What is a surety bond?
A surety bond is simply an agreement between three parties: Principal, Surety and Obligee. The surety provides a financial guarantee to the obligee (i.e. government) that the principal (business owner) will fulfill their obligations. Therefore, a surety bond is a risk transfer mechanism.
A principal’s “obligations” could mean complying with state laws and regulations pertaining to a specific business license, or meetings the terms of a construction contract. If the principal fails to meet their agreed upon obligations with the obligee, the surety may be required to resolve the dispute by paying a claim to the obligee. It is in this sense that a surety bond is similar to a form of credit extended to the principal by the surety.
What does a surety bond guarantee?
For license & permit bonds, they guarantee that a principal understands and follows the regulations outlined for their specific license. This is where the term “license & bonded” comes from. Examples of a license violation could include fraud, misrepresentation, or late payment. If a covered violations causes a claim against the bond that the principal is unable to resolve, the surety will be required to pay the claim to the obligee.
In the construction industry, surety bonds typically ensure that a bonded contractor will fulfill their obligations specified in a signed contract. If a bonded contractor defaults on the contract, the surety guarantees that the obligee will be made whole. This can include either a financial payout or taking other actions to make sure the work is completed per the terms of the contract.
What happens if a claim is paid by the surety?
As a bonded principal, you must take every action possible to avoid claims. Claim activity may happen in the process of conducting business, whether valid or invalid, but it is ultimately the responsibility of the principal to make sure the disputes are resolved prior to the surety paying out on a claim. Before becoming bonded, you will be required to sign a indemnity agreement with the surety company where you must agree to pay the surety back if they have to pay a claim due a violation by your company. The surety is only extending you credit, and therefore will expect to be reimbursed if a valid claim is paid. Having a paid surety claim may make it very difficult for you to become bonded again in the future, as it is a standard question on all bond applications, and is usually a cause for declination.
Is a surety bond insurance for my business?
To understand what a surety bond is, it’s helpful to know what it is not. A false misconception is that a surety bond is insurance for your business. This is not true. Instead, bonds are more like insurance for the public , or your customers, that you are required to pay for. Consider surety bonds a cost of doing business with the U.S. government. Most businesses are also required to have some sort of separate business general liability coverage that protects their business from routine perils and losses. It’s important to understand that difference between the two to make sure you have the right type of coverage for your business.
How much does a surety bond cost?
Rates depend on multiple factors, including obligees’ risk preferences, applicants’ credit ratings and the type of bond required. For license and permit bonds, applicants with strong personal credit usually pay annual premium between 1% and 4% of the total bond amount. Applicants with higher personal risk or applying in higher-risk markets typically pay between 5% and 15%.
How do I get a surety bond?
First apply for one. Once your application is approved, your agent will let you know how much your bond premium will be and will give you an agreement with the bonding company. After you pay your premium and provide a signed copy of the agreement, you will receive your original bond along with a power of attorney from the surety. In most circumstances, the principal will be required to sign the original bond prior to filing it with the obligee.
How long does it take to get bonded?
The length of time from application to issuance varies depending on the type of bond, promptness of premium payment and other factors. Most bonds are approved instantly upon completing our online application, and are generally issued one to two days after receipt of payment and a signed copy of the agreement.
Is a bond insurance for me?
Surety bonds and insurance are miles apart. Although both require premium payment, the similarities end there. Insurance premiums are payments that help transfer a certain amount of risk and responsibility to the insurance firm. The insurer then pays a given percentage of any damages or losses incurred by the insured person. The idea behind insurance is to protect the person who buys it from suffering unduly for mishaps that, while regrettable, are usually inevitable in everyday life.
Surety bonds, on the other hand, aim first to shield the obligee–not the bond buyer. While bonds do provide principals extra time to pay off claims if needed, they mostly give principals an incentive not to have mishaps or claims in the first place. Premiums for surety bonds are more like service charges; the principal is still responsible for paying the full amount of the claim as well as the bond premium.
Which bond company should I choose?
Bond companies are not all created equal. Some will only consider bonding strong applicants with stellar personal credit, while others offer high risk bond programs designed to help just about anyone become bonded. Before taking the time to apply, applicants should consider whether or not a bond company will meet their needs and be an acceptable surety for the obligee. Our agency only works with bond companies that have A-Rated AM Best Ratings or better, and are approved with the U.S. Department of Treasury to write federal bonds. This is how we can guarantee that a bond written through one of our sureties will be accepted.
Why should I buy a surety bond?
First and foremost, you will need a surety bond when the customer demands it. When contracting with the government or even a private company or citizen, this entity will require any contractors to buy a surety bond before work can begin. This is because the surety bond assures them that you will honor your contract and provides penalties if you don’t. In short, surety bonds protect customers, and they will only work with people who provide this protection.
Surety bonds also have many attractive features. Principals seldom have to put up collateral, leaving capital available for investment. The interest earned usually outweighs the amount paid for the bond premiums.
How does a surety bond work?
The principal buys a surety bond from the surety and pays a premium, or a percentage of the bond sum. In return, the surety extends the principal surety credit, essentially telling the obligee that this project is guaranteed to work out, whether done with this particular contractor or not, at no extra cost. The principal then follows the terms of the bond to finish the project; if no claims arise the principal pays nothing but the bond premium.
Why become bonded if I’m required to pay for claims?
A false misconception about surety bonds is that they are a form of insurance. Surety bonds are instead a form of credit whereby principals are required to provide payment for claims. The primary benefit of obtaining a surety bond is that they will rarely require the principal to provide collateral, which can act to free up capital. Payments made by principals for bond premiums are usually less than the principal could earn if they were to make conservative investments with the capital made available. This makes surety bonds more attractive than alternatives such as posting cash or obtaining a letter of credit.
Can I renew my surety bond?
Yes. However, payments for the renewed bond are usually invoiced and due months before the original bond expires. Check the terms of your specific bond agreement to see when bonds expire and may be cancelled. Be sure to pay your renewal premium by the specified due date to avoid cancelation.
How do License and Contract Bonds differ?
In essence, contract bonds only ensure that work will be completed. They are almost exclusively used for construction contracts, while a wide variety of license bonds–including those that cover car dealerships, freight brokers and health clubs–simply make sure practitioners uphold federal and local laws that protect the consumer from physical and financial harm. As the name implies, no specific contracts for work are signed or needed with license bonds.
What is the difference between a Principal, Obligee and Surety?
The principal is the person who applies for and buys the bond. In general, these are contractors and other business owners hired to do work, or required to be licensed.
The obligee is the entity–usually a governmental department–that is requiring the guarantee of a surety bond.
The surety is the institution who financially backs the deal, assuring the obligee that work will be done properly, or that the principal will comply with the terms of their license.