What is a Surety Bond?
Surety Bonds are a specialty insurance product required of numerous businesses and individuals for various reasons. They are three party financial obligations guaranteeing the fulfillment of a contract or promise. The parties to a bond are the:
- principal (the party who has to obtain the bond)
- surety (the insurance companyy who underwrites the bond and takes the risk)
- obligee (the party being protected; the one who requested the bond)
Bonds differ from insurance primarily because the beneficiary is not the insured (Principal), but rather a third party, the Obligee. The buyer of an insurance policy transfers his own financial risk to an insurer, while the buyer of a surety bond provides financial assurance or fullfilment of an obligation to a third party. The obligation can range from performing a contract, as in construction, to following laws related to an operating license. Other obligations include being honest, paying a judgment to a court, paying taxes or lease fees, supplying goods, and more. √ Top
How is surety underwritten?
Surety is similar to credit and surety underwriters look at a bond risk basically the same as a bank would look at a loan. Large loans require detailed financial information, corporate information, management biographies, introductions to key employees and more. Small loans require less information, sometimes just a credit report, sometimes no information, just a personal signature guaranteeing the loan. The surety company however is not looking at the ability of the Principal to repay a loan, but to fulfill an obligation. The obligation may be simply to comply with certain laws, or to pay bills on time, or it may involve the performance of a complex task, as with construction.
Surety companies look at a great deal of information when they consider a large bond risk. They want to understand the company they are dealing with and they want to be seen as partners in the event something goes wrong. Surety companies also want to be able to act quickly if their Principal requires another bond for another project or opportunity. Therefore the surety always needs to be abreast of the current situation with the company they are bonding.
In the event of a claim on the bond, the surety has options as to how it can satisfy the claim. These include completing the obligation themselves, hiring someone to complete the obligation or just writing a check for the amount to complete or in a worst case event, the full amount of the bond. The decision as to the course of action is usually the surety's. √ Top
What is Indemnity?
Indemnity allows the Surety the right to recover any losses it incurs on behalf of a Principal. Because surety is not insurance, the Principal does not "benefit" in the event of a loss. If the Principal does not perform, the Surety steps in. If the Surety losses money, it has the legal right to recover those funds from the Principal -- This is the concept of indemnity.
Surety companies have the right to indemnity based on common law. Most surety companies still require a Principal to sign a General Indemnity Agreement (GIA) so that the Principal fully understands their obligations. The GIA also permits the Surety clearer rights to recovery than does common law.
GIAs vary by insurance company and vary in complexity by the size and type of bond being written. The larger the bond, the more lengthy the GIA becomes, and usually more people have to sign. Indemnity is almost always taken on the majority owners of the business in addition to the business itself. √ Top
Types of Bonds
There are thousands of surety bonds and because the requirements vary depending on the type of bond, we have broken surety bonds into the following categories which are explained in more detail below:
- Contract
- Court/Probate Bonds
- Fidelity
- Commercial
Contract Bonds
Contract bonds are typically performance and payment bonds, guaranteeing the faithful completion of construction contracts. They can be quite large, ranging in size from $100,000 to $1 billion. They serve to protect the owners and lenders of a project. Most Contract bond obligations are written for construction contracts or service and supply contracts. Contract bonds expire when a contract has been fulfilled. The premium is charged only once - at the point of execution and is generally a percentage of the contract price ranging from 1% - 3% depending on the strength of the contractor. √ Top
Performance Bond
A performance bond is typically paired with a payment bond and it guarantees the successful outcome of a contract. If the contract is performed according to its terms and conditions, the bond is void, otherwise it remains in full force and effect.
The bonded contract can be for a construction project, the supply of goods, the manufacture of goods, a service contract and more. Basically any obligation where a task must be completed could benefit from a performance bond. √ Top
Payment Bond
A payment bond is typically issued with a performance bond to guarantee that all labor and suppliers on a project are paid. The bond ensures that funds for the job go to pay bills related to the job and the owner is delivered a lien free project. Most State lien laws permit second tier labor and suppliers to lien a project if they were not paid. Therefore, if a general contractor was paid funds to be distributed to a plumbing sub-contractor, but the general contractor failed to pay the plumbing contractor, the plumbing contractor could lien the project, even though the project owner paid out those funds.
Most surety claims are related to the payment bond, since money is the first place trouble with a contract or contractor shows up. A common scenario is a contractor runs into trouble on a project and diverts funds from other projects to the troubled one. This in effect causes all projects to be problematic. √ Top
Supply Bond
A supply bond is a type of contract bond. It ensures the fulfillment of an obligation to supply product or services. These are frequently required for companies that do business overseas. A supply bond can be substituted for a letter of credit. They are also requried of very large corporations such as Boeing, for the supply of jets or parts. √ Top
Compliance Bond
A compliance bond is a fairly low risk obligation which guarantees a bonded Principal will comply with appropriate laws. These bonds are required of many types of licensees.
Court Bonds
A court bond is one required by a court. There are many different types including appeal, plaintiffs, attachment, stop notice, release of stop notice, probate, executor bonds and more. The bonds help ensure the validity of a law suit or an appeal, and serve to protect the interested parties. √ Top
Fiduciary Bonds
Fiduciary bonds are required of Trustees who manage estates, wills, bankruptcy workouts, and more. √ Top
Appeal Bond
An appeal bond is used when a court has decided a verdict against a party. If that party wants to appeal the case, the court may require a bond be posted to guarantee that if the party losses again, they will pay the previous award plus interest, plus court costs. √ Top
Probate Bond
A probate court bond may be required by a judge for of an administrator or executor of an estate. The bond ensures the other heirs will not be defrauded by the bonded party. These bonds are common when minors have their own fortunes, such as with child actors or when there is a death and an estate needs to be settled. √ Top
Fidelity Bonds
Fidelity Bonds are considered different from Surety, and more closely resemble an insurance policy. They protect an organization from theft or fraud. Fidelity bonds are commonly written for financial institutions and very large corporations. However, there are many small fidelity obligations, referred to as dishonesty bonds, which protect either the applicant company or third parties from theft. These are needed by janitorial, maid service, small pension funds, homeowners associations, and other companies. An ERISA bond is a specialty fidelity bond that _________ √ Top
Commercial Bonds
Commercial bonds are provided for businesses requiring surety to conduct their operations. They are required of numerous businesses throughout the country for various reasons. There are hundreds of Commercial (or non-contract) bonds. These include various bonds including lease, financial guarantee, license and permit, and miscellaneous bonds. √ Top
How do I select a Surety?
In the state of Michigan, you must work with an agent to find a Surety Company. The agent will assist you in finding a Surety Company that is right for you. At SBS we have made your selection process easier by pre-qualifying and then monitoring our Surety carriers. We only represent Surety companies who meet and maintain a high level of professionalism, stability and financial strength. All of SBS’s Surety partners are reputable companies with a history of paying claims fairly. All meet required State and Federal licensing and liquidity ratios. And, we enjoy working with all of them too.
The items typically considered in selecting who writes your bond can be based on name recognition, size of the carrier, financial strength of the carrier, Best Rating of the carrier, Federal Department of the Treasury Registry listing of the carrier, and more. Most typically, a name you know will jump out with a price that is good.
We provide important information about each Surety company for you to make an informed decision. We endorse ALL of our surety company partner companies. We firmly believe you will be happy with any of them. Chose the one that makes you comfortable. √ Top
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