You may have heard about surety bonds but aren’t exactly sure what they are… Many people get confused between insurance vs. bond. While they appear similar, they can have very different implications for both businesses and consumers. The team at Viking Bond Service is here to clear up the confusion by explaining the difference between surety bond vs insurance policy.
Bond vs. Insurance Policy – What’s A Bond?
Let’s start with the basics. For anyone new to the world of surety bonds, we’ll outline what is a surety bond and what businesses may need to secure one. A surety bond is a contractual agreement where the bond underwriter agrees to pay any claims made against the bond. Although this sounds like insurance, there’s one key difference: the bond purchaser cannot make claims against the bond. Surety bonds can be required by the state or a business’ client. There are endless types of bonds, but they are most commonly used in industries including construction, liquor, oil, and mortgage markets, where they are frequently needed as part of the licensing application process. Each state has its own rules about which businesses are required to maintain active surety bonds and the amount those bonds must cover. Check with an experienced bonding agent or your state’s regulations to discuss your bonding needs.
How Does a Surety Bond Work?
When someone files a claim against the bond, the surety agency that issues and backs the bond launches an investigation, much like when an insurance company receives a claim. Provided that the claim proves true, the surety agency compensates the claimant, which is still similar to how insurance policies work. The final step is where things differ. When the insurance company settles a claim, that’s the end of the process. When a surety agency settles a claim, however, the bondholder must pay that amount back to the surety. The insurance company accepts financial liability, but the surety agency only acts as an intermediary to ensure that injured parties receive guaranteed compensation. The surety never accepts liability, and anytime they settle a claim, the bondholder (who accepts liability legally under the bond agreement) must pay the surety back.
We’ll also compare key aspects of both bonds and insurance below, where we’ll cover surety bond vs. insurance policy and everything you need to know to understand the difference between surety and insurance.
The Key Differences Between Insurance and Surety Bonds
So, how does insurance differ from a surety bond? Here are five key differences in their organization and approach.
Qualified Assistance: A key difference when approaching a surety bond vs insurance policy is who to work with. A surety professional is by far better equipped to deal with the surety bond process. They’ll help you determine which one of many types of surety bonds better fits your unique needs, will help you fill out the application forms, and guide you through the process of obtaining the required bond. There are just too many differences between insurance vs surety bond, that an insurance agent simply won’t be qualified enough to support you effectively.
Participants: An obvious difference between surety bond vs insurance policy is that a bond is an agreement signed between three parties: the obligee (the entity or individual who requires the bond), the principal (the business or individual purchasing the bond), and the surety (the entity backing the bond). This is a particularly important difference between surety and insurance. And the protected parties are different in insurance vs bond, too.
Put simply, a business chooses to purchase insurance purely to protect themselves, although, at times, insurance may be a requirement as well. With regard to surety bonds however, the obligee, which can be the state, another business, or an individual, is protected against loss caused by a breached contract or license requirement – not the bondholder.
Recovering losses and claims: You wouldn’t expect an insurance company to be repaid by its client. That would defy the whole point of their relationship, which is to minimize risks for the insured. For a surety, on the other hand, the bond acts as a bank loan where they expect the contractor to reimburse them if there is a claim against their bond.
Coverage: This refers to the party being protected by surety bonds vs. insurance policies. With bonds, out of the three parties involved, the surety protects the obligee only, not the principal, while the insurance policy protects the insured.
Risk management: Risk or liability management is approached differently in insurance vs surety bonds. An insurance company anticipates losses, so they adjust their premium rates to cover the losses and expenses to help offset them. Meanwhile, a surety bond only covers risks that are qualified and considered safe.
Let’s take a closer look at how insurance differs from a surety bond.
Who Covers the Financial Losses?
Even though insurance companies often underwrite both surety bond vs insurance policy, the two products do not work in the same way.
Insurance: When an insurance company pays out on a claim against an insurance policy, they absorb the financial loss. The business will only be required to pay a small amount, if any, of the cost of the claim.
Surety bonds: However, when a surety pays out on a claim made against a surety bond, something very different happens. The surety will pay the cost of the claim, but they then expect to be fully reimbursed by the bond principal, which is the business or individual who purchased the surety bond. Surety bonds work more like a form of credit than insurance, with the surety only covering the claim cost for a short period of time until the business repays them in full.
