of the surety," thus providing the surety with certainty that any given loss would be shared by the reinsurer to the extent of its percentage commitment.

We now find the current SBA staff is interpreting the existing legislation in such a manner as to place SBA in the position of an indemnitor rather than a reinsurer with regard to the surety bond guarantee program. The SBA, through this interpretation, is now free to set up a series of defenses appropriate to indemnity that would allow SBA extensive latitude to question the underwriting and general conduct of the surety on hindsight and deny liability on its percentage commitment to the financial detriment of the surety companies.

In my opinion, under this current SBA interpretation of the existing guarantee legislation, the surety companies, particularly the small specialty surety companies, cannot continue to support the program due to the possible large exposure created should the SBA deny liability on a single bond or a series of bonds.

In many cases, a large bond denial would not only seriously impact the financial structure of a small specialty surety company, but could conceivably cause the company to go into liquidation.

In addition, State insurance departments which have amended. their insurance regulations allowing the companies to address the SBA guarantee as reinsurance in the event of a denial of liability, in my opinion, would be forced to amend their regulations disallowing the SBA guarantee provisions as reinsurance in an insurance company's financial reports.

This exposure is now causing the existing specialty surety companies to reexamine their participation in the SBA guarantee bond program, and in my opinion will create a withdrawal from the program of many of the companies now actively writing bonds in the program.

Correcting of this situation by strengthening the term "guarantee" in section 410 of the Small Business Investment Act of 1958, we believe will put an end to the practice of denying liability to a surety in situations where the denial is unwarranted.

We also believe that the strengthening of the SBA guarantee to the surety will encourage other small specialty companies, many of whom are apprehensive of participating in the program due to the possibility of a large denial of liability on a bond, to reconsider supporting the program.

The Congress originally established this program in the best interest of the small contractors in this Nation, who could not otherwise obtain bonds except for this program. The benefits of this program have been many, in addition to aiding the small contractor, increased employment, increased stability among self-employed in the construction industry and increased competition in that industry, plus absolute dollar savings to the Government certainly justify the continuation of the surety bond guarantee program.

Legislation strengthening the SBA guarantee in the program will allow the surety companies to grow with the program and will assure continuing stability and success of the program in years to come.

Mr. Chairman, I would like to thank you and the other members of the committee for inviting me to testify here today. If you have any questions, I would be pleased to answer them and I would also be pleased to provide you with any further information or data that would assist you in the resolution of this problem.

Thank you.

Senator BARTLETT. We will now hear from Mr. William D. Walsh, Jr., vice president, Morrison Assurance Co., Inc., P.O. Box 2608, Mobile, Ala.

Please proceed, Mr. Walsh.

STATEMENT OF WILLIAM D. WALSH, JR., VICE PRESIDENT, MORRISON ASSURANCE CO., INC., MOBILE, ALA.

Mr. WALSH. Thank you.

Mr. Chairman, my name is William Walsh. I am assistant vice president for underwriting at Morrison Assurance Co. We are a small property and casualty insurance company incorporated in the State of Florida. Our administrative offices are in Mobile, Ala.

I am here today to speak to you concerning Senate bill 836 and the proposed amendment to this bill. I would like to point out that the views in my statement are entirely those of the management of Morrison Assurance Co. We are not represented by any organized lobby in Washington or elsewhere.

Our company has participated in the Small Business Administration's surety bond guarantee program for just over 14 months. Compared to some of the other sureties participating in the program, we are a relative newcomer. However, our managing general agent has been personally involved with the SBG program since its inception, and our management personnel are well grounded in the surety field. Our company is committed to the development and growth of the SBG program.

I believe that it is important for you to understand our marketing concept in order to fully understand our position. In the language of the insurance industry we are a specialty company. Specialty companies tend to be smaller than standard companies, and do not write the full line of insurance and bond coverages written by the standard carriers. In the various States in which we operate, we have selected certain agents and appointed them as attorneys-in-fact. These agents, in turn, act as a wholesale source for SBA bonds. Business is brought to them by producing agents who may be considered as independent contractors. This business is then passed to us through our managing general agent.

