Surety bonds are an important risk mitigation tool. But it’s important to know that surety bonds and insurance are two different types of tools. Because the terms “surety bond” and “surety insurance” are often interchanged it causes confusion between consumers. It’s important to note that surety bonds are not insurance.
It’s an important distinction that is easily confused. Surety bonds are actually a form of credit. They’re mistaken for insurance because they often involve payment when things don’t go as planned. But with surety bonds, risk is always with the principal, not an insurance company.
With most insurance policies, risk is typically spread among a pool of similar clients. Policy holders contribute premiums, which help cover losses. Surety bonds are three-way agreements where loss is not expected and premiums generally pay for pre-qualification services and the cost of underwriting. It’s similar to paying interest on a bank loan, where the interest is a fee for borrowing money and not a means of covering losses on loan defaults.
For example, most municipalities and governmental agencies require construction bonds on public works projects. A contractor must obtain a payment bond that guarantees subcontractors and other workers will be paid in the unlikely event the contractor defaults. The surety bond insulates the municipality against financial harm. But it is not insurance. If a subcontract issues a claim against that payment bond, the surety company ensures the maligned party is compensated by the contractor who purchased the bond.
The surety bond provides protection for the obligee, or the project owner. But they’re not on the hook financially for any premium costs or potential losses. In most cases, the principal, or entity whose obligations are guaranteed by a bond, will sign an indemnity agreement that stipulates he or she will repay the surety bond company if it pays out a claim.
If the principal can’t actually cover the payment, compensation falls to the surety company that issued the original bond. That’s a relatively rare occurrence as surety companies rely on strict underwriting guidelines to weed out unreliable businesses.
But surety bonds and insurance are two different risk-management tools. If you are looking for a surety bond, we can give you a no obligation quote on our site or contact a surety specialist if you have any questions.