In terms of insurance and risk products, surety bonds can be some of the more confusing in their terminology and how they respond to covered losses. As insurance bonds go, it’s one of the most commonly used products for companies in the construction industry and those in licensed and regulated industries. It helps mitigate against financial loss and can often mean the difference between winning a contract bid or not. It’s so common in the construction industry that it’s often confused as a type of contractor’s insurance.
So let’s dive in and break down the ins and outs of surety bonds in an easily digestible way.
What is a Surety Bond?
A surety bond is a guarantee to be held responsible for the debt or failure of another party. It’s a type of contract with three parties involved:
- The Surety – They are held responsible for the performance of the principal
- The Principal – They must complete a set project or tasks for the obligee
- The Obligee – They have hired the principal and require them to purchase a Surety Bond
In a nutshell, the Obligee is trying to protect their organisation or business if the principal fails. In this three-party agreement, The Surety agrees to take the financial risk in case of this failure. Protecting the obligee from any financial loss or financial risk.
Who needs a Surety Bond?
Surety bonds are needed most by those in the construction industry or those providing a service to government entities. Businesses generally only require it; for argument’s sake, we can call it a form of business insurance.
Large-scale public infrastructure projects require a variety of bonds from those bidding for construction projects. The Canadian government have detailed documentation for surety bonds and companies when dealing with government contracts at all stages of contracts.
What are the different types of surety bonds?
Surety bonds fall into two main categories, contract surety bonds and commercial surety bonds.
Contract surety bonds
Contract surety bonds, also known as a construction bond, are most commonly associated with the construction industry. In these bonds, the construction company or contractor is typically the principal. Within this category, there are a few key types of bonds:
- Bid Bond, as the name suggests, bid bonds are used at the bidding or tendering stage of contract negotiations. This surety bond protects the project owner and ensures that if the contractor wins the bid, they will be able to follow through with their commitment.
- Performance Bond, this type of bond guarantees that the principal will follow its contractual obligations and complete the construction project as agreed. Performance bonds can be issued up to 100% of the contract value. However, they are more generally issued to the value of 50% of the contract.
- Labour and Material Payment Bond, also known as Payment Bonds, this type of surety bond is only issued in combination with a performance bond. It guarantees that the contractor will pay all subcontractors or suppliers for goods or services supplied to the project.
- Maintenance Bonds, this surety bond protects the project owner from any defective work after a project is completed. The principal agrees to guarantee the job for a fixed period of time, not too dissimilar to a warrantee, except that the surety company a
Commercial surety bonds
These types of bonds ensure that a business follows any regulations, legal or security requirements while doing a job. A claim can be made against these bonds if there is any breach of law or dishonesty.
- Court bonds, also known as fiduciary bonds, it ensures that the principal acts in the interest of their client and also in line with any laws and court orders. It’s most commonly used by those offering financial advice or managing an estate on behalf of a client.
- License and permit bonds, this kind of bond is required by government entities when a business operates in an industry that requires a licence or permit to operate. Its purpose is to act as a deterrent to breaking regulations and protect the public from bad actors. It’s required in a variety of different industries, from credit providers, car dealers, and contractors to collection agencies.
How much does a Surety Bond cost?
A surety bond’s cost is calculated as a percentage of the bonded amount. For example, if you require a bond amount of $20,000 and your rate is 5%, you would be charged $1,000 by the surety company.
The cost to obtain a surety bond varies depending on three main factors, the type of bond, the amount of bond coverage required, and your credit score.
Your insurance and bond broker will be able to detail your specific cost factors.
Common Surety Bond Questions
Who does a surety bond protect?
A surety bond protects the principal from financial risk. This is the party paying for the contract or job to be completed.
Why are surety bonds required?
They offer a guarantee payment in the event that a party fails to uphold their side of a contract, reducing the risk to the principal.
What is a performance bond?
A performance bond is a type of surety bond that ensures a party will uphold it’s contractual obligation.