs’ It is important to remember that the system
that are strapped onto the boots. Once the technician will not teach a line technician how to climb a pole.
reaches his working position on the pole, a safety belt is Those skills must be learned though instruction and
wrapped around the back of the pole, which allows him experience. Even though the system slightly hinders the
to lean back, and frees his hands for working. At any ease of movement on a pole, it provides the confidence
point during the process, if the technician’s footing is of knowing that a fall will not be the result of losing
not solid or if he shifts his weight the wrong way, it can contact with the pole. This removes much of the fear
cause the gaff to pull out of the pole, resulting in a fall. factor that technicians experience when learning how to
climb poles and allows them to focus on mastering this
A new climbing system developed by Buckingham
important skill.
Manufacturing Company is intended to support the
technician should his gaffs lose contact with the pole. The Special thanks to Cynthia Howard, assistant to
system changes the standard safety belt into a system of administrator/risk manager, and Alan Loveless, electric
two separate belts and locking mechanisms that surround utilities manager, for this information.
the pole instead of just wrapping around the back of the
Risk Letter 14
American appraisal project completed
In August 2008, SCMIRF completed the reappraisal existing structure, bringing in specialized construction
process for all members who joined SCMIRF in 2004 equipment (like cranes) and putting the structure back in
or earlier. This culminated a three-year project, which “new” condition.
SCMIRF invested nearly $1 million to ensure member
If members wish to elect out of any of the
properties were properly insured-to-value.
values developed by American Appraisal, they may
“Having properties properly insured for their full sign an actual cash value endorsement. “Actual cash
economic is essential to getting favorable reinsurance value endorsements take into account depreciation
terms, as well as ensuring members aren’t left out in and significantly reduce the potential recovery on a
the cold when a total loss occurs,” said Jeff claim. All of the property coverage enhancements,
Thompson, assistant director including the 150 percent valuation clause, are
of Risk Management removed from the property coverage. We don’t
Services. “While it may recommend members pursuing this route, as
appear the appraiser it reduces the coverage without a substantial
gives values which decrease in premium.”
may seem higher than
While no definitive
might be expected,
decision has been made,
it’s important
it is SCMIRF’s
to remember
intention to
that these
reappraise member
aren’t market
properties periodically,
valuations but
certainly more often than
replacement
every 10-15 years.
cost valuations.”
Replacement cost If you have any questions regarding the
valuations take into reappraisal process, contact the Underwriting
account demolishing the Department at 803.354.4752.
Multiprogram discount projected
for 2009 program year
In 2008, members of both SCMIT and SCMIRF losses, and vice versa. The programs achieve certain
accrued an additional 2 percent discount on their economies of scale when municipalities are members
worker’s compensation, property and liability of both programs, and this discount recognizes these
premiums. These discounts equated to more than economies, as well as reward them for their loyalty to
$500,000 in premium relief to members of both the programs.”
programs.
SCMIT and SCMIRF will renew these discounts
Harvey Mathias, director of Risk Management in the 2009 program year. If you are a member of only
Services, stated, “The goals of SCMIT and SCMIRF are one program and are interested in getting a quote in the
very similar. Controlling workers’ compensation losses other program, give us a call.
has a direct effect on controlling property and liability
Risk Letter 15
Fundamentals of surety continued from page 12
consideration between the principal and the surety for the
SCMIRF coverage
extension or limit this defense to the narrow period of the
default occurring during the time extension. enhancements coming
Failure to Mitigate Damages: Public entities can’t
be reckless when they know a project is in trouble. Raw
materials, work in progress and finish portions all must The new underwriting staff at RMS has identified
be protected to the best of their ability when the entity three substantial enhancements that will be included as
knows or should have known the contractor is in trouble. part of the 2009 renewal process.
Exoneration Acts: Some states have a state law The Auto Physical Damage coverage for SCMIRF
that requires the owner to sue the contractor before the will now include a depreciation factor, meaning
surety acts. Failure to do so results in the surety being members with older fleets will pay relatively less for
released from the bond. the auto physical damage premium than those who have
Are there alternatives to surety products? Yes, newer fleets.
there are some insurance products that behave like The Coverage Contract will undergo an extensive
a surety product. Their use is very rare and they are review in order to ensure consistency in wording and intent.
