Surety Bond | Worldwide Insurance Specialists, Inc

A surety bond is a legal contract between three parties that guarantees specific obligations are met or compensation is provided. In other words, a surety bond helps ensure the job gets done.

The type of surety bond required depends on your state and industry. If you're a contractor or a licensed professional, chances are you need one. The good news is that surety bonds help you land valuable contracts and keep you out of legal or financial trouble.

Keep reading to learn how a surety bond works, the different types available, and how to get one.

What's Inside

• Surety Bond Definition and Examples
• How Does a Surety Bond Work?
• Types of Surety Bonds
• Surety Bond vs. Insurance
• Advantages of Surety Bonds
• How to Get a Surety Bond
• Surety Bond FAQs

Surety Bond Definition and Examples

A surety bond is a legal contract that ensures an agreement is carried out properly. When a surety company sells a surety bond, it promises one party that the other party (usually a small contractor) will fulfill their contract terms. If the contract isn't executed fully or properly, the surety bond company steps in to resolve the situation — typically with a payout up to a predetermined amount.

As mentioned, a surety bond involves three parties:

• Principal: The party that needs the bond (you).
• Obligee: The party that requires the bond (typically the client or government).
• Surety: The company that issues the surety bond and ensures that the principal fulfills the contract.

What Is an Example of a Surety Bond?

A business owner (obligee) is expanding and hires a construction contractor (principal) to build a new office. Before work begins, the business owner requires the contractor to obtain a surety bond for $100,000. The contractor obtains a surety bond from the surety.

Now, say the construction contractor falls short and can no longer complete the project. The business owner files a claim against the bond, and the surety issues financial recompense of $100,000 to cover the project losses.

How Does a Surety Bond Work?

There are three terms to keep in mind when researching surety bonds: capacity, premium, and term.

• Bonding capacity: The maximum amount a principal can claim when a project goes south. If the maximum bonding capacity is $10,000, for example, the obligee can't claim more than $10,000 in reparations.
• Bond premium: What the surety company charges the principal — typically 1% to 15% of the bonded amount, depending on the type. For example, a 3% premium on a $10,000 bond would be $300.
• Bond term: How long the surety bond is active. Terms typically range from one to three years and are renewable.

Surety bonds are purchased by the principal, but their function is to protect the obligee against incomplete work, shoddy workmanship, and more. Being bonded tells your client that you have a financial safety net to cover the cost of claims when you don't meet your end of the deal — including losses, damages, and legal fees.

While a surety bond is handy when a dispute arises, don't think you're off the hook financially. Yes, the surety company compensates the client if you fail to complete a contract. However, the principal — that's you — is still responsible for repaying any amount (up to the bonded amount) that the surety used to settle the obligee's claim against the bond.

Types of Surety Bonds

The number of surety bonds available is far more than you can count on two hands — or ten. With hundreds of bond types out there, the ones required will vary by your industry and state. Some common surety bonds include:

• Contractor license bonds: A contractor license bond is a surety bond that a governing agency (usually a state or local municipality) requires to become a licensed contractor.
• License and permit bonds: Often required by municipalities to protect the general public against dishonest practices, this bond ensures that licensed professionals comply with certain laws and industry regulations.
• Performance and payment bonds: Obligees often require this bond to ensure that contractors complete the project properly. The bond terms also guarantee that all subcontractors and vendors involved in the project are paid for their services.
• Motor vehicle dealer bonds: A required bond for an automotive dealership. This bond protects consumers when the dealer misrepresents a vehicle, fails to pay necessary fees and taxes on the vehicle, does not obtain a valid title, or engages in other questionable practices.
• Site improvement bonds: Typically used by developers and builders, this bond ensures that site improvement projects for roads, sewers, electric facilities, and other structures are properly completed.

Surety Bond vs. Insurance

Surety bonds and insurance policies are often confused, but they work differently:

• A surety bond is a contract between three parties (principal, obligee, and surety); insurance is a contract between two parties (the insured and the insurance company).
• A surety bond protects the obligee (e.g., a business owner or government agency); insurance protects the insured party.
• A surety bond protects against incomplete contractual obligations (e.g., building construction not finished); insurance protects against covered incidents (e.g., negligence, theft, physical disasters).
• When a bond claim is paid, the surety settles the claim, but the principal remains financially liable; when an insurance claim is paid, the insurer reimburses the insured for the financial loss.

