A surety bond is a mechanism used to transfer risk during a project or as indicated by a legal agreement. Three key players are involved, each with a specific role during the agreement: an obligee, a principal and the surety or bonding company. A surety bond is a type of guarantee between the obligee and the principal, backed by the surety. These bonds are used to protect companies and individuals from the principal’s action, offering financial protection by making compensation available to the affected party when a claim is made.
How A Surety Bond Works
In construction projects, when the general contractor fails to meet the economic obligations to their subcontractors and/or suppliers, the surety bond will be asked to pay the outstanding invoices due at that moment by the general contractor.
The obligee is the party requesting release of funds by the surety company, after the principal as provided the coverage. The surety company provides coverage by backing the bond up to the full amount of the bond coverage. The principal is required to pay a premium to the company issuing the surety bond.
There are different ways to provide coverage under an indemnity agreement, and one of the ways could be in the form of a collateral such as cashier’s check, CD or letter of credit. The surety bond will be backed up using unsecured guarantee or collateralized up to 100%. When the claim is made, and the surety agency pays the principal obligations, then the principal will need to repay the surety company.
Types Of Bonds
There are many types of bonds available. Our company focuses on contractor surety bonds. Some of the most popular bonds in this category include:
- Bid Bonds. A bid bond serves as a guarantee that the bonded contractor will commit to the contract once it has been awarded.
- Performance Bonds. Performance bonds guarantee the ability of the contractor to complete and meet construction execution and installation of project goods.
- Payment Bonds. Payment bonds is required to ensure that contractors and suppliers will get paid after labor and material is installed.
- Maintenance Bonds. Maintenance bonds go into effect after the contract is completed and usually cover one or even two years after work is complete.
- Contractor License Bonds. These bonds are required before contractors get all of their permits and licenses at the local, state or any other jurisdiction.
There are many other types of bonds to consider for your project. Speak with an experienced surety agent to determine the appropriate coverage for your needs.
Difference Between Insurance & Surety Bonds
The surety is different from an insurance, as the surety bond provides coverage to the obligee instead of the insured. The surety bond needs to be repaid by the principal, while insurance coverage assumes there will be losses that they won’t be able to recover. Also, the surety bond provides coverage during the contract period under a one-time payment, while the insurance will require monthly payments or installments.
See our blog for a deeper dive into the differences between what it means to be bonded vs insured.
Surety Bond Costs & Factors To Consider
Bond costs vary depending on some factors and the coverage being provided. Applications are often divided into high risk or low credit score applicants and premium applicants. These two factors are the most critical factors when deciding how much you will need to pay for the surety bond.
The surety agency will also evaluate assets, financial statements, liquidity and experience of the individual or company acting as the principal. The principal with good credit scores and good financial stability can end up paying up to 3% of the total bond amount, subject to qualification and analysis by the surety agency.
Request A Quote
Contractor Surety Group is an agency with years of experience specializing in bonds for developers and all types of contractors, including large multi-national general contractors and trades of every sort. If you are in need of surety bond for your project, request a quote today.