usually only used to solve a high-risk problem. They are
mostly used outside the United States, in areas where Standard Property Extension coverage will now
credit risk and nationalization of the project are an issue. be available to members at no additional charge. This
includes a base limit of $100,000 for Business Income
There are alternative techniques that you can use and Extra Expense coverage, and non-mobile data
to replace a performance bond or a payment bond. processing equipment included as part of the standard
Although used only once in my career, a contractor property coverage.
who abstains from progress payments during a project
doesn’t really need a performance or payment bond. “These changes are being implemented to ensure
The entity has no risk, all things being equal, if the fairness across the membership,” said Jeff Thompson,
contractor is willing to self-finance or makes other assistant director of Risk Management Services. “We
arrangements. Once the project is completed, the entity initially presented several enhancements and changes
still has to solve the issue of warranty period coverage, to the SCMIRF Board of Trustees in August. The board
but at that time the contactor may be able to secure a provided additional guidance, and is extremely aware of
performance bond for the warranty period alone. the tough budget year many of our members are facing.”
With surety, the public entity risk manager has a Look for a report on these and other changes at the
powerful resource to safeguard capital improvement annual members meeting in November.
investments in their community.
Mark Ferraro is a past president of PRIMA
and is currently on sabbatical from his normal risk SCMIT and SCMIRF annual members
management duties.
meeting to be held November 20
This article was originally published in the July 2008
issue of Public Risk magazine, the member publication RMS will hold the annual SCMIT and SCMIRF
of the Public Risk Management Association PRIMA is annual members’ meeting on November 20 at the
the one-stop resource for educational programming, Embassy Suites in Columbia. Mark your calendar, and
risk resources and networking opportunities for public plan to attend to hear about the upcoming 2009 renewals.
sector risk managers. www.primacentral.org.
Did you know?
The governor signed legislation to abolish the South Carolina Occupational Health and Safety Review Board.
Effective January 1, 2009, the SC Administrative Law Court will handle all hearings on SC OSHA cases.
Risk Letter 16
MASC Risk Management Staff
Harvey Mathias Amy Lindler Neepa Shah
Director Risk and Safety Services Financial Specialist
803.933.1212 Consultant 803.933.1260
hmathias@masc.sc 803.933.1271 nshah@masc.sc
alindler@masc.sc
Phil Cromer Anne Shissias
Risk and Safety Services Barbara Little Health and Wellness Manager
Manager Administrative Assistant 803.933.1272
803.933.1210 803.933.1237 ashissias@masc.sc
pcromer@masc.sc blittle@masc.sc
Jeff Thompson
J. Wayne George Cindy Martellini Assistant Director
Field Services Manager Claims Manager 803.933.1216
803.933.1242 803.933.1235 jthompson@masc.sc
wgeorge@masc.sc cmartellini@masc.sc
Joy Gloster Heather McBride Municipal Association of South
Administrative Assistant Chief Financial Officer - RMS Carolina
803.933.1289 803.933.1258 PO Box 12109
jgloster@masc.sc hmcbride@masc.sc Columbia, SC 29211
803.799.9574
Julie Hollaway Leigh Polhill www.masc.sc
Underwriting Specialist Underwriting Manager
803.354.4755 803.354.4752
jhollaway@masc.sc lpolhill@masc.sc
Companion Claims Staff
Connie Martin Dawn Allison Brenda Kegler
SCMIRF Claims Supervisor SCMIT Claims Supervisor SCMIT Associate Adjuster
803.933.1262 803.933.1267 803.933.1268
connie.r.martin@ dawn.allison@companiongroup.com brenda.kegler@
companiongroup.com companiongroup.com
Lisa Branham
Holland Folsom SCMIT Senior Adjuster Carol Santilli
SCMIRF Senior Adjuster 803.933.1266 SCMIT Administrative
803.933.1263 lisa.branham@ Coordinator
holland.folsom@ companiongroup.com 803.933.1264
companiongroup.com
carol.santilli@companiongroup.com
Marcye Holland Martha Gaw
SCMIT Senior Adjuster SCMIT - Companion
SCMIRF Adjuster
803.933.1265 P.O. Box 11447
803.933.1253
marcye.holland@
martha.gaw@companiongroup.com Columbia, SC 29211-1447
companiongroup.com Toll Free: 877.825.2477
Sue Grist
Trudy Stevenson SCMIT Claims Adjuster SCMIRF - Companion
SCMIRF Senior Adjuster 803.933.1269 P.O. Box 11512
803.933.1261 sue.grist@companiongroup.com
Columbia, SC 29211-1512
trudy.stevenson@ Toll Free: 877.825.0544
companiongroup.com
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