So, What is a Surety Bond Anyway?
Surety Bonds – An Overview
A surety bond is a financial guarantee that brings three parties together in a mutual, legally binding contract. Corporate surety dates back to the 1800s, but became more common with the creation of the Miller Act of 1935. This federal law required performance and payment bonds for public construction in an effort to protect tax dollars in the case of contractor default.
So, where do you and your contracting business fit into all of this?
By means of a bond, the surety guarantees that the principal (that’s you) will perform an underlying obligation as promised to a third party, the obligee (the project owner).
Surety is similar to insurance in that a bond is an assumption of risk in exchange for a payment and it protects against loss. However, unlike insurance, bonds do not protect the product purchaser. They protect your project owner, the obligee.
Also, full repayment (not a deductible) is paid by the principal in the event of a loss. The surety basically says if any claims occur, you’re good for it.
Surety bonds guarantee many obligations, such as codes, ordinances, licensing requirements, statues, court orders, and contracts. Bonds are a required prequalification credit for principals and provide protection to third parties.
It's all the same, right? Wrong!
Similarities and Differences of Insurance and Surety Bonds
If you’re not familiar with surety bonds, don’t sweat it — we’ve got you covered on the basics and key differences between insurance and surety.
Corporate surety is closely related to insurance, and has a longstanding history of protecting businesses. Some similarities between insurance and surety bonds include:
- Risk evaluation, followed by a company taking over a risk.
- Protection against financial loss in exchange for the receipt of premium.
- A contract defining the risk.
Although there are similarities between these two protections, and they often house under the same insurance company, there are significant differences between surety and insurance.
One major difference to take note of is how losses are handled and who is protected. With insurance, losses are caused by accidental occurrences (e.g. accidental damage to a site, or malfunction). If coverage applies, the insured pays their deductible and the carrier makes them whole again. Traditional insurance seeks to remove or lessen loss exposures.
Bond losses, on the other hand, are caused by the failure of one entity to perform contractual obligations that they committed to, not accidental events. Sureties do not protect the buyer of a bond (the principal). Bonds protect the third party (the obligee).
In the event of a loss, the principal (you, the contractor) is expected to completely reimburse the surety. Consequently, the contractor is not protected against financial loss. The risk of default remains with you, the principal.
Surety losses can be substantial. Hence, accounts are highly scrutinized and underwritten. Underwriting is a constant and ongoing process.
In short, bonds and insurance have differences. However, they both carry the Westfield promise and mitigate risks to benefit others.
Say what? There's more than one type of surety bond?
Surety Is a Tool That Facilitates Commerce
Types of Surety Bonds
There are two main categories of surety bonds: Contract and Commercial. As we’ve mentioned before, surety bonds are essentially a promise made by a surety to pay the obligee a set amount of money if the principal fails to fulfill the job they were contracted for.
Contract Surety Bonds
Contract surety bonds are largely used for the guaranteeing of construction contracts. There are three parties involved with a contract bond: the project owner, a contractor and a surety. The surety guarantees the project owner that the contractor will fulfill their obligations as outlined within the written contract.
Below is a breakdown of the different types of contract bonds:
|Bond Type||What It Guarantees|
|Bid Bond||If a principal bidding on a project is the lowest bidder, it will enter into the contract and post a performance and payment bond.|
|Performance Bond||The contract will be performed according to plans and specifications, within the allotted time frame, at the agreed upon price.|
|Payment Bond||Bills for labor and materials associated with the contract will be paid.|
|Maintenance Bond||Work will be free of defects for the agreed maintenance period.|
Commercial Surety Bonds
Commercial surety bonds involve all situations outside of a contract bond in which a guarantee is needed. Guarantees are all extremely unique. It is essential that both parties involved understand precisely what the bond is guaranteeing, and the responsibilities of you, the principal.
There are also countless types of commercial surety bonds. Those specific to your needs as a contractor include:
|Bond Type||What It Guarantees|
|Supply||A guarantee that the supplier will provide all the contractually obligated supplies and materials.|
|License and Permit||A municipality or other public body may require as a condition to engage in a specified activity, and guarantees that the party seeking the license or permit (the obligor) will comply with applicable laws or regulations.|
What's In It For Me?
The Value of Surety Bonds
How does surety benefit each party, specifically? In other words, what do you, the contractor, get out of it?
