WEDNESDAY, DECEMBER 23, 2020
Surety bonds are required for many businesses and professionals. It operates differently than an insurance policy, however.
Rather than a business owner purchasing an insurance policy and filing claims directly with the insurer in a two-way agreement, a surety bond operates as a three-way agreement between the business owner, client and the surety. The business owner, known as the principal in this situation, must carry a surety bond in order to complete a certain contractual obligation. The obligee is the party, or client, that may require a surety bond and the surety is the entity that provides the bond.
Since surety bonds work differently than insurance policies, so do their claims.
Who Files a Claim on a Surety Bond?
In general, the obligee may file a claim on the surety bond in case the principal is unable to fulfill the bond’s obligation.
Consider performance bond, for example. A performance bond is a type of surety bond that promises the principal (usually a contractor) will complete a certain project as agreed upon with the obligee (their client). To cover their potential losses, the obligee may require the principal (or the client will require the contractor) to purchase a surety bond. If the contractor is unable to complete the project as agreed upon with the client, the client can then receive compensation through the surety. The surety is then responsible for filling the position of contractor with another individual or entity that can complete the project.
This does not mean that the original contractor, or principal, is out of the woods, however. If a surety has to pay out for a claim, the surety can then turn to the principal for compensation for the losses. This may also affect the principal’s credit score and surety bond costs if they have to purchase another bond in the future.
How Does a Surety Bond Pay Out?
One of the main differences between a surety bond and an insurance policy is that an insurer doesn’t generally look for compensation after paying out a claim. For example, if you have to file a claim on your car insurance policy, your insurer does not ask you to repay for the repairs they cover. Instead, you may just see a rise in your car insurance rates.
A surety bond, however, allows the surety to seek compensation from the one who purchased the surety bond if compensation must be paid.
Compensation is also not given for the sake of the principal, or the one who purchased the surety bond. Instead, compensation goes to the obligee who required the surety bond to be purchased. Going back to the example of a performance bond, if the contractor is unable to complete the project under contract, the surety will provide compensation to the client whose contract was not fulfilled. Once compensation is paid, the surety may then turn to the contractor (or principal) for reimbursement for settlements and any other related legal costs involved.
Once a claim is filed, the surety company will investigate the claim to discover whether or not the obligations of the contract were withheld by the principal. If not, the surety will pay compensation to the obligee before seeking reimbursement from the principal. Invalid claims, such as if the surety believes the obligations of the principal to be fulfilled, will result in no further action beyond the investigation.
Keep in mind that different types of bonds may pay out differently. Payment bonds may operate differently than performance bonds or fidelity bonds. If you have a bond for your business or a certain project, make sure to remain in contact with the surety throughout the claims process. It is the responsibility of the obligee to file a claim if they believe that the principal has not completed their end of a contract.
If you are the principal who is required to have a surety bond (such as a contractor or someone seeking a certain business license), make sure to read the contract carefully and fulfill obligations to the best of your ability.
Is a Surety Bond Expensive?
The cost of a surety bond varies depending on the type of bond, size of the bond and how much the principal is required to pay. Surety companies will quote principals to pay different percentages of a surety bond primarily based on credit score. A principal with a low credit score, for example, may pay a higher percentage of a surety bond than someone with a high credit score purchasing the same type of bond.
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