What are Surety Bonds and How Do They Work?

What are Surety Bonds and How Do They Work?

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Surety bonds provide valuable protection to consumers and are often legally mandated for select businesses. Surety bonds act as a legal contract that ensures an agreement is executed properly and fairly.

 

Surety companies sell surety bonds and essentially make a promise that the agreement will be carried out properly or proper compensation (up to a predetermined amount) will be arranged to make up for a failed agreement or predatory behavior on the bond holder’s side.

 

Keep reading for more insight into what surety bonds are and how they work.

What is a Surety Bond?

Surety bonds guarantee that certain parties operate within the law and fulfill their contract term or financial recompense for the wronged party can be pursued. For example, performance and contract bonds guarantee that a project is completed and meets certain expectations or proper compensation is provided.

 

Surety bonds don’t just benefit the party that can file a claim against the bond if something goes wrong. When a business purchases a surety bond they benefit as well. To start, by doing so they are complying with state and federal requirements. Not only does this make it possible to operate their business legally, but their clients can have confidence knowing the business is running a legal operation with good practices. It can be much harder to secure projects without having a legally required bond as most contracts will require that.

 

A surety bond also helps businesses financially as once they have a surety bond they won’t need the entire amount of cash required to pay out a claim on hand. When taking out a surety bond, you only pay a premium which is a much smaller percentage of the bond amount. If a claim is filed and approved by the surety company, they will pay out the claim initially and then the business will need to pay them back.

 

Surety bonds always involve three different parties:

 

     Principal. The party that must take out the bond (you).

     Obligee. The party that requires the bond—this can be the client or a government.

     Surety. The company that issues the surety bond and ensures that the principal fulfills the contract. They will pay out any approved claims initially.

Types of Surety Bonds

There are hundreds of different types of surety bonds on the market and which one a business needs can greatly vary by state and industry. We can’t walk through all of them because the list is so varied, but these are a few examples of popular bond types.

 

     Contractor license bonds. This type of bond is usually required by a governing agency (usually a state/local municipality) in order to become a licensed contractor.

     License and permit bonds. Municipalities often require license permits and bonds to protect consumers against dishonest practices by ensuring that licensed professionals comply with certain laws and industry regulations.

     Performance and payment bonds. An obligee may require a performance and payment bond to ensure the contractors complete their project properly and pays all subcontractors and vendors involved.

     Motor vehicle dealer bonds. Automotive dealerships generally need to obtain a motor vehicle bond that 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 does other questionable practices.

     Site Improvement bonds. This type of bond is used by developers and builders to ensure that site improvement projects to roads, sewers, electric facilities, and other structures are properly completed.

How Does a Surety Bond Work?

Surety bonds are purchased by the principal, but for the most part they are designed to protect consumers against issues llike incomplete work, and shoddy workmanship. Having a surety bond can give consumers and other businesses the confidence to work with the bonded business because they know the business in question has a financial safety net to cover the cost of claims when they don’t meet your end of the deal—such as losses, damages, and legal fees.

 

To better understand how a surety bond works, it helps to know what the following terms mean.

 

     Bonding capacity. This is the maximum amount a principal can claim when a project doesn’t go according to plan. If the maximum bonding capacity is $10,000 then the obligee can’t claim more than $10,000 for reparations.

     Bond premium. The bond premium represents how much the principal will spend on the bond and is typically 1% to 15% of the bonded amount.

     Bond term. Bond terms represent how long the surety bond is active and typically ranges from one to three years and are renewable.

 

Remember—surety bonds don’t let the principal off the hook for a claim like some insurance policies do. While the surety company will initially pay the claim out, the principal will eventually be responsible for repaying any amount (up to the bonded amount) that the surety used to settle the obligee’s claim against the bond.

 

Need a surety bond? Learn more about how Worldwide Insurance Specialists, Inc. can help you cover your needs today!


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