Surety vs. Insurance
Surety bonds are used in numerous industries, in order to make these business fields safer to do business. Bonds exist to safeguard the interests of the general public, and the authorities that regulate different trades. Since the terms “surety bonds” and “surety bond insurance” are both used to describe bonding, it’s easy to mistakenly think surety bonds are like insurance. In fact, these two forms of security serve completely different purposes. In the case of insurance, you and other insured entities contribute premiums on a regular basis, so that the insurance company will offer you compensation if you incur any losses that are covered by the insurance. Insurance protects you, and insurance companies mitigate the risks you are facing in return for your regular payments. However, surety bonds work differently. They are required from you or your business, to guarantee your honesty, performance, or abiding by certain rules, laws or regulations. Surety bonds protect parties that may be affected by your business, such as clients, subcontractors, or the state. You also need to pay a premium in order to get bonded, but if you fail to fulfill your obligations under the bond, you might get a claim on your bond. With bonds, the premium covers the underwriting and pre-qualification services costs. Thus, the entire risk stays with you as the principal. If a claim against you is proven, it is your responsibility to repay affected parties. Being bonded is a powerful sign for your customers and relevant authorities that you are safe to do business with. It boosts your business reputation, and sends a powerful message in marketing your company.
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How does bonding work?
What is a surety bond, then? There are usually three parties involved in bonding. There is a principal, which is you or your company, which is asked to post a bond by an obligee, which is usually a state or local authority. The bond is then underwritten by a surety provider who ensures that you will respect the contractual conditions set forth by the obligee.
In order to get bonded, you don’t need to pay the full surety bond amount that’s required from you. You need to cover only a fraction of that, which is called the bond premium.
Once you’ve covered that premium, you are bonded, which is similar to having an additional line of credit with a bank. Your surety backs your business by guaranteeing its lawful operation and successful performance.
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Who needs to obtain a surety bond or insurance?
Both surety bonds and insurance are required from a wide range of businesses, in order to compensate for risks in different aspects of their operation. They are both risk-management tools, but are used for different purposes.
The most common professions that need to get bonded include auto dealers, construction contractors, freight brokers, telemarketers, and mortgage brokers, among others. Usually the surety bond is required as an essential element of their licensing process.
As for insurance, its application is even more widespread, even when not required by law, to mitigate certain risks for individuals and companies. Most of the trades that require being bonded also include getting proper insurance, in order to operate in compliance.
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What do they mean
While both surety bonds and insurance guarantee financial compensation in the case of unforeseen events, being bonded means something completely different for your business than being insured. In many cases, businesses are actually required to obtain both a surety bond and a relevant type of insurance.
For example, if you are a contractor who is duly bonded, in case you cannot complete a project that you’ve signed, the project owner can claim a compensation up to the penal sum of your bond for non-completion. The surety initially covers the claim costs, which you’ll need to fully repay.
Surety bonds and insurance serve different functions, and are often used together to guarantee the safety and performance of businesses. As a contractor, you usually need to obtain workers’ compensation and liability insurance. Thus, if you cause damage to the property you’re working on, or there are unforeseen medical costs for your employees, your insurance will cover the costs.
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How much does a surety bond cost vs insurance?
Because surety bonds and insurance serve very different purposes for a business, their prices are formulated in different ways.
In the case of bonding, your surety bond cost is a percentage of the maximum penal sum that can be paid to affected parties on proven claims. Depending on the type of business you’re in, the standard bonding rates are in the range of 1%-5%. Bad credit applicants usually are offered premiums between 5% and 20% of the surety bond amount.
The specific bond price that you will have to pay to get bonded depends on the bond amount required from you, as well as on your personal credit score, business financials and other financial and professional factors.
The cost of your insurance, on the other hand, represents your regular payment to an insurance company in return for transferring certain risks that it takes responsibility for. Insurance companies determine your premiums based on the risk of providing insurance to you.
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How are claims handled for surety bonds?
Unlike insurance, in the case of claims on surety bonds, it is the bond buyer, or the principal, that needs to cover any proven claims.
When an affected party files a claim, your surety conducts a thorough investigation. The claim can be brought to court if there are disputable aspects to it. In case the claim is proven, the claimant can be reimbursed up to the penal sum of your bond.
At first, your surety covers the claim costs, so it ensures any affected parties are compensated for the mishaps or unlawful actions on your side. According to the agreements stipulated in the bond, however, you are then liable to repay the surety in full.
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What is a surety bond indemnity agreement?
When you obtain a surety bond, it constitutes a contract between three parties. The principal is either you or your business entity, the party that requires you to get bonded is the obligee, and the surety is the underwriter of the bond. By signing this contractual agreement, the surety grants its financial backing in your name, so that you can meet the requirements of the obligee.
The main purpose of the indemnity is to secure fair compensation to the surety in case of a claim against your bond. If the principal undergoes a claim procedure and does end up having to reimburse claimants, the bond underwriter is the one who will cover the costs at first. That’s why in some cases, the surety will also require a collateral that backs up your duties under the agreement.
Generally, if the bonded party defaults on its repayment towards the surety, or does not comply with other provisions in the GIA, the indemnity is the protection that the bond provider can use. It may take legal action by bringing the case to court. In that case the indemnity will be used as the basis for suing the principal. That’s how the surety will be able to recover the funds it has used for the bond claim. Enforcement of the indemnity also includes the fees and expenses connected with the court case.