A surety bond is a three-party contract between a principal (business owner purchasing bond), an owner (state agency requiring bond) and a surety (the bond agency). For the customer, the surety serves as a source of insurance in case of work unfinished. For the business owner, it functions as a line of credit in business matters and as a source of reliability for the customer in choosing the company.
If the surety is defaulted on, the bond company is then required to pay a lump sum to the customer that the business has left with unfinished work. Here are some common misconceptions that you may be unaware of.
Myth One: They are the same as Insurance
Typically, surety bonds and insurance can be sold by the same company. Surety bonds and insurance are similar in that both assure financial reimbursement. They are paid for in annual premiums that are fractional compared to the entire sum of the purchased policy. However, here are some differences:
- Surety bonds are between three-parties, while insurance is only between two-parties.
- Surety bonds are paid out by the bond company and the principal owner. Insurance funds only derive from the collective premiums.
- Losses are unusual in surety bonds, but they are more common in insurance.
- Surety bonds manage losses through underwriting. Insurance losses depend on theory of probability to regulate theirs.
Myth Two: Surety Bonds are very costly
A common misconception of surety bonds is that they tend to have an extreme fee. What most people do not know is that surety bonds usually end up only costing between about one and three-percent of the entire price.
Oftentimes, contractors don’t even end up paying a dime, as the bond company pays back the full price of the bond in the first payment. Keep in mind that to drive down costs, higher credit scores will lower any premiums.
Also, clearing any outstanding civil judgments, collections and tax liens will lower premiums. The cost of clearing these debts might save money overall if the premium ends up being lower than the funds used in paying them off.
Myth Three: All Sureties are the same
Not all of the agencies that sell sureties are equal. State insurance agencies can show whether or not the surety is in the suitable project jurisdiction because not all agencies are on the U.S. Department of the Treasury Listing of Approved Sureties.
Also, some agencies do not have many partnerships in the bond industry. Therefore, they do not have the ability to send an application to several different places, which might decrease the chances for a lower premium quote.
Some small agencies do not have the authority to evaluate in-house applications, which might possibly increase approval wait times and fees.