Using this wholesale marketing concept, we are able to offer the SBA bond facility to literally every agent in a given State. It is at this point, however, that there exists a difference between the SBA and the insurance industry concerning the interpretation and understanding of certain industry practices.

The bill that is before you would extend the definition of surety to include attorneys-in-fact-those agents holding corporate power of attorney; the wholesalers. It is reasonable to assume that a corporation would not give its power of attorney lightly, and would, therefore, expect to be held accountable for the actions of those so designated. It should be noted that this same section would, in effect, exclude the surety's responsibility for the possible fraudulent actions of a producing agent or independent contractor. We feel that this too is reasonable as no surety company, and certainly not a specialty company, could be responsible for or even exercise control over the thousands of agents to whom this program is made available.

By contrast, the SBA has stated its position as wanting any form of fraud to be a defense for the denial of its liability. The SBA has been quick to point out that the Government cannot be held responsible for the errors or misrepresentations of any of its employees. However, the SBA would deny liability to a surety when fraud was perpetrated on that surety by a producing agent who, in the eyes of SBA is an employee of the surety. We cannot endorse this double standard.

In any case, producing agents are not employees of the surety and if they are responsible for fraudulent misrepresentation, there are other means available for prosecution rather than a denial which might seriously impair the financial stability of a specialty surety.

Mr. Chairman, many hours of debate and huge quantities of time have been expended in arguing the relative merits of the terms "reinsurance", "guarantee", "indemnity". These terms are well understood in the insurance industry and the principal difference is the degree of absolutism or commitment associated with each term.

In our opinion indemnity is the weakest term. By its very nature there is a series of activities which must take place before indemnity is actually accomplished, and time is certainly not of the essence in the proceedings. Guarantee is a stronger term but there is still some doubt as to its reliability in terms of SBA's interpretations. Reinsurance is the strongest term, and there is no doubt in the insurance industry as to its meaning or procedural requirements.

We at Morrison Assurance Co. advocate the use of reinsurance for two reasons: It is a term that is clearly understood; and it will force the SBA to make a commitment that it has previously been unwilling to make, that is, to follow the fortunes of the primary company regardless of the outcome of any so-called Monday morning quarterbacking sessions.

We do not choose to fight over semantics. However, the absolute commitment to reimburse a surety in the instant claim must be the announced position of the SBA, regardless of which term is actually used.

For whatever reasons, the large standard sureties have not chosen to actively participate in the SBG program, but rather the program has been supported by the smaller specialty carriers. These sureties do not share the same deep financial strength, and must rely on reinsurance the unequivocable following of the fortunes of the primary company. Should such a primary company be denied liability on a given claim by a reinsurer, in this case the SBA, grave doubt will occur as to the reliability of the reinsurer on other future claims. In the face of this doubt, and considering the more shallow financial strength of the specialty companies, a withdrawal from the SBG program by the specialty sureties would be a very real possibility.

The SBA should not look to deny liability to a surety fradulently induced by a producing agent or an independent contractor. Instead, it should accept the surety as having acted in good faith, and ask other appropriate branches of Government to pursue that agent. Remember that the contractor in question chose his insurance agentnot the surety company-and that contractor probably participated in any fraud.

This posture does not, as has been claimed, deny the SBA all actions against a surety. The SBA has every opportunity to weed out unde

sirable sureties and to promulgate such requirements as it deems necessary to control the ongoing activities of participating sureties.

The bill is quite specific as to the two circumstances under which liability may be denied: Fraud on the part of the surety and statutory excess. In order to maintain a comfortable relationship with the sureties, the SBA must come forward and commit to a clear, concise set of rules, understood by all, and interpreted by their staff to mean unquestioned reimbursement except for the two circumstances stated above.

Congress intended that the surety bond program reach every qualified contractor wishing to obtain such bonds. The SBA could not possibly staff up to accomplish this goal. The specialty surety companies supporting this program have provided the marketing, underwriting, and claims personnel necessary to do the job. But the quality of the reinsurance necessary to spread the risk and protect from possible financial disaster is in question.

