A surety bond is a written legal agreement in which an obligation’s performance is guaranteed. They are also known as ‘surety-ship agreements’. There are different players in the field of surety bonds, including the surety bond company, and they all come together to ensure that money is paid should a principle perform in the way the bond specified it would. It is not a form of insurance, however, but rather a mechanism to transfer risks. Essentially, the risk of working with a principal moves from the obligee to the surety.
Players in Surety Bonds
As a minimum, three parties are involved in surety bonds:
- The principal, which is the party that gets bonded, i.e. you. Essentially, your bond will specify a certain obligation, and you agree to undertake that. As such, you are the contractor. In public official bonds, it is the public official; in a license bond, it is the person getting licensed; in a guardianship bond, it is the guardian, and so on. On obligor and a principal are one and the same.
- The obligee, which is the person who benefits from the transaction and wants you to have a bond. This could be a company, an individual, a government agency, a municipality, and so on. The bond is given to the obligee, which includes protection against potential lost. If you, as the principal, don’t meet your obligations, the surety company will compensate the obligee.
- The surety, which is the company that issues a bond. Essentially, they guarantee that the principal will meet the obligation to the obligee. If they do not, then the obligee will receive financial compensation.
Understanding Surety Companies
Most of the time, surety companies are insurance companies. They are legally authorized to be underwriters of surety bonds. A surety bond is not insurance, however. There are similarities between the two, but some key differences as well, including:
- Insurance policies are agreements between an insurer and insured. Surety bonds, by contrast, have three parties involved.
- Insurance policies are designed to move the risk a policyholder has to the insurance company. A surety bond, meanwhile, only protects losses sustained by the obligee and not by the principal.
- It is possible for anyone to purchase an insurance policy. People have to qualify for insurance bonds, however. Essentially, a surety bond is a credit type, and surety companies will only take certain risks in that.
- An insurance companyexpects that they will have losses, which their insurance rates are supposed to cover. With a surety company, credit is extended because they expect that the principal will meet their obligations. They do not, therefore, expect that there will be a loss.
- An insurance company anticipates losses and increases policy premiums to protect themselves from this. With a surety bond, however, there are some underwriting expenses to be aware of, but there is no protection in case of a loss.
- Surety bonds, by and large, are for professional people, whereas insurance policies can be purchased by anyone for anything.