Are you a construction contractor wondering what’s the difference between surety bonds and insurance? Then this article is for you. Keep reading to get the top 5 most common bonds vs. insurance questions answered!
1. Is a surety bond the same as insurance?
Surety bonds are not the same thing as insurance but it’s somewhat related. Consider it a semi-distant cousin. While surety bonds do provide a guarantee, it’s definitely not the same as insurance. In fact, it’s more helpful to think of surety less like insurance and more like obtaining a line of credit from the bank (more on that later).
For starters, insurance is a two-party agreement between the policyholder and the insurance company and protects the policyholder.
Whereas a surety bond is a three-part guarantee between the obligee (the entity paying for the work and who requires the bond), the principal (the person or company performing the work and who must obtain the bond), and the surety (the insurance company backing the surety bond).
Unlike traditional insurance that protects the policyholder, surety bonds are meant to protect project owners, not the contractors who obtain the surety bond.
In fact, the sole purpose of surety bonds is to protect buyers from individuals or companies who don’t fulfill their contractual obligations.
To keep things simple, think of it this way:
Insurance is a two-part agreement and protects the policyholder.
Surety bonds are a three-part agreement and protect the project owner.
2. Do surety bonds protect the contractor?
No. Surety bonds are not “insurance” for contractors. In fact, surety bonds are meant as a guarantee that contractors will hold up their end of the contract and perform all of the work as promised to the project owner.
For example, a developer (obligee) is building a new $11 million dollar apartment building in Indianapolis and requires the general contractor (principal) to obtain an $11 million dollar surety bond before signing the contract. The surety bond guarantees that the contractor will faithfully perform the work in the contract. If they don’t, the obligee can file a claim with the surety and be compensated for the full bond amount.
As the example shows, surety bonds are definitely not insurance for contractors, but they do protect project owners from bad-performing contractors.
3. Do surety bonds require monthly premiums like insurance?
There are no monthly premiums with surety bonds. When you are approved for a surety bond, you are required to pay a one-time premium at the time of obtaining a bond. Premiums are typically 1% - 3% of the total cost of the surety bond.
4. Are you required to get a surety bond?
All federal government projects valued over $150,000 require that contractors are bonded in order to be awarded the contract and most state and local governments have similar requirements through the Miller Act.
States and municipalities have laws that closely follow the Miller Act called Little Miller Acts and requirements vary from state and municipality.
Private owners can also require that contractors obtain a bond before they will award the contract.
5. If a surety bond claim is made, who is responsible?
This is the biggest differentiator between insurance and surety: the principal (contractor) is always 100% liable to repay the surety company for any losses the surety pays out to the obligee. The losses are incurred when a claim is deemed legitimate through the bond and contract.
Remember at the beginning when we said that surety bonds are less like insurance and more like getting a line of credit from the bank? This is why. Just like getting a loan from the bank requires 100% loan re-payment, so do any surety claims paid out.
The surety company’s job is to ensure the contractor faithfully performs their contract and fully completes their scope of work. But in the event things go south and that doesn’t happen, then the obligee is legally entitled to the full bond amount. The surety would then pay the obligee the amount the surety bond stipulated, and the principal would have to pay the surety back the money they paid out to the obligee.
While there are some similarities between surety bonds and insurance, they are definitely not the same thing.
Insurance is a two-party guarantee and protects the policyholder.
Surety bonds are a three-part guarantee that ultimately serves as a guarantee for obligees (project owners). In the event that a claim has to be paid out, the principal (contractor) is always 100% liable to repay the surety the full bond amount.
Interested in getting a surety bond quote today? The team here at Shorewest Surety would love to help. For the last 20+ years, we’ve been exclusively focused on helping construction contractors get the best rates, expertise, and service possible. We truly care about our clients' success and are honored to partner with them and share our bonding expertise so they can bid on the projects that matter most. Give us a call today at (800) 264-1634 and talk with an agent who will give you a personalized quote.