Surety bonds are considered as unnecessary business expenses. They are seen as a passport for certain, qualified firms to access bids on projects. Construction firms looking into significant private and public projects understand the necessity of bonds.
What is Suretyship?
This is a form credit in a form of financial guarantee. You should note that it is not an insurance in a traditional sense, and that is why it is surety bond. The purpose of these bonds is to ensure that contractor will perform his obligations to the client. In case, the contractor fails, surety steps in and offers financial indemnification to allow performance of client to be completed.
The main three parties to surety bond are Principal, Surety, and Obligee. Principal undertakes obligation under bond; the Obligee receives the benefit of a surety bond. The Surety is the party, which issues surety bond.
Surety bonds are different from insurance. The main difference is Principal’s guarantee to the surety. In a traditional insurance policy, you are required to pay premiums. The other difference is loss estimation. In traditional insurance, a lot of complex mathematical calculations are done by qualified actuaries to determine estimated losses. Insurance companies will calculate the probability of loss and risk payments. Loss estimates are used to underwrite to ensure
adequate cover to losses, yield a reasonable profit, and pay insurer’s expenses.
Surety companies underwrite the risks expecting zero losses. However, you are required to pay premiums. These are fees charged for ability to get Surety’s financial guarantee. This is a requirement by the Obligee to ensure the project is completed in case Principal fails to meet obligations. Under this bond, the general contractor offers indemnification agreement to Insurer.
Surety bonds are available in different variations. The main types of bonds include Bid Bonds, Payment Bonds, and Performance Bonds. Bid bonds offer assurance to project owner that his chosen contractor has submitted a bid in good faith. In case, the contractor forfeits the project, the owner accepts the next highest bid. Defaulting contractor will forfeit maximum bid bond amount. On other hand, performance bonds offer economic protection to project owner that the contractor will perform according to the contract. Payment bonds are meant to avoid potential project delays. Therefore, sub-contractors and material suppliers are paid by Surety.