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.
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 a surety bond is 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.
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.
Surety Bond vs. Insurance Policy:
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.
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 and bonds 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. To find the best-priced bond it’s important to work with an experienced bonding company such as Viking Bond Service.
Bond Vs. Insurance Policy – Securing the right surety bond