How Do Surety Bonds Work? | ccisbonds.com

A Surety bond is a contract issued by an insurance company that provides a financial guarantee to an interested party (usually a government agency) that a named person or business will adhere to the terms established by the bond.

Surety bonds have three parties; (1) the person or business required to purchase and file the bond (the “Principal”), (2) the insurance company providing the financial guarantee (the “Surety Company”) and (3) the government agency (or other interested party) requiring the bond (the “Obligee”).

How does a surety bond work?

The Surety Company provides the Obligee with a financial guarantee up to the dollar amount of the bond (“penal sum” or “bond amount”) that the Principal will comply with the requirements defined in the bond form. When the Principal violates the provisions of the bond, the Obligee files a claim with the surety company for financial damages and the Surety Company is responsible for making payment to the Obligee. Ultimately, the Principal is responsible for their actions and required by law to reimburse the Surety Company for any payments made under the bond.

Are Surety Bonds Insurance?

Surety bonds are not an insurance policy. Most people make the assumption that a surety bond is insurance because they are issued by insurance companies and involve payments when things don’t go as planned. However, surety bonds and insurance policies are different for four key reasons: (1) the number of parties involved, (2) the protected party, (3) the party responsible for claims and (4) the expectation of claims.

Key Difference #1: The Number of Parties Involved

Insurance policies involve two parties: the insurer and the insured.

Key Difference #2: The Protected Party

Insurance policies exist to protect the insured from loss due to unexpected events such as accidents, medical emergencies, or natural disasters.

The majority of surety bonds exist to deter individuals and companies from violating the law. They protect the Obligee (the party requiring the bond)—and sometimes the consumer—when such violations occur.

Key Difference #3: The Party Responsible for Claims

When a claim is made against an insurance policy, the insurer pays the claim. The insured is not expected to reimburse the insurance company.

When a Principal fails to meet the obligations of a surety bond, the Surety Company initially pays the claim. However, and this is crucial to understand, the Surety Company requires the Principal to repay the claim in its entirety. In other words, the Principal not only purchases the bond, but is also legally responsible for reimbursing the Surety Company for any claims paid out on the bond.

Key Difference #4: Expectation of Claims

Insurers expect claims. Premiums pooled from large numbers of policyholders are structured to absorb this loss and to minimize risk.

Surety bonds are primarily utilized to provide financial payment for inappropriate or illegal conduct. Therefore, Surety Companies approach the transaction with the expectation that a claim is unlikely.

What types of surety bonds are required of contractors in California?

While all licensed California contractors are required to carry a $15,000 contractor license bond, certain contractor licenses may require a $12,500 Bond of Qualifying Individual, a $100,000 LLC Employee/Worker Bond, or a Disciplinary Bond depending on their license status. Contractors may also be required by the owner of a project to provide a bid, performance and payment bond, often referred to as Contract Surety Bonds, on a job by job basis.