Since most surety bonds are available through insurance companies some mistakenly believe that a surety bond is the same as insurance. Even though they have a few minor similarities, they are not the same. We will discuss five of the differences in this article.
Comparing the Surety Bond to Insurance
Comparison #1 � A surety bond is a three-party agreement that joins the issuer of the bond (the surety) with the second party (the principal) in a financial guarantee to the third party (obligee) that the principal will fulfill all obligations in a contract. The principal relies on the financial strength of the surety in order to obtain a contract with the obligee. Insurance is a two-party agreement where the insurance company agrees to pay the insured in case of loss or damages.
Comparison #2 � Losses are not expected under a surety bond. The contracting company to which a bond is issued must be financially strong and stable to qualify for bonding. The surety company conducts a rigorous background check into the contractor�s reputation, credit worthiness and the skills and ability to complete the project as specified along with other check points. The contractor seeks a surety bond because it is required by the project owner.When an insurance policy is purchased, losses are expected. Insurance rates are adjustable to compensate for the law of averages, expenses and losses.
Comparison #3 � A surety company expects to recover losses occurred. If the principal defaults on the contract and the surety bond must pay the obligee, the surety expects to be repaid by the principal. The surety loaned its assets to the principal and therefore seeks repayment.Repayment is not expected of an insurance claim. The purpose of insurance is to cover losses.
Comparison #4 � The premiums paid for a surety bond act as a service charge for qualifying the principal for the bond. A surety company is more selective of the companies they agree to bond since the bond serves as a non-collateral loan. The surety company charges � percent � 3 percent of the contract amount and is determined by the financial strength of the principal. Premiums are generally paid annually while insurance premiums cover expenses and losses. Most insurance companies can issue an insurance policy to nearly everyone. The issuance of a policy depends on the level of risk. The more risk to the insurance company, the higher the rate and premium will be.
Comparison #5 � As stated before, surety companies are highly selective of the companies they choose to bond. They require several years of business success, stable financial strength and the ability to complete projects on time and within budget. Surety agents are highly trained not to make bad loans.
The insurance agent is generally more flexible since he can write almost any policy at a rate that�s appropriate. The insurer operates on a high volume of business in order to cover every policy holder and make a profit.
As you have just learned there are several major differences between surety and insurance. Their different functions meet a need in business and most business owners use both of them to protect themselves from loss.