Surety bond insurance is an agreement between three parties (the principal, the surety issuer, and the obligee). It ensures the principal will act in accordance with the terms of a bond and in the best interest of the obligee and the general public. If things go wrong, the surety bond will respond by paying damages to the obligee.

Still unsure? Don’t worry! The Thimble team is here to explain how surety bond insurance works, the types of surety bonds available, the benefits of these bonds and how to apply for one.

What is a surety bond?

Like a bank loan, a surety bond vouches for a business and guarantees an obligee will be paid retributions for mistakes or incomplete work. Surety bond insurance is a guaranteed contract between a company and a client or government authority underwritten by a surety issuer, typically an insurance company.

However, unlike traditional insurance, the principal will have to pay back the total amount of the bond to the surety issuer should the surety need to make a payment to the obligee.

To better understand surety bond insurance, let’s review the parties involved.

  • The principal: The principal is the person or business purchasing the surety bond to guarantee their work. Contractors, entrepreneurs and start-up companies regularly secure surety bonds when entering agreements to establish trust and generate assurances that the work will be done correctly.
  • The obligee: The obligee is the entity or client requiring the principal to obtain a surety bond. In many cases, government agencies that enter contracts with a business or individual require a surety bond to ensure they complete the work. However, clients entering large contracts with a private company may require the same.
  • The surety: The surety is the organization that underwrites or backs the surety bond. If the principal does not complete the agreement or things go wrong, the surety will pay the bond to the obligee as compensation.

How surety bond insurance works

Surety bond insurance is designed to protect a business’s client rather than the business itself.

Let’s say you own a construction company and enter a contract with a city to build a new school. The local government requires that you obtain surety bond insurance to finalize the agreement. A series of unfortunate events lead you to fail to finish construction by the agreed-upon date.

In that case, the surety provider will compensate the city to cover the costs of temporary classrooms, storage and any other damages caused by breaking the contract. Your construction company will most likely then have to pay back the surety bond amount to the surety issuer.

How surety bonds differ from traditional insurance

Wait, isn’t insurance supposed to cover the costs of claims? Well, this is where surety bond insurance differs from other types of business insurance. Surety bond insurance protects a business’s client, government organization or general consumer. If a company messes up, the surety issuer compensates the obligee. However, the principal is still on the hook for the financial loss.

Unlike insurance, where you typically pay premiums and deductibles and then your insurance covers the remainder of your claim, with a surety bond, the surety will pay the obligee for whatever financial damages you’ve caused. Once this payment is issued, the surety will make you pay the total amount of the bond back to them. We’re usually talking about thousands of dollars but it could be much greater depending upon the terms of your bond.

While both insurance and surety bonds ensure that there will be financial compensation for unforeseen events, surety bonds only provide that for third parties.
Insurance, on the other hand, protects you as well.

Business owners need general liability insurance and professional liability insurance to cover themselves from unforeseen events. It is a good idea to pair these types of coverages alongside a surety bond.

Types of surety bonds

There are three main types of surety bonds used for specific purposes.

  1. Commercial bonds: Most state governments require commercial bonds before granting a permit or license to individuals or businesses intending to conduct business in that state. Examples include those constructing a government building, starting an auto dealership, establishing a medicare company or becoming a mortgage broker.
  2. Contract bonds: Contract bonds ensure the principal carries out a contract agreement legally. These bonds include bid bonds to commit contractors to their initial bid pricing, performance bonds to ensure work completion and quality, and payment bonds to guarantee payment to subcontractors or employees.
  3. Court bonds: Court bonds are guarantees the government uses to protect people, communities and businesses in the wake of civil or criminal tort litigation, including appeal, custodial and fiduciary bonds.

Benefits of surety bond insurance

Surety bonds satisfy the obligee — a business’s client or governing authority. However, there are also benefits for the business itself. Here are some of the main advantages of surety bond insurance:

  • Increases consumer and taxpayer confidence by demonstrating the principal has independently verified financial stability
  • Prevents penalties and fines for practicing without a bond — a requirement in some industries such as debt collectors and private investigators
  • Provides an affordable alternative to a line of credit or guaranteed funds
  • Allows small businesses to compete alongside larger corporations during bids
  • Reduces competition from unqualified businesses that do not perform well enough to get a surety bond
  • Often expands protection into a maintenance period after the completion of a project in case problems arise — providing additional reinsurance to subcontractors and other interested parties

How to apply for a surety bond

Surety bond applications differ by state. First, determine your state’s requirements and the amount you need to fulfill your contract. Databases, such as the Nationwide Multistate Licensing System, electronically track surety bond requirements.1 The U.S. Small Business Administration’s SBA Surety Bond Program will also guarantee surety bonds “for certain surety companies, which allows the companies to offer surety bonds to small businesses that might not meet the criteria for other sureties.”2

The surety bond underwriting process typically involves a lot of forms. The surety will want to know all about your credit history, credit utilization, current account balances, business size, ownership structure and standards. If you have red flags such as previous claims against your business, a lot of debt, a low credit score or lack of experience, your application is less likely to be approved.

The good news is you can often fill out a surety bond application at your own pace online, and the in-house underwriting capabilities of the surety often allow for bond approval within minutes. Higher-risk and more complex performance and payment bonds may take longer.

Once your surety bond quote is approved, all parties must sign an indemnity agreement. Once signed and you pay your invoice, you will receive your bond, typically through the U.S. mail. You’ll also want to file your surety bond with your obligee.

While it may feel like you’re done, remember that a surety bond only protects the obligee and not the principal (aka you). If something goes wrong on the job, you could be left on the hook to cover the expense of damages. Make sure your business is covered with a small business insurance policy designed to fit your needs, whether for the year or just for the job.

How much does surety bond insurance cost?

Many factors go into pricing a surety bond, including:

  • The state you file in, including state-mandated taxes
  • The type of surety bond
  • The coverage required
  • Term length and expiration dates
  • The kind of work you plan to engage in
  • The credit history of the business and parties involved

Typically, the cost of a surety bond will fall between one and 10 percent of the total bond amount.3 If your credit score as the business owner is strong, you can likely expect to pay between one to three percent of the total bond amount. Those with credit issues can expect to pay in the higher range, between 4% to 10% of the total bond amount.

Remember, if you don’t complete your obligations, you will have to pay back the full bond amount.

Protect your clients and your business

A surety bond is great for covering your clients, but you need to cover your business as well. After all, you worked hard to land this contract!

At Thimble, we help you stay protected on the job with insurance made just for you. To get started, click “Get a Quote” or download the Thimble mobile app, answer a quick set of questions, and get covered within minutes. Once you see how easy insurance can be with us, you’ll be bonded for life.

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Sources:

  1. NMLS Resource Center. NMLS Electronic Surety Bond. 
  2. U.S. Small Business Administration. Surety Bonds. 
  3. Lance Surety Bond Associates. How Much Does a Surety Bond Cost in 2021?