If you’ve been asked to obtain a surety bond, you might be uncertain about its purpose or cost. Understanding the fundamentals of surety bonds can help clarify their function. Here are four key points to consider:

• Surety Bonds Are Different from Insurance: Many people mistakenly equate surety bonds with insurance, but they serve distinct purposes. Insurance is a two-party agreement between the insurer and the policyholder, where the insurer collects a premium and assumes financial risk for covered events. For instance, homeowners’ insurance provides coverage for fire damage. Go to site.
• A surety bond, on the other hand, involves three parties:

• Obligee – The entity requiring the bond (e.g., a government agency or project owner)
• Principal – The individual or company purchasing the bond (e.g., a contractor)
• Surety – The entity providing the bond and guaranteeing the principal’s performance

For example, if a construction company is awarded a government contract, the city (obligee) may require a surety bond to ensure the project’s completion. The surety company guarantees construction company (principal) will fulfill its obligations. Unlike insurance, surety bonds do not cover unexpected losses; instead, they guarantee that the principal will adhere to the contract’s terms.

2) Obtaining a Surety Bond Requires an Indemnity Agreement: Securing a surety bond is similar to obtaining a loan. Before issuing the bond, the principal must sign an indemnity agreement, which states that if the surety company has to pay a claim, the principal must reimburse the surety.

This arrangement differs significantly from insurance. When a policyholder pays an insurance premium, the insurer assumes financial responsibility for covered losses. However, with a surety bond, the principal remains accountable for reimbursing any claims paid by the surety.

3) Surety Bonds Are a Specialized Financial Product: Unlike insurance policies or loans, surety bonds are a niche financial instrument. Not all brokers or financial institutions offer them, making it essential to work with an expert in the field.

When selecting a broker, it’s important to assess their expertise, industry experience and claims-handling process. Your regular insurance provider may not necessarily have the specialized knowledge to secure the best surety bond for your needs.

4) Surety Bonds vs. Cash or Letters of Credit: In some cases, an obligee may allow a principal to provide cash or a letter of credit instead of obtaining a surety bond. While this might seem like a simpler alternative, it carries inherent risks.

With a surety bond, if an obligee files a claim, they must provide evidence that the principal has failed to meet contractual obligations. The principal also has an opportunity to dispute the claim before the surety investigates, offering an added layer of protection.

Conversely, when an obligee holds cash or a letter of credit, they can access the funds immediately without needing to justify their claim. This can lead to an immediate financial loss for the principal, making surety bonds a more secure option in many cases.