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SFAA Seeks Improvements to License Bond Requirements for Financial Services Providers in Indiana

Wednesday, January 23, 2013  

Indiana HB 1081 revises the existing bond requirements for several different financial services providers and creates a new bond requirement for pawnbrokers. SFAA believes that there are three problems with the new requirements for these bonds: the bond amounts for some are too high; there is a long tail for filing claims for these bonds; and the requirement of an A- rating for the surety issuing these bonds is unnecessary. SFAA recommended amendments throughout the bill to the bill sponsors in order to make each license bonda more workable bonding obligation.

HB 1081 addresses the following license bonds: small loan lenders, debt management service providers, money transmitters and the persons and entities that would not otherwise be subject to the mortgage lender or broker bond: persons acting as creditors in first lien mortgages, entities exempt from licensing who employ mortgage loan originators, and creditors licensed as supervised lenders and lenders who are exempt entities employing mortgage loan originators.

For debt management service providers, the bill specifies a new $100,000 bond amount. Upon renewal, the bond would have to be in an amount equal to the "average monthly balance of funds held in trust for Indiana residents during the licensee's most recently concluded fiscal year.” The bill specifies a new $300,000 bond amount for money transmitters. Existing law requires the bond to be for $300,000 or the amount resulting from the formula, whichever is less. The bill would eliminate the option of alternative forms of security such as letters of credit that may be used in lieu of a surety bond for money transmitters. The bill would require a surety bond only instead.

In SFAA’s letter to the bill sponsor, we point out that the amount of the bond required affects the extent of availability for the bond. As the bond amount increases, the surety tightens its underwriting parameters. Part of the surety’s underwriting involves a financial assessment of the principal. The surety will require a certain threshold of financial strength relative to the bond amount – the higher the bond amount, the higher the threshold. If the law requires an unduly high bond size, some licensees may not be able to obtain the required bonds.

For most of these existing license bonds, HB 1081 would require the bond to remain in place for two years after the licensee stops providing financial services to Indiana residents. For money transmitters, the bill would add a five year tail. For small lenders, the existing two-year tail would be revised under this bill to make the bond payable to the State in addition to consumers as provided in existing law.

Presumably, these provisions are intended to provide the claimant adequate time to discover a loss and make a claim. SFAA believes that these provisions are problematic for two reasons. First, the provisions do not contemplate that one surety could be replaced by another surety during the period the licensee is licensed. The time for which losses can be discovered under the first surety’s bond should begin to run when the first surety cancels its bond. The time between cancellation of the first bond and the time when the licensee ceases to do business could be rather long, and a surety would be unwilling to maintain an open exposure for such a long time. As the duration of the bonded obligation becomes longer, and the surety must predict the strength of the bond principal and its operation for periods of time well into the future, the certainty of the judgment is lessened and the surety’s risk increases. To compensate for the increased risk, sureties typically tighten their underwriting standards. As a result, fewer bond principals will qualify for the bond.

Second, the requirements that the bond be "in effect” for a period of time after the licensee ceases to offer the relevant services raises a question of whether a surety would be responsible for the licensee’s activity even after the license period expires. Certainly, a surety would not want to undertake this liability.

Under HB 1081, the surety issuing each of these bonds would need an "A-” rating from a nationally recognized investment rating service. Because of the system of state regulation that is in place for the insurance industry, the primary criteria for the surety company issuing a bond should be that it is licensed and in good standing with the Indiana Department of Insurance, which is the state agency that is charged with regulatory oversight of the surety industry. Relying on the state insurance department also would be the most effective way to assure the financial condition of the surety.

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