The ABCs of Surety Bonds

This publish is a part of a collection sponsored by Outdated Republic Surety.

What’s the distinction between surety bonds and insurance coverage?

That’s a query I hear usually, and it’s a superb start line for dialogue. Realizing these variations helps contractors perceive why they want each merchandise. We will define the bounds of conventional insurance coverage protection. It additionally makes clear why Outdated Republic Surety is an effective firm to contemplate while you want a surety bond for building.

In some methods, insurance coverage and surety bonds are related. Each are a sort of protection normally written by an insurance coverage firm. In each circumstances, the service assumes dangers and expenses a premium for that danger. They each shield in opposition to monetary loss.

Two events vs. three

There are some main variations, nonetheless:

• Insurance coverage is a two-party settlement between the insured (the policyholder) and the insurer (the insurance coverage firm). The insurance coverage coverage pays the insured for a coated loss.
• A surety bond is a three-party settlement between the principal (the contractor), the surety (the underwriter of the bond), and the obligee (the undertaking proprietor or municipality). The surety ensures that the principal will full its obligation to the obligee — i.e., end the job and pay subcontractors and suppliers.

Surety losses are borne by the principal

With an insurance coverage coverage, the insurer is obligated to make the insured complete if there’s a declare. With a surety bond, the principal assumes this obligation. If the principal defaults, the surety will make good on the duty to the obligee — and can search compensation from the principal.

An insurer expects losses on the insurance policies it points. When a surety points a bond, it doesn’t count on any losses. The surety prequalifies the principal to a degree the place it expects the principal to carry out its contractual obligations. The financial danger stays with the bonded principal.

An insurance coverage firm shouldn’t be reimbursed for losses from insurance coverage insurance policies. Sureties, however, have signed indemnity agreements with their principals guaranteeing that if there are any losses paid on the principal’s behalf, the principal will repay the surety.

Just like a banking association

One other means of viewing a surety bond is to contemplate it as an extension of credit score much like a financial institution mortgage. The financial institution doesn’t count on to undergo any losses because of its lending settlement with the borrower. If there’s a default on the mortgage, the financial institution has a proper to pursue compensation from the defaulting borrower.

Equally, the surety supplies the principal the advantage of its credit score standing. If a principal defaults, the surety has the precise to restitution.

Indemnity agreements

Many contractors are unfamiliar with the idea of indemnity, which is an integral a part of the bonding course of. An indemnity settlement protects the surety within the occasion the principal defaults on a undertaking. It’s a separate settlement between the principal and the surety that ensures that the surety will obtain all due funds from the bonded principal. The Indemnitor (principal) assumes full legal responsibility, giving the indemnitee (surety) authorized safety in case it has to pay out a claim on the bond.

The principal’s majority house owners are the events to an indemnity settlement. An proprietor and a partner may must indemnify, particularly if the bond’s underwriting relies on the proprietor’s creditworthiness. In most situations, each company and private indemnities are required. An indemnity may be required for facet or affiliated firms.

Higher accounting means higher bond pricing

One other distinction between surety bonds and insurance coverage is the extent of economic info wanted from the principal to underwrite a bond.

Smaller contractors typically face challenges in offering the accounting info a surety might ask to see. They might want to rent a CPA with construction experience. The CPA will assist them put together their financials, together with a percentage-of-completion assertion with a schedule of accomplished and uncompleted initiatives.

Accounting is essential as a result of it impacts a contractor’s stability sheet. That, in flip, determines the dimensions of the bond it might probably qualify for and the pricing it’s going to obtain. With out detailed financials, contractors are restricted within the initiatives they’ll pursue. Some contractors will merely fall again on credit-based bonds which might be tied to their private credit score.

Outdated Republic Surety helps contractors develop by enhancing their monetary shows. We sit down with them and clarify how accounting impacts their stability sheet. I do know of a number of purchasers we’ve taken from a credit-based program (FastBonds) to a standard program.

Not like many strains of insurance coverage, the surety is a relationship-driven enterprise. We actually get to know our purchasers. We visit with the owners and managing companions. We go to the job websites. It’s a relationship constructed on mutual loyalty to at least one one other. Ensuring our purchasers perceive the ABCs of surety bonds for building is only the start. For extra details about contract bonds, or to seek out an company close to you that’s appointed with Outdated Republic Surety, contact your local branch.

This weblog was initially printed on the Old Republic Surety website. It’s reproduced right here with permission.