What Is A Surety Bond and Why You Need One

December 22, 2022

What Is A Surety Bond?

A surety bond is a financial tool that is used to guarantee the performance of an individual or business under specific circumstances. A surety bond functions as collateral, which can be forfeited if the individual or business does not fulfill its obligations as outlined in their contract and cannot be purchased directly. The company that provides the surety bond must first conduct thorough research to determine whether or not the business is eligible for coverage and what type of policy would be most beneficial for its situation. The bond serves as a safeguard for the insurer in case the business fails to meet the contractual obligations regarding risk management, claims reporting and payment, maintenance of property, and other conditions related to your policy. It has three parties involved. They are:

  • Principal – the party who purchases the bond to protect themself. This is the party promising to finish the work contracted.
  • Surety – this is the surety company issuing the bond and guarantees the work to be performed. If the principal fails, the surety is legally bound to pay for losses that are incurred.
  • Obligee – this is the party requiring the bond to be purchased and is usually the recipient if a payout regarding the surety is to happen. In most cases, this is usually a government entity.

Fun fact: the first believed use of a surety bond dates back to 2750 BCE found on a Mesopotamian tablet. They also exist in the Code of Hammurabi. 

Types of Surety Bonds

There are a number of different types of surety bonds that you can purchase. Depending on the specific requirements of your business and contract, the surety bond company may be able to offer more than one type of policy for your business. 

Two of the most commonly purchased surety bonds include: Contract bonds – Contract bonds are required when an agreement that you have entered has a clause regarding the use of financial collateral. Contract bonds are required to ensure that the other party to the agreement has a means of repaying any debts should you fail to meet your contractual obligations. They are often used in government contracting situations, as well as in the event that you are obtaining a loan from a financial institution. Performance bonds – Performance bonds are typically required by construction companies, engineering firms, contractors, or other businesses that provide a service and create products based on a client’s specifications. If a client fails to pay for the service or product provided by your business, the performance bond will reimburse the client for the cost of the project.

Most of these bonds are issued for 1-3 years, but they can also be issued as “continuous” bonds which just means it stays in force until one party cancels the bond. These bonds usually fall under state contractors and auto dealers. 

Why You Need An Surety Bond

A surety bond is required by many of the most popular types of business insurance policies. Most insurers will not provide a policy if a business fails to obtain a surety bond to cover potential financial losses; it is necessary because it provides a means of insurance coverage in the event that a client fails to pay for a product or service, or claims are made that are later found to be fraudulent. In these situations, the insurer can make a claim against the surety bond and recover the funds that were paid out to the client. These policies also serve as a good indicator of the financial solvency of the business and can be used as a rating system when considering whether or not to provide coverage.

Aside from these being required in some circumstances, they also provide protection for the buying party regardless of purchase obligation—that is to say, it might be a good idea to consider them in any circumstance even when they aren’t required. It protects the business doing the work should something pop up that prevents them from being able to complete the work. 

How To Find a Surety Bond Company

If you are interested in obtaining a surety bond, you should take some time to research the companies that provide these policies. The best way to find a reputable surety bond company is to ask a business associate or industry expert for a referral. You should be as specific as possible when describing your business and needs, and make sure to ask plenty of questions to ensure that you choose the best company for your situation. You can also scour the internet to find a company you feel matches your needs. Try to find reviews for that company to see how others have fared in their dealings with them. 

Once you’ve found a few potential companies, you’ll want to conduct a thorough background and regulatory compliance check to make sure that each company is trustworthy and legitimate. You can do this by researching the companies on the Better Business Bureau’s website, as well as by conducting your own internet search much like what was mentioned in the paragraph above.

Getting the bond is fairly quick and painless. In most cases, applicants can be approved same day as much of the underwriting process is automated. Prices for these bonds are usually established as a percentage of the amount of coverage the company needs in that particular bond situation. Some companies offer a lower premium on these bonds if the company purchasing is willing to put up collateral or include co-signers in the process. While this can help drive premiums, it could be a bad deal if you aren’t 100% sure the job can be completed as per the contract for that particular work. 

Bottom Line: You Really Should be Considering Them

Surety bonds protect a company from the financial risk involved with not completing contracted work as it pertains to that contract. They provide protection should the hiring party decide to recoup losses upon incomplete work. 

Now that you understand what a surety bond is and why you need one, it may be time to find a company that can provide you with a surety bond. Make sure to ask plenty of questions, do thorough research into the company, and remember that having the proper surety bond is the first step to obtaining the most coverage for your business. 

While you’re considering surety bonds to protect your business, how much thought have you given to the compliance of contractors under you? What about vendors? Anyone working for your company who isn’t technically an employee presents a unique risk opportunity

When you collect their certificates of insurance (COIs), do you know where to look and what to look for to make sure you are covered? If you do, that’s awesome, but the more you have to look at, the more room for error creeps in. That’s why, at some point, you should consider partnering with myCOI to help you track the certificates you hold on your subcontractors. We can flag gaps in coverage, issues with additional insured and waiver of subrogation endorsements, and overall COI management. 

We would love to show you how easy it can be to manage your COIs in a way that ends chaos, mitigates compliance issues, and saves you TIME! Our clients see compliance jump from around 30% to over 80%! That’s huge.

Book your free demo today to see inject some simplicity into your certificate tracking efforts! You won’t regret it!

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