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Surety Bonds with Fair and Unfair Pricing

Author

Listed:
  • Achim Wambach

    () (Department of Economics, University of Cologne, Albertus Magnus Platz, Koeln D-50931, Germany.)

  • Andreas R Engel

    (TWS Partners, Widenmayerstr. 38, D-80538 Muenchen, Germany)

Abstract

Surety bonds are instruments used in public and private procurement to avoid the problem of contractor bankruptcy. A surety company issuing such a bond guarantees to either finish the project itself or pay the bond to the procurement agency in case of contractor's bankruptcy. This situation is analysed under the assumption that the bond is either priced fairly, or a risk loading that is proportional to the money at risk is imposed. If the surety is priced fairly, full insurance (or even overinsurance) is optimal. If the surety is priced unfairly, more solvent contractors are more likely to win, thus the problem of abnormally low tenders is alleviated.

Suggested Citation

  • Achim Wambach & Andreas R Engel, 2011. "Surety Bonds with Fair and Unfair Pricing," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 36(1), pages 36-50, June.
  • Handle: RePEc:pal:genrir:v:36:y:2011:i:1:p:36-50
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