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Surety Bond Insurance and other Illogical Misnomers

April 14, 2011

It’s a widely believed “fact” that surety bonds are like insurance policies for companies. While there are several surface-level comparisons that can be drawn between the two, each functions in a fundamentally different way. As a business owner it is critical to understand the opportunities and obligations brought forth by a bond. As a consumer, it is equally critical to be aware of the protection afforded to you by these bonds in the unfortunate case of a default.surety bonds

Business Benefits

New business owners will quickly realize it takes a small mountain of paperwork to get a company up and running. Obtaining a business license often makes up a large part of this paperwork, and for people starting in the brokerage, dealership, contracting, construction or financial industries a bond is generally required as part of the process. The bond functions much like a “pay to play” card where companies must pay for a bond before they are allowed to begin operating or submitting bids for contracts. Having a bond gives companies access to their given field, allowing them to make money. Being a bonded company also comes with a credibility that makes consumers feel confident in selecting your business.

What the Fine Print Says

The way a surety bond is put into use is what really differentiates it from an insurance policy. With insurance, premiums are paid by a consumer to an insurance firm, and should anything happen (a broken bone for medical insurance; a fender bender for auto insurance) the firm pays for corrective action to be taken. In contrast to the two-party insurance system, bonds involve three parties: a principal (the company seeking to operate) secures a bond from a surety (an independent firm) who protects the interests of the obligee (the consumer purchasing or using the principal’s services). In this system, the principal pays for the bond, but does not receive the benefits of it. After securing a bond, the principal is permitted to perform work for clients or customers, who become obligees. Should the principal perform faulty work or fail to deliver on their contractual promises, an obligee files a claim with the surety to receive compensation for the principal’s default. The surety can pay out claims up to the total amount of the bond for any claims it deems to be credible. After all claims have been settled, the surety will contact the principal for repayment of all claims. In this way, the principal winds up paying for any damages or faulty service they have caused and the surety is simply an intermediary that ensures consumers receive fair compensation.

Consumer Interests

While bonds are great for businesses in that they make it possible for companies to legally perform work, bonds provide the greatest benefits for consumers. Surety bonds in their current form originated in the late 1800s when the federal government realized many of its public projects were not being completed adequately by the firms who had submitted a winning bid for the work. By instituting bonds, obligees can rest assured that their contract with a construction team, mortgage company or even health club will be honored in full.

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