What Do They Cost?
Surety bonds and insurance have one major thing in common: the underwriter examines the risk of issuing the policy in order to calculate applicant eligibility and the premium cost. There are some differences between surety bonds and insurance regarding the factors the underwriter will consider when determining bond cost.
Insurance: Insurance premiums are calculated against the value of the asset being insured or size of the policy. Insurance also takes the risks involved into account, such as what type of activity the insured partakes in or type of business they conduct.
Surety bonds: Bond premiums are calculated by the size and type of bond and by the financial strength of the principal. There are a number of things that can drive up the cost of a bond. For example, certain types of bonds carry a higher risk factor, meaning they are more likely to be claimed against, making them more expensive.
An applicant’s credit history also has a big impact on bond price. People with strong credit scores and business financials are considered lower risk and, in turn, pay lower premiums. While individuals with poor credit may pay a higher premium. To find the best-priced bond, it’s important to work with an experienced bonding company such as Viking Bond Service.
How Do You Obtain Them?
The application process looks similar for surety bonds vs insurance policies, at least in the outline. Applicants for either will need to submit basic information about themselves, their background and the business they want to bond/insure. If there is more than one owner, each one may need to submit application materials. There are also some important differences:
Insurance: For most types of insurance, the application and underwriting process is less rigorous than for surety bonds. Applicants will need, in most cases, to provide less documentation, and a credit check may not be necessary.
Surety bonds: A surety agency will always run a credit check on any bond seeker. For certain types of bonds, they may also require extensive financial documentation. A good surety agency will work to streamline the process and minimize the burden on applicants. Nonetheless, expect obtaining a surety bond to be more involved than obtaining an insurance policy.
Covering Your Business
One reason people confuse surety bonds vs insurance policies is that they often need both – and for similar reasons. Take construction companies, for example. Construction contracts frequently include surety bond requirements, which protect the project owner (the obligee) should the contractor fail to meet expectations. Contracts also mandate certain levels of insurance coverage a contractor must have as protection against things going wrong. Winning the contract means getting the right surety bonds and having adequate levels of insurance coverage, but otherwise, the surety bonds and the insurance policy do not overlap in any way.
For professionals and business owners focused more on attracting customers and completing work, the obligation to get surety bonds on top of insurance coverage can feel like an unwelcome burden, not to mention an unwanted cost.
Surety bonds may be an obligation, but they don’t have to be an obstacle. The key is to find the right surety bond partner: one that can issue all the bonds you need and make the process simple and straightforward every time. Rely on the surety agency to take the hassle out of bonding so that it’s not a distraction and it never puts business opportunities at risk.
Keeping Costs Low
Many businesses require both surety bonds and insurance policies, so they want to keep the cost of both as low as possible. A principal has some control over the costs of the bonds, as there are several ways to manage and even reduce surety bond costs. Your first step would be to find the right surety agency to work with. Surety bond prices can vary by huge margins. Some companies charge drastically more than others without providing any extra value in return. That’s why it’s important to work with a trusted agency with an established reputation and the resources to keep costs low for all applicants.
The second way to manage surety bond costs is with creditworthiness. In general, the lower the credit score the higher the bond cost. Bonds will cost more to obtain and cost more to renew (when necessary) for people with a credit score below 700 or with something like bankruptcy on their financial record. Improving credit scores between bond renewals can lead to lower premiums each time.
The final and most important way to manage surety bond costs is by avoiding claims whenever possible. Since the bondholder is financially liable for all claims, and those claims can be substantial in some cases, any claim that leads to a settlement represents a significant financial loss. The losses grow even larger when interest and fees are added to the settlement amount. Therefore, it’s vital to understand what actions or behaviors could lead to claims against the bond, then avoid those at all costs.
Bond Vs. Insurance Policy – Securing The Right Surety Bond
Viking Bond Service has many years of experience helping businesses and individuals obtain an affordable surety bond.
We serve customers in all 50 states, we issue most types of surety bonds, and we deliver quotes in as little as 24 hours. Our team goes adobe and beyond to make bonding easy for all. Contact us today for all of your surety bond needs.