Skip to content

“THE ROAD TO SUCCESS IS ALWAYS UNDER CONSTRUCTION”

Lily Tomlin

What is a Surety Bond?

A bond issued by an entity (the surety company) on behalf of a second party (the contractor) guaranteeing that the second party will fulfill an obligation or series of obligations to third party (the owner/oblige). In the event that the obligations are not met, the third party will recover its losses via the bond.

Many people confuse Surety bonding with Insurance. Surety is NOT Insurance and probably more similar to Banking Credit. See below to understand better:

Bonding vs. Insurance:

While many insurance companies have surety divisions (such as Travelers and Liberty), the products are much different.

  • Insurance is a two (2) party contract while Surety bonds are a three part obligation between the Surety, Contractor (principle) and owner (obligee).
  • Surety bonds are a non-traditional insurance product.
  • Surety bonds are more similar to bank credit than Insurance whereas they guarantee an obligation and are a recoverable form of credit.
  • Insurance is underwritten with various degrees of loss expectation (a risk pool) and Surety bonds are underwritten with a 0% loss ratio expectation.  When underwriting, the surety takes into account recoverable assets the “principle” has that will indemnify or hold harmless the surety in the case of a claim.
Types of Surety Bonds:
  • Bid Bond – Allows the contractor to qualify their bid.  The Bid Bond provides financial assurance that the bid has been submitted in good faith and that the contract WILL enter into the contract at the price bid and will provide necessary performance and payment bonds- otherwise suffer a “bid bond penalty”. 
  • Performance Bond – The Performance Bond protects the project owner from financial loss if the contractor fails to perform the duties outlined in the contract.  This bond guarantees that the contractor performs the job according to the specifications outlined and within the time period allowed.
  • Payment Bond – The Payment Bond guarantees that the contractor will pay all subcontractors, laborers and for supplies relating to the 
    project at hand.
  • License and Permit Bond: A License and Permit Bond guarantees that a business will operate in accordance with federal, state, or local laws and regulations. Each License Bond is specific to one industry and protects customers and/or the state from damages.
  • Subdivision Bond:  Guarantee purchased by a landowner when upgrades or changes are required by a local government authority. The subdivision bond guarantees the work is completed well and according to terms. This is usually a developer guaranteeing proper roads, curbs and water line installations.
  • Union Bonds:  Union Bonds, sometimes referred to as “Wage and Welfare Bonds,” are required in cases when a company wants to hire an employee represented by a union. The bond guarantees that the employer will cover all due payments on wages and welfare for the union employee.
Costs of Bonds:

Premium

The cost of the bond paid by the principal to the surety in exchange for the financial guarantee provided by the bond. The bond premium is typically a percentage of the total bond amount.

  • The cost/premium of a bond is determined by two factors: The risk associated with the account and the filed rate of the surety company. Below is a basic outline of the standard premium rates but your rate could differ depending on the circumstance:

 

    • Bid Bond – no charge EVER through the Loxme Group.
    • Performance Bond – 1% - 3% of contract price.
    • Payment Bond - included with performance bond cost.
    • License and permit bonds, Subdivision and Union bonds can have various rates associated with them that may differ from above and even your current account rate due to the varied degree of risk associated with each.

Definitions:

Agent

A licensed and authorized representative of an insurance or surety company. Only a licensed agent can legally solicit or sell insurance policies or surety bonds.

Attorney in Fact

A person who has the Power of Attorney, granted to him or her by a surety company. This allows them to enforce or execute a surety bond on behalf of that company.

Bid Bond

A bond required by contractors in order for them to be able to bid on a contract. The bid bond guarantees that a contractor will execute a contract at the bid price they have offered. See Contract Bond.

Bond

A legal agreement between three parties: the surety, the bond obligee, and the bond principal. Under the bond agreement, the surety agrees to answer in front of the obligee for the default of the principal.

Bond Term

The duration of the bond. A term may be a fixed amount of time, typically annual or biennial, or a continuous term which means it is automatically extended until cancelled or terminated by one of the parties to the bond.

Bond "Line"

The amount and size of projects a surety is willing to bond over the course of a year for a contractor. This may either be a single bond size limit or an aggregate limit.

Bond Back

A requirement by the surety for subcontractors on a project to be “bonded back” to the general contractor.

Bond Penalty

Also known as the penal sum of the bond. This is the total bond amount, i.e. the total amount of compensation that may be extended under a particular bond.

Broker

Someone acting as an intermediary between a client (such as a contractor) and a surety in negotiating or obtaining a bond on behalf of the former.

Cancellation Clause

A clause in the bond agreement allowing a surety to cancel any future liability under the bond. The surety must inform the obligee of its cancellation through written notice.

Claim

A non-judicial dispute resolution proceeding made against a bond by a claimant.

Claimant

A party defined within a surety bond agreement or a statute as being entitled to make a claim against a bond to be compensated for losses or damages it has suffered.

Co-surety

One of several sureties participating on a bond with an obligation joint and several. A limit of liability for each surety may still apply under a co-suretyship.