Below, we’ve rounded up the top benefits that surety provides each participating party.
|Principal||Grants them access to additional bonded work, and thus revenue/profit, while also eliminating unqualified competition.|
|Surety||Adds an additional product line to the portfolio, which is often profitable.|
|Obligee||Prequalifies bidding parties and ensures payment/completion of contractual obligations.|
|Citizens||Protects tax dollars and ensures proper completion of projects.|
Bonds are extremely important to ensure faithful performance and payment of contracts. Without bonds, there would be losses to taxpayers due to the misuses of public funds. Owners would be left with unfinished projects and no means to complete them. The bond underwriting process ensures only qualified and responsible bidders perform public work.
What tools are in your toolbox? Use our Find an Agent tool to establish your business with a leading surety company supporting a local insurance agency both dedicated to you and the local business.
Don’t Get Lost in (Insurance) Translation
Glossary of Surety Bond Terms
Bid Bond: A type of contract surety bond that ensures a bidder for a supply or construction contract will enter into the contract within the stipulated timeframe if the company wins the bid.
Capacity: The largest size of a bond allowed by a surety.
Commercial Surety Bonds: A type of surety bond that can be required by state and local regulators in a wide variety of situations to protect consumers and taxpayers. Some of the most significant for government policymakers include: license and permit bonds, reclamation bonds, mortgage broker bonds and subdivision bonds. Learn more about the different types of surety bonds.
Contract Surety Bonds: Surety bonds that involve construction projects. In the event a contractor defaults, contract surety bonds ensure funds are available to complete the contract and pay subcontractors, suppliers and laborers. Learn more about the different types of surety bonds.
Indemnification: An agreement not to take legal action against an individual for a loss.
License and Permit Bonds: Statutes and regulations require these bonds if a company seeks to obtain a license or permit in a state or local jurisdiction. If a principal (you) violates its obligations, this bond pays the obligee (the project owner) or other third party.
Maintenance Bonds: Bonds that offer protection in the event of faulty or defective materials, even after a project’s completion for a specified time period (similar to a warranty).
Miller Act: A law passed in 1935 that requires performance and payment bonds for federal construction projects over a designated amount, currently for contracts over $150,000. Learn more about surety bond basics.
Obligee: The project owner or individual that requires the bond. This person / company is protected if there is a loss or default on the contract.
Payment Bond: A bond given by a contractor to guarantee payment to subcontractors, laborers and suppliers for work performed under the contract.
Performance Bond: A bond that guarantees performance of the terms of a written contract.
Premium: Required by a surety company from the principal for the issuance of a bond. Performance and payment bonds come with a one-time premium that typically equals up to 2 percent of the contract price.
Principal: Also called “obligor.” This is the party who seeks out the bond and whose obligations are guaranteed by the bond — aka. you, the contractor.
Reclamation Bond: These bonds provide a financial guarantee that the public lands mined will be restored. These bonds are typically required by a state regulatory agency, such as the Department of Environmental Quality (DEQ), for a business that seeks to mine or perform related activities on public lands.
Subcontractor Bond: A bond that a general contractor may require of a subcontractor, which guarantees the subcontractor will perform work in agreement with the terms of the contract. This also means the subcontractor will pay for certain labor and materials under the contract.
Subdivision Bond: Developers must get this bond from a surety if they plan to develop a plot in a municipality to sell lots or homes. Local development authorities require these bonds, which guarantee a developer’s obligation that the project will adhere to state and local statutes and regulations, before they issue a development permit.
Supplier: Individual or company contractually bound to deliver the materials and goods according to the contract conditions.
Surety: Third party that issues the bond to the principal and is responsible for fulfilling the claim in the event of a default or loss.
Surety Bonds: A written agreement where a surety obligates itself to a second party, called the obligee, to answer for the default of the principal. In the case of public works contracts, the obligee would be the state agency and the principal would be the contractor.
Surety Bond Company (also called a surety, surety company or bonding company): is the party of the surety bond that takes on the risk and is responsible for paying the surety bond obligee in the case of a default by the surety bond principal. Learn more about surety bond basics.
Trustee: An individual who is responsible for managing the financial responsibilities (e.g. debts, assets, revenue, etc.) of a company or organization.
Use our Find an Agent tool to establish your business with a leading surety company supporting a local insurance agency whose primary focus is you and your local business.