WHAT EXACTLY IS A SURETY BOND?
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Surety Bonds
A surety is simply the guarantee of the debts of one party by another. There are 3 parties to the contract:
Guarantor: The party that guarantees the debt (aka the surety). This is a line of credit guaranteeing the payment of any claim.
Principal: The party required to provide the bond.
Obligee: The party requiring the bond.
Types of Surety Bonds
01 – Contract Surety Bonds
provide financial security and construction assurance on building and construction projects by assuring the project owner (obligee) that the contractor (principal) will perform the work and pay certain subcontractors, laborers, and material suppliers.
02 – Commercial Surety Bonds
guarantee performance by the principal of the obligation or undertaking described in the bond.
What is the difference between a Surety Bond and Insurance?
Surety Bonds
Surety bonds are agreements between three parties:
- The bond obligee (the party that requests the bond)
- The bond principal (the party that must obtain the bond; e.g. contractors, auto dealers, freight brokers, etc.)
- The surety company (the party that issues the bond and backs it financially)
The bond agreement is issued by the surety as a form of guarantee that the principal will comply with the conditions stated in the agreement. In other words, the surety vouches for the principal in exchange for a particular cost or premium. If the principal violates these conditions and harms the obligee, the latter may file a claim against the bond to request compensation.
Insurance
Insurance policies are agreements between two parties:
- The insurer who issues the policy
- The insured (or policyholder) who is protected by the policy
By obtaining a policy, the insured wants to protect themselves, and not a third party, from various risks and losses.
Who assumes the risk with Surety Bonds and Insurance?
Surety Bonds
With surety bonds, the risk remains with the principal, and the protection is for the obligee(s). In other words, surety companies do not assume liability for the violation of bond agreements on behalf of bond principals.
If a bond agreement is violated and a claim is filed against the bond, the surety may initially extend compensation to claimants. Ultimately though, the bond principal must repay the surety in full for any compensation it has extended.
This is why surety bonds are frequently compared to a line of credit which must be repaid if it is made use of. If no claims are made against a bond, then the only cost a principal has is the premium that they pay to get bonded.
Insurance
With insurance policies, the risk is transferred from the individual or company to the insurance company in exchange for an insurance premium.
If an insured complies with the conditions of their insurance and makes regular premium payments, then the insurance company will assume the costs of a claim when it occurs. Insurance companies operate on the assumption that a certain number of claims will be paid out.
What’s the cost of a Surety Bond versus Insurance?
Surety Bonds
The cost of a surety bond and the cost of an insurance policy are formed in different ways, due to their different purposes.
Your bond cost, also known as a bond premium, is equal to a percentage of the full amount of the bond you are required to obtain. This percentage is determined by the surety on the basis of your personal credit score as well as other factors such as your financial statements and assets.
For a bond company, the higher your credit score is, and the better your overall financials, the more reliable you are as an applicant. Bond rates vary somewhat between the different bond types but in general applicants with high credit scores are offered rates in the range of 1%-5% of their bond amount. Applicants with lower scores are offered rates upward of 5% up to 15%.
Insurance
The cost of your insurance policy is instead determined by the risk that the insurance company will assume in providing you with the policy. Depending on the size of the risk as well as its likelihood, the insurer will request a particular premium from you.