You may have heard about surety bonds but aren’t really sure what they are… Many people get confused between bonds and insurance but although 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 bonds and insurance policies.
Bond vs. Insurance Policy – What’s A Bond?
Let’s start with the basics, for those of you who are 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. They are commonly used in many 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 confirm 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 know to understand the difference between surety and insurance.
One of the main differences between surety bonds and insurance is the number of parties involved.
In business, insurance contracts are between one party and the insurance company.
Bonds are different, they involve 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 leads on to the next point:
Insurance and surety bonds are designed to protect different parties:
A business takes out insurance to protect their business from loss. The insurance provides protection against the covered forms of financial loss. Put simply, a business chooses to purchase insurance purely to protect themselves, although at times insurance may e a requirement as well.
Surety bonds protect one of the three parties involved in the contract—the obligee, which is the party that required the business to purchase the bond. The surety company agrees to compensate the obligee should the principal fail to meet the agreed upon contract or license terms. This means that 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.
Who covers the financial losses?
Even though insurance companies often underwrite both surety bonds and insurance policies, the two products do not work in the same way.
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.
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 bond and insurance when it comes to the factors the underwriter will take into consideration when determining bond cost.
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.
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, this makes 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 a 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 and 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:
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 Bond
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 that people confuse surety bonds with 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
Since many businesses need both surety bonds and insurance policies, they want to keep the cost of both as low as possible. There are several ways to manage and even reduce surety bond costs. First, pick 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.