Common Questions about Surety Bonds
What is Bonding?
Bonding is a specialized line in the property and casualty insurance field. It is a three-party contract whereby the surety guarantees to the obligee that the principal will fulfill their obligations as outlined in a written agreement.
What is a Surety Bond?
It is an extension of credit in which the surety co-signs for the principal and guarantees performance and payment obligations.
How is Bonding different from more common lines of insurance?
Bonding is a three-party contract while insurance is a two-party contract. A bond is in effect until the obligation is complete while insurance is for a specified period. Performance and payment are covered under a bond while named perils are covered by insurance. The bonding company has rights of subrogation against the principal for any losses yet the insurance company has no such rights versus their insureds.
In traditional insurance, the risk is tranferred to the insurance company. In bonding, the risk remains with the principal. The protection of the bond is for the obligee.
In traditional insurance, the insurance company takes into consideration that a certain amount of the premium for the policy will be paid out in losses. In true bonding, the premiums paid are "service fees" charges for the use of the surety company's financial backing and guarantee.
In underwriting traditional insurance products the goal is to "spread the risk." In bonding, surety professionals view their underwriting as a form of credit so the emphasis is on prequalification and selection.
How does a surety underwrite?
Each bonding company has its own guidelines and underwriting criteria. However, the following basic factors (the three C's) will be taken into consideration.
- Capacity. Does the applicant have the skill and ability to complete the obligation?
- Capital. Does the financial condition of the applicant warrant approval?
- Character. Does the principal's record show him to be of good character?
What is Personal Indemnity?
It is a legal obligation on behlf of the company owners, spouses, or third parties which guarantees to repay to the bonding company for any losses and expenses incurred under their bond.
The reasons for this common requirement are that the surety requires all personal assets to be available to back the guarantee and that there is less chance a principal will avoid its responsibilities if its personal assets are at stake.