Collateral

Assets or anything else of value pledged with the surety to protect it from loss due to a principal defaulting on their bond agreement. Collateral can be used as a principal’s indemnity in case of default.

Contract Bond

A general term for any type of surety bond required by a contractor working on a contract. Contract bonds, also known as construction bonds, guarantee that a contractor will comply with the conditions of the contract. See Bid Bond, Payment Bond and Performance Bond.

Contract Price

The sum of money paid by the client, or owner, to the contractor. The contract price is the basis for the bond cost or premium that contractors need to pay to get bonded.

Contractor License Bond

A pre-licensing requirement for contractors in most states. The bond guarantees that contractors will comply with state rules and regulations for contractors and conduct business honestly and professionally.

Court Bond

A general term for any type of bond required by a court. Court bonds may be required by probate courts, to guarantee for the trustworthiness of a fiduciary, and appeal courts when a litigant wants to appeal a court judgment. See Fiduciary Bond.

Default

The violation of the terms of a surety bond or a contract due to failure to perform the duties set forth therein.

Effective Date

The date on which the coverage provided by a bond becomes effective.

ERISA Bond

A bond required by the Employee Retirement Income Security Act to protect employees with benefit plans covered by the Act. The bond protects employees’ benefit plans from theft or fraud.

Exoneration

When the obligation of a surety toward a project or obligee ends. Usually a surety is not exonerated upon completion of a project - under most contracts there is a warranty period after completion during which the surety is still liable.

Fidelity Bond

A general term for any type of bond that is intended to protect employers and companies from employee dishonesty, theft, fraud or else.

Fiduciary Bond

A fiduciary or probate bond is typically requested by a probate court. This bond is issued to a court-appointed fiduciary, guardian, administrator, trustee as a guarantee for their trustworthiness.

Indemnity

The guarantee, under a bond agreement, that a principal will reimburse the surety for any compensation it extends to a claimant under that bond.

Indemnity Agreement

The agreement to restore a party to its previous financial position, and protect it against loss. An indemnity agreement is signed by bond principals to guarantee that they will repay the surety if it extends compensation to oblige(s) under the bond agreement.

License and Permit Bond

The license and permit bond is a pre-licensing requirement for individuals and companies who need to obtain a business license in order to operate their business. This bond guarantees that the business will operate in accordance with all laws and regulations pertaining to its industry. It is also known as a commercial bond.

Miller Act

The 1935 Miller Act requires contractors working on federal government projects to obtain a performance bond that guarantees their performance on the contract. The Act further requires contractors to obtain a payment bond to guarantee that they will pay their subcontractors and material suppliers. Most states have so-called Little Miller Acts that pose a similar requirement on state projects.

Obligee

The party protected by loss or damages under a bond agreement; a bond ‘runs to’ the obligee. The obligee can be an individual, company, government or government agency.

Payment Bond

A type of contract bond that serves as a guarantee that a contractor will pay the subcontractors, suppliers and laborers they work with on a contract. Typically issued alongside a performance bond. See Contract Bond.

Performance Bond

A type of contract bond that serves as a guarantee that a contractor will perform work according to the conditions set forth in the project contract. The performance bond protects the project owner from contractors who default or violate the conditions of the contract. Typically issued alongside a payment bond. See Contract Bond.

Premium

The cost of the bond paid by the principal to the surety in exchange for the financial guarantee provided by the bond. The bond premium is typically a percentage of the total bond amount.

Premium Adjustment

If a contract amount is changed, the surety will adjust the premium to decrease or increase, depending on the change in the contract amount.

Principal

The party that is bonded to the obligee under the surety bond agreement. The bond is put in place to guarantee the principal’s honesty, integrity and compliance with legal requirements.

Reinsurance

Protection that the surety company secures for itself through a reinsurance company. A reinsurance guarantees that if a surety suffers a major loss, a large part of that loss will be carried by the reinsurance company. Reinsurance is a form of ceding part of the liability to another company.

Sales Tax Bond

A type of financial guarantee bond. The sales tax bond guarantees that businesses will pay any outstanding taxes or dues to the government as well as file business tax information within the legal deadlines.

Surety

The company which issues the bond and guarantees for the performance of the principal to the obligee.

Surety Bond

A three-party agreement between a principal, an obligee and a surety. Backed by the surety, the bond guarantees to the obligee that the principal will keep their contractual obligations.

Surety Bond Renewal

The continuation or renewed issuing of a bond for a new premium term. When renewing a bond, principals will need to pay a bond renewal premium.

Treasury Limits

A surety must meet the qualifying limits imposed by the U.S. Department of the Treasury to be eligible to issue bonds on federal contracts. These limits are determined by the U.S. DoT on the basis of the “qualifying power”, or financial capability, of the surety.

Treasury Listing

The U.S. Department of the Treasury list of sureties eligible to issue bonds on federal contracts.

Underwriting

The process of qualifying for a bond. During underwriting, the surety investigates the character, capacity and capital of the bond applicant to assess the risk involved in issuing a bond to them.

Scroll To Top