Contractor Bond vs. Insurance

May 5, 2024
contractor bond vs insurance

In our blogs, we’ve talked a lot about the importance of contractors carrying insurance coverage. Another way that project owners can secure protection, especially in cases of contractor default, is through insurance bonds. Unlike policies specifically intended to protect project owners from financial obligations from third-party claims, bonds aim to ensure that a contractor will fulfill their job duties. However, both are important concepts in the construction industry – and we’ll tell you why.

This blog will discuss the pros and cons of contractor insurance vs. bonds. 

What Is an Insurance Bond?

An insurance bond, also known as a surety bond, is a financial agreement between three parties guaranteeing that one will fulfill their contractual obligations to the other. The three parties involved are: 

  • The principal is the party that must purchase the bond and promise to fulfill its obligations under a contract. In construction projects, this is usually the contractor or contracting business.
  • The obligee: This party requires the bond to guarantee completed work. In construction projects, this is usually the client who hires the contractor. 
  • The surety: This party assumes the principal’s financial risk, guaranteeing the obligee for the principal’s work or financial protection. In construction projects, the insurance agency or financial institution issues the bond.

What Does Surety Bond Insurance Cover?

A surety bond, sometimes also referred to as surety bond insurance, is an agreement that provides a financial assurance that a party such as a subcontractor (the principal) will fulfill their contractual obligations to another party (the obligee), with an insurance or surety company (the surety) guaranteeing the principal’s performance. Subcontractor bonds usually protect either job bids, performance/completion, or third-party payment. These bonds are not insurance coverage in the traditional sense, but they guarantee a principal doing what they say they will. 

Who Pays for a Construction Bond?

The principal, or the party who agrees to do contract work on a job, is generally expected to pay for their bond, thus guaranteeing their performance and compliance with the contract. The contractor will pay for the construction bond in premiums, a percentage of the bond amount, in exchange for its protection. Additionally, since a principal must repay their surety in the case of a loss, they will likely complete the work. A construction bond’s cost (the premium amount) is usually not as high as insurance coverage premiums. It will be influenced by factors such as the bond amount, the contractor’s track record, and the contract terms.

How Does Insurance Differ from a Surety Bond in Construction?

Bonds and insurance in construction are risk mitigation and financial protection, although they serve distinct purposes. Insurance provides financial protection to a policyholder against various risks common to contracting work, such as bodily injury, property damage, or other legal liabilities stemming from their operations. Bonds, conversely, guarantee that the work will be done on time and to the expected standard, with all other contractual obligations (such as suppliers being paid, etc.) being fulfilled. Similarly, subcontractor default insurance is a type of insurance that, like a bond, aims to ensure that a job gets completed, even in the case of a worker default. Let’s dive deeper into the unique characteristics of contractor bonds vs. insurance.

What Is the Difference Between Being Bonded and Insured?

Bonding and insuring are two ways for contractors and other third-party service providers to prove to clients that they are dependable workers. However, purchasing an insurance policy means obtaining financial protection from likely on-the-job claims, whereas purchasing a bond essentially means establishing a guarantee to a project owner that they’ll complete the job. 

Surety bonds protect an obligee (hiring party) against a contractor’s (principal’s) failure to perform. Insurance policies protect an insured (contractor) from liabilities on their job (also protecting the hiring party by eliminating the possibility of downstream financial risk making its way to them). 

Should I Use a Contractor that Is Not Bonded?

Working with bonded contractors is one way to ensure that a job will be completed to your company’s standards, although it is not always considered a “make or break” for hiring someone. On the other hand, insurance coverage is an industry-wide best practice for third parties to have and/or for hiring parties to require. That is because you’ll want to ensure that if anything goes wrong on a project, your hires will have the right protections to cover the damages rather than your business being held responsible. Hiring bonded and insured contractors is your safest bet for projects getting completed successfully, on time, and without large financial risk.

To verify that all hired parties have valid and up-to-date contractor insurance coverage, request certificates of insurance (COIs) from everyone, and consider using a digital COI management platform to streamline your tracking.

Understand Contractor Compliance with myCOI

Contractors need insurance due to the high likelihood of things going wrong – small property damage, bodily injury, failure to complete a project, etc. Surety bonds are another measure of safety that helps guarantee a contractor will finish their job as required. 

As someone hiring workers who have the potential to get hurt, be sure to do your due diligence and ensure their protection. Book a demo with us today to learn more about where your compliance efforts may be lacking.

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