Surety Bonds

A Surety Bond is a three-party agreement whereby the surety guarantees to the obligee (the project owner) that the principal (the contractor) is capable of performing the contract in accordance with the contract documents. Performance of the contract, which is the subject of the bond, determines the rights and obligations of the surety and the obligee.

Here are the eight different families of surety bonds:

  1. Contract Bonds (Bid and Performance Bonds)
  2. Fidelity Bonds
  3. Fiduciary Bonds
  4. Judicial Bonds
  5. License and Permit Bonds
  6. Miscellaneous and Federal Bonds
  7. Notary Bonds
  8. Public Official Bonds

Frequently Asked Questions

What is a surety bond?

A bond guarantees the performance of a contract or other obligation. Bonds are three party instruments by which one party guarantees or promises a second party the successful performance of a third party.

  1. The Surety — is usually a corporation which determines if an applicant (principal) is qualified to be bonded for the performance of some act or service. If so, the surety issues the bond. If the bonded individual does not perform as promised, the surety performs the obligation or pays for any damages.
  2. The Principal — is an individual, partnership, or corporation who offers an action or service and is required to post a bond. Once bonded, the surety guarantees that he will perform as promised.
  3. The Obligee — is an individual, partnership, corporation, or a government entity which requires the guarantee that an action or service will be performed. If not properly performed, the surety pays the obligee for any damages or fulfills the obligation.

The example below illustrates how a surety bond works:

Joe, the principal, has promised someone (the obligee) that he will do something. If Joe fails to perform as he has promised, financial loss could result to that person.

Consequently, the obligee says to Joe, “If you can be bonded, I’ll accept your performance promise.” Joe goes to a surety and asks to be bonded.

After the surety is satisfied that Joe is qualified and will live up to his promise, it issues the bond and charges Joe a “premium” for putting its name behind Joe’s promise.

Joe is still responsible to perform as promised. The surety is responsible only in the event that Joe does not fulfill his promise.

What is the purpose of a surety bond?

The purpose of a surety bond is to protect public and private interests against financial loss.

Therefore, the surety bonding company must be profitable and must have a strong balance sheet. No one is likely to accept the guarantee of a party with a bad name or a weak balance sheet. The surety bonding company guarantees performance. Its good name and its balance sheet back up that guarantee.

Probate bonds, notary public bonds, court bonds, license and permit bonds and public official bonds all guarantee protection of public interests from financial loss.

Why has corporate surety become such a vital part of doing business in today’s economic society? Because there is no practical alternative for protecting public and private interests from financial loss.

What are the differences between surety & insurance?

Although surety companies are often regulated by state insurance departments, surety bonding is different from insurance.

Several Differences

Insurance is a risk sharing device. It assumes that there will be losses. The expected losses are calculated by actuaries. These losses, coupled with anticipated overhead and other expenses, form the basis for the premium.

Surety is not actuarially rated as is insurance. Both insurance and surety call their fee a “premium.” The surety’s premium is as much a service charge as a conventional premium, which is determined on the basis of actual or anticipated losses. It is based largely on the cost of investigating the applicant and handling the transaction.

Surety: A Form of Credit

Surety is as much like banking as insurance. Bankers extend credit in the form of dollars loaned or as a commitment to loan. Every banker granting a loan fully expects to have the loan repaid. He investigates the borrower in sufficient detail to assure that such will be the case. Surety underwriters proceed in the same way.

Suretyship vs. Insurance

SuretyshipInsurance
Three-party agreement.

Most surety bonds are three-party agreements. The surety guarantees the faithful performance of the principal to obligee.
Two-party agreement.

Insurance is basically a two-party agreement whereby the insurance company agrees to pay the insured directly for losses incurred.
Losses not expected.

Though some losses do occur, surety premiums do not contain large provisions for loss payment. The surety takes only those risks which its underwriting experience indicates are safe. This service is for qualified individuals or businesses whose affairs require a guarantor.
Losses expected.

Losses are expected. Insurance rates are adjusted to cover losses and expenses as the law of averages fluctuates.
Premiums cover expenses.

A large portion of the surety bond premium is really a service charge for weeding out unqualified candidates and for issuing the bond.
Premiums cover losses and expenses.

Insurance premiums are collected to pay for expected losses. If an insurance company can get enough average risks of one class, it will always have enough money to pay losses and the expenses of doing business.
Sureties are selective.

A surety agent is selective. Like a banker, he is trained not to make any bad loans.
Insurors write most risks.

The insurance agent generally tries to write a policy on anything that comes along (at the appropriate premium rate) and allows for a large volume to cover the risk.

When the surety company is called in, the principal has usually paid as much of the loss as he is able. At this point, the surety company must pay the difference. The surety then tries to reclaim its loss from any resources left to the principal. In some cases the surety recoups all of the money it had to pay the obligee. In most cases, however, the principal either cannot be located or proves to be insolvent.

In reality, no obligee wants a claim against a surety bonding company. The obligee wants the principal to carry out his obligation. A surety bond is written because the obligee expects the surety company to weed out any applicant who cannot fulfill his commitments.

Are there alternatives to surety?

The job of the surety bonding company has become as complex as the rest of our economic society. In an age of lawsuits, broken promises, bankruptcies, and a generally high level of financial instability, the surety company provides basic public protection. To do this, the surety must responsibly determine the qualifications of those who wish to be bonded.

A surety provides the best method for guaranteeing performance and protecting public interests. Still, people tend to distrust business–even when history proves that private enterprise has been the consumer’s single most important benefactor.

The government has tried many programs to provide surety guarantees for the public. None of them have worked well.

“Risk pooling” and so-called “state funds” have been tried in all their various forms. Risk pooling is a government program which “assigns” to surety companies various applicants who are unable to obtain bonds elsewhere. State funds are nothing more than state agencies which go into the bonding business. In almost every case, both concepts have failed.

There are three important reasons for this failure:

  1. Insolvency—In many cases, state funds are too liberal in their payment of claims. The resulting problem is evident; the state fund becomes insolvent. During the 1980s there have been a few state funds which have gone bankrupt. When this happens, either the state or the licensees have to make up the difference, or the consumers must go without recovery.
  2. Difficult Recovery—In other cases, the state has tried to reduce losses by making it so tough for a consumer to get a claim paid that it’s not worth the effort. Most recovery funds require that the consumer obtain judgments and exhaust all civil and administrative remedies before they can submit a claim against the fund.
    By comparison, bonding companies are bound by laws that require timely and proper claims handling procedures. The surety always pays promptly upon being shown a minimum amount of proof of loss.
  3. Surety bonding does not depend upon the law of averages. Losses cannot be expected to be covered by “premiums”. Only through proper and exacting underwriting procedures can surety bonding be profitable, reliable and valuable for public and private protection.

In short, corporate sureties have the necessary knowledge, experience and expertise in the especially crucial areas of underwriting and claims handling. State funds are not only lacking in these areas; they also frequently lack the proper staffing.

Public protection can only be maintained by an independent party – the surety. In addition, by taking responsibility for investigation, evaluation, and recovery of loss, corporate sureties keep thousands of cases out of the legal system every year. The result is additional public savings.

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