Advantages of Surety Bonds

The most obvious benefit of a surety bond is compliance: you're meeting state and federal requirements, and your clients can rest easy knowing you're running a legal operation with good practices. In many contract terms — especially when working with the government — a project can't move forward until you're properly bonded. That means potential revenue loss for your business if you don't meet the bonding requirements.

Second, a surety bond lets you guarantee the bonded amount without needing the entire amount on standby. Can you imagine a client requiring that you have $100,000 in cash just in case things go wrong? With a surety bond, you only need to pay a small percentage of the bonded amount — a $2,000 premium for a $100,000 bond, for instance.

Do I Need a Surety Bond?

Surety bonds are commonplace for many businesses — those that work in the construction industry or with municipalities, for example. License and permit bonds may also be necessary for certain professionals, such as electricians and auto dealers. However, surety bonds aren't necessary for every type of business. Be sure to research your federal and state requirements to determine the surety bonds necessary for your business, if any.

Requirements for Surety Bonds

Generally, sureties will want to review your credit score, how long you've been in business, and your business financials. Depending on the surety company and the bonded amount — $1 million, for example — the requirements can be extensive:

• Minimum credit score of 650.
• Three years in business.

The surety may also want to review your personal and business financial statements, including tax returns, cash flow history, and profit and loss statements.

Quick tip: A high credit score, strong business financials, and experience will typically qualify you for a lower bond premium.

An indemnity agreement may also apply for certain surety bonds. An indemnity agreement is a legally binding contract that holds you responsible for paying for losses and damages up to the full bond amount when the obligee files a claim. Some sureties will require you to pledge collateral to guarantee the bond, similar to applying for a loan.

How to Get a Surety Bond

Surety bonds are commonly available through insurance companies. Insurance companies often have subsidiaries or a dedicated division that handles and issues surety bonds. In some cases, they may contract with a surety bond producer that functions similarly to a broker and sells surety bonds on their behalf.

Applying for a Surety Bond

Obtaining a surety bond is easy when applying with Worldwide Insurance, Inc. Just fill out our initial application form and get an instant quote in minutes. We issue all types of surety bonds in all 50 states. No credit check required and no obligation.

Surety Bond FAQs

What is a surety bond good for?

Surety bonds ensure certain parties fulfill their contract terms and operate within the law. Performance and contract bonds, for example, guarantee that a project is completed and meets certain expectations, or that proper compensation is provided. A guardianship or conservator bond helps guarantee that the guardian or conservator acts in the best interest of the minor or conservatee.

Are surety bonds paid monthly?

Surety companies typically charge a one-time upfront fee when you obtain the surety bond. You'll need to pay another fee to renew the surety bond term. We do offer financing for some bonds.

How long is a surety bond good for?

Terms on surety bonds vary by type and state. Most motor vehicle dealer bonds, for example, have terms of one year but can extend up to three years in Oregon. For many surety bonds, you'll have the option to renew the term.

Can you cancel a surety bond?

The cancellation process can vary by bond type, state, and surety company. A written agreement signed by all parties may be necessary to cancel the bond. In some cases, a full or partial refund is possible but not guaranteed.

How do I get a better rate on my surety bond?

One of the main drivers of your surety bond rate is your credit score. Improving your credit score is an important step toward achieving a low surety bond rate. Here are some tips to help you improve your credit score:

• Pay your bills on time. Late payments can have a significant negative impact on your credit score, so make sure to pay all your bills — including credit card payments, loan installments, and utility bills — by the due date.
• Reduce your credit utilization. Your credit utilization ratio is the amount of credit you're using compared to your total available credit. Aim to keep your utilization below 30% by paying down debt or increasing your credit limits.
• Maintain a mix of credit accounts. A diverse mix of credit accounts — such as credit cards, loans, and a mortgage — can positively impact your credit score. Be cautious about opening new accounts unnecessarily, though, as it can also hurt your score.
• Regularly check your credit report. Monitor your credit report to ensure it's accurate and free from errors. You can obtain a free copy once a year from each of the major credit bureaus (Equifax, Experian, and TransUnion) — report and correct any inaccuracies you find.
• Avoid excessive credit applications. Each time you apply for new credit, it triggers a hard inquiry on your credit report, which can lower your score. Limit the number of credit applications you make and only apply when necessary.
• Maintain a long credit history. A longer credit history tends to be more favorable for your credit score. If you have old credit cards in good standing, keep them open to demonstrate a longer credit history.
• Be cautious with closing accounts. While closing unused credit accounts can be beneficial, closing your oldest accounts can shorten your credit history. If you decide to close an account, prioritize newer ones over your oldest accounts.
• Use credit responsibly. Show lenders that you can handle credit responsibly by using it in a disciplined manner — avoid maxing out your credit cards and try to pay off the balance in full each month.
• Consider credit-building tools. If you have a limited credit history or a low credit score, explore tools like secured credit cards or becoming an authorized user on someone else's credit card to establish or rebuild your credit.
• Be patient and consistent. Building a good credit score takes time and consistent, responsible financial habits. Stick to good credit practices over the long term, and your credit score will gradually improve.

