Surety bonds are a popular insurance-like risk mitigation tool, but it’s essential to know that insurance and sureties aren’t the same. Customers often confuse these two and combine their meanings as surety bond insurance. Surety bond requirements are different from insurance in many ways.
What is Surety Bond Insurance?
Surety bonds and insurance are critical risk-reduction strategies, but it’s crucial to note that they’re two different things.
Contrary to popular belief, bonds don’t serve as a form of insurance. While they can be purchased to offer protection, they can also be bought to guarantee that specific conditions have been met or to ensure someone follows the terms of an agreement.
Surety bonds work as a legally binding contract where a 3rd party guarantees the performance of an obligation. Otherwise, they pay restitution if a default occurs and the claim is validated. Surety bonds are helpful as a means of preventing fraudulent activity against the government or private sector and ensuring the completion of contract obligations.
A surety company offers Surety bonds, which are often mistaken for insurance due to their payment when things don’t go as planned. Mechanically though, surety bonds act as a form of unsecured credit. The risk is always held by the Principal (applicant or person purchasing). Meaning the purchaser of the bond is not the beneficiary. The client they are performing the obligation for is. In insurance, the purchaser is the direct beneficiary of the coverage.
How many parties are involved in Surety bond?
There are three parties involved in every surety bond are :
- Principal: The person or company who is bonded to the Obligee. The Principal is obligated to the Obligee in completing a service or providing goods.
- Obligee: These are businesses or government agencies purchasing the Principal’s service or good, and the beneficiary of the bond.
- Surety: These are surety companies providing a credit extension to the Principal applicant for them to be able to meet the Obligee’s needs.
Insurance doesn’t require three parties. Only two parties are involved in insurance.
Parties that are involved in an Insurance policy include:
- Insurer: This is the person who provides insurance policies to the insured.
- Insured: The insured covered by the policy can submit a claim to the insurer if something goes wrong.
What does the premium of Surety bond cover?
The surety bond ensures the Obligee, or project owner, against financial loss. They are not financially liable for any premium expenditures or potential losses.
The Principal, or entity on whose behalf a bond secures a guarantee, will almost always sign an indemnity agreement that states he or she will reimburse the surety company providing the surety bond if the Principal fails. The Surety is forced to pay out a claim.
Who is protected with a surety bond?
An insurance company will cover you from various catastrophic or unforeseen circumstances. For example, an insurance company will cover the costs if your house is broken into or damaged by a natural disaster.
A surety will cover the Principal only if they fail to complete their project requirements from circumstances not considered a default. These requirements will vary by industry and their respective bond type.
While bonds can vary in their type of coverage, common types of surety bonds include:
Contract Surety Bonds
These are typically for construction projects:
- Bid bonds
- Payment bonds
- Performance bonds
Commercial Surety Bonds
- License and permit bonds
- Court bonds, Probate Bonds, or Judicial Surety Bonds
- Fidelity bond
What is the procedure for handling claims in surety bonds?
Both of them have very similar processes for handling claims:
The insured files a claim to their insurance company, which then investigates and covers the costs of the claim is valid.
The Obligee submits a claim to the Surety, who investigates and either pays or denies the claim whether the Principal has failed to complete their obligation.
What determines if the claim is paid in Insurance vs. Surety?
In an insurance policy, you can file a claim with your insurer when you have sustained damages from a natural disaster or when someone is injured on your property. In general, they will request that photos of all damaged items and documentation of the costs to replace them be submitted along with a completed claim form.
In a surety bond agreement, the Obligee can file a claim if the Principal fails to deliver items or services required by the contract. They must provide the contract outlining the scope and proof of what failed to be completed before asking for payment from the Surety.
How much do Surety Bonds cost?
The value of the guarantee bond depends on several things. These include the type of bond, duration of protection, risk of acquiring the bond. Based upon this data, surety bond prices may vary significantly but hover around 1-8%, dependent upon the applicant. Generally, every state has its requirements. The Obligee will inform you whether the bonds need to be issued, the bond types, and the required insurance amounts.
Who does a Surety Bond protect?
Like most policies, surety bonds don’t cover the owner of the policy (the bond). Bonds typically have responsibilities to defend third-party entities, Obligees, such as suppliers or construction project owners. When an Obligee incurs financial damages because the applicant violates the contract and surety bond terms, the Obligee is entitled to damage compensation from that breach.
Does an Insurance Company Issue Surety Bonds?
The answer to this question is both yes and no. An insurance company may issue a surety bond, but not all insurance companies offer this service. In cases where they do, the insurance company has a specialized division that provides surety bonds.
There are several different types of surety bonds, so it is essential to work with an experienced agent to help you find the proper bond for your needs. At Simpli Surety, we have over 40 years of experience in the surety industry and can help you find the appropriate bond for your business.
Wrapping Up Surety Bonds and Insurance
It is essential to understand the difference between a surety bond and insurance. A surety bond protects third parties from financial harm if an obligor fails to meet their contractual obligations, whereas insurance compensates for losses incurred by the policyholder. The premium on bonds varies depending upon several factors such as duration of protection, risk of acquiring the bond, etc.. Still, it can be challenging to know how much your particular needs will cost without help from a qualified agent or broker.