I urge you to pass this bill, not in light of SBA's alternatives as may regard any one specific case, but in view of the almost certain demise of the entire program given a denial of liability based on the rule of interpretation rather than the rule of follow the fortunes.

Mr. Chairman, it has been my pleasure to speak to you and the other members of the committee. If you have questions, I will be happy to respond.

Senator BARTLETT. Thank you very much.

We will now go back to Mr. Turner for comments and then hear from the rest of you on the statement made by the SBA, and to also ask questions.

Please proceed, Mr. Turner.

Mr. TURNER. Thank you, Senator.

My comments with respect to the formal statement as made by SBA, would begin at the bottom of page 3 of the statement. Where SBA endorses the change that expands the guarantee to include losses, and so forth.

However, going to the top of page 4, SBA wishes to limit the level at which it can reimburse a surety without its prior consent to $10,000. My comment with respect to that would be, No. 1, I think the technical correction is necessary to make clear that SBA has the authority to pay where the surety has expended funds prior to a technical breach.

That is an important technical correction.

Second, I think the limitations that SBA is talking about here should not be legislated. It does not make sense to me in the context of how these matters occur, that dollar levels should be legislated at $10,000 or any figure.

It seems to me that is a figure simply pulled out of the air, it does not make any economic sense, and it might not have any economic sense 10 years from now.

If SBA wants to somehow control the disbursement of those funds, it seems to me it should do so by regulation.

Payments or actions by the surety prior to a technical breach occurs rarely, although they do occur, and I am not prepared to testify that the dollar level proposed is a significant one or relevant one, maybe Mr. Trapp or Mr. Walsh can better speak to that.

My point is let us not legislate that. If SBA finds that is a problem, it seems to me they could control that by regulation.

I will say this, the way this business operates, it is not always possible for a surety to make a decision and then obtain prior approval from SBA because decisions have to be made too fast, and sometimes that simply cannot be done.

Sometimes it can be done, but there are many times when it cannot be done. Therefore, I would oppose a proposed regulation to that effect.

With respect to the endorsement by SBA of the proposal to limit the situations in which it can deny liability, I think that it is tremendous that SBA now recognizes that is a problem, and endorses that legislation.

However, my comment with respect to its contingencies are that those contingencies again should not be legislated. Do not think SBA expects the contingencies that it has in the statement to be legislated. SBA is stating to this committee that perhaps it is going to put some contractural provisions into its guarantee agreement to cover some of these points. It is fine for the surety to represent in its guarantee agreement with SBA that the surety has reasonable expectations to believe that no fraud or misrepresentation has been made, I think that is consistent with the good faith that exists between the surety and the SBA and other surety reinsurers.

I think it is also reasonable for the surety to state that there is a reasonable expectation the contractor will perform the covenants and conditions of the contract because if that were not the case, the surety would not be willing to bond that contractor. The surety should not be required to state that the contract meets requirements for feasibility of successful completion or reasonableness of cost as that is not possible. I am pleased Mr. Gibb said so as it is not possible for SBA to do that or the surety. That language is in the existing legislation, it has never been able to be met, and I was very pleased to see that it would be eliminated by this legislative proposal. If this legislation were passed, to put it right back in the guarantee agreement would not solve what we are trying to solve here. So again, while SBA suggests its endorsement of that legislative proposal is contingent upon this provision, that is an impractical provision, and I know it recognizes that.

With respect to the change in the definition of surety that is proposed in section 101 of the bill, the SBA opposes that definition, and I understand SBA to say that what it suggests is that the definition of surety not be changed at all.

That means in effect that there is in the legislation no definition of surety, other than to say that the surety is the company, or the person that issues the bid, payment or performance bond. That is what the existing legislation says, and it does not say anything more

than that.

Now, there has been a problem in the operation of the program as to the extension of the surety's liability for the conduct of certain people involved in the processes of issuing bonds. SBA would argue, and I believe I understood Mr. Gennetti to say that he wishes to have this liability to extend beyond normal principal Agency relationships to include, for example, an independent broker who brings a piece of business to the surety's agent.