Remember, improving your credit score is a gradual process, and it may take time to see significant changes. Stay committed to good financial habits, and you'll be on your way to a better credit score.

What is A.M. Best, and why is it important for bonding?

A.M. Best is a global credit rating agency and information provider with an exclusive focus on the insurance industry. The company was founded in 1899 by Alfred M. Best, with the goal of reporting on the financial stability of insurers and the surety bond industry.

A.M. Best is well known for issuing financial-strength ratings, which measure a surety company's ability to pay claims and meet its financial obligations. These ratings range from A++ (Superior) to D (Poor).

Here's why A.M. Best ratings matter:

• Assessing financial strength: A.M. Best ratings provide a relative measure of a surety company's financial strength and ability to meet ongoing surety bond and contract obligations. This matters to policyholders because it indicates the likelihood that the insurer will be able to pay out claims.
• Choosing insurance providers: Consumers and businesses use A.M. Best ratings when choosing which insurance companies to work with. An insurer with a high rating is generally considered a safer bet than one with a low rating.
• Industry standards: A.M. Best's ratings are widely recognized as the benchmark for assessing insurers' financial strength.
• Informed decision-making: Ratings help potential investors make informed decisions about which insurance-related securities to buy.
• Regulatory compliance: In many jurisdictions, insurance regulators use A.M. Best's ratings to determine whether an insurance company meets the minimum capital and surplus requirements to be licensed to do business.

A.M. Best plays a critical role in providing transparency about the financial strength of insurance companies, helping policyholders, investors, and regulators make informed decisions. At WWIS, Inc., we only work with A-rated, T-listed companies as rated by A.M. Best.

Do you require business financials for my surety bond?

At Worldwide Insurance Specialists, Inc., we have over 5,000 bonds — and growing — that require no credit check or financials. A business financial statement is typically only required for larger contract bonds.

Financial statements are formal records of a business's financial activities. These statements provide an overview of a company's profitability and financial condition in both the short and long term. There are four basic types of financial statements:

• Balance sheet: Also known as a statement of financial position, the balance sheet provides a snapshot of a company's financial condition at a specific moment in time. It consists of assets (what a company owns), liabilities (what a company owes), and shareholders' equity (the difference between assets and liabilities, also known as net assets).
• Income statement: Also known as a profit and loss statement, the income statement shows a company's revenues and expenses during a particular period. It presents information about the profit or loss of a business over that time.
• Cash flow statement: This statement shows the flow of cash and cash equivalents coming into and going out of the company during a specific period. It's divided into three main parts: cash flows from operating activities, from investing activities, and from financing activities.
• Statement of shareholders' equity: This statement shows changes in the interests of the company's shareholders over time. It includes details like new shares issued, shares repurchased, dividends paid, and the impact of changes in profits or losses.

Why does the surety want to review financials prepared on an accrual basis?

Cash basis and accrual basis are two different methods of accounting used to record transactions.

Cash basis accounting: This method recognizes revenue when cash is received and expenses when they're actually paid. It doesn't recognize accounts receivable or accounts payable. Many small businesses opt for cash basis accounting because it's simple to maintain — it's easy to determine when a transaction has occurred (the money is in the bank or out of the bank), and there's no need to track receivables or payables.

Accrual basis accounting: This method recognizes revenues and expenses when they're incurred, not necessarily when cash changes hands. For example, if a company performed a service or shipped a product, it would recognize revenue even if the customer hadn't paid yet (resulting in an account receivable). Similarly, if it received a bill for a service from a supplier, it would recognize the expense even if it hadn't paid the bill yet (resulting in an account payable). Accrual basis accounting provides a more accurate picture of a company's true financial condition, but it's also more complex to implement and maintain.

In short, cash basis accounting is simpler but less precise, while accrual basis accounting is more complex but provides a more accurate view of a company's financial health. Which method to choose largely depends on the nature and size of the business, as well as regulatory and reporting requirements.

Related Content:

Getting a Surety Bond

What Are Surety Bonds and How Do They Work?

FAQ About Surety Bonds