What is a Surety Bond and How It Differs from Insurance
From small businesses to large corporations, the phrase bonded and insured is commonly used. However, not all business owners understand the difference between surety bonds and insurance. The two have distinct characteristics that give each a unique purpose in the business world. It is necessary for businesses – and the consumers they serve – to have an understanding of how surety bonds and insurance work, when each is needed, the cost of protection, and which agencies offer one or the other.
This brief guide offers a simple breakdown of the subtle and significant differences between surety bonds and insurance.
How They Work
The most substantial difference between surety bonds and insurance comes down to how each works in practice. Surety bonds create an agreement between three specific parties – a surety agency, the individual in need of the bond, and the organization or person requiring the bond in the first place. The surety agency offering the bond promises to pay, up to the bond limits, should the individual carrying the bond not perform or delivery on his or her responsibilities. This payment of a bond claim goes to the organization or person requiring the bond, not the individual who purchased the bond in the first place. When a claim is made, the bondholder is required to repay the surety agency.
Insurance differs in that a contract is created between two parties only – the insured and the insurance company. When securing insurance coverage of any type, an individual or business secures coverage from an insurance agency, not a surety agency. Insurance coverage is meant to protect the insured from financial loss from a disaster, theft, or liability. When a claim is made for any of these issues, the insurance company pays a benefit, up to the policy limits, to the individual or business directly. There is no third party that receives payments, and insurance policies do not require the insured to repay amounts received to cover a claim.
When a Bond or Insurance is Needed
Another stark difference between surety bonds and insurance coverage revolves around when each is a requirement. Surety bonds are a necessary component of certain professions, including licensed contractors, mortgage brokers, and freight brokers. Having a surety bond ins place is required as part of the licensing process, as it provides some financial protection to a business owner or contractor’s customers.
Insurance, on the other hand, is not often a required part of doing business. Instead, business owners and contractors are encouraged to have insurance in some form to cover specific risks, such as disability, death, or liability. Businesses and contractors may be required to have general business insurance when signing a new lease or when purchasing equipment, but it is far less common than surety bond requirements.
Paying for Bonds and Insurance
It is also important to recognize the differences between surety bonds and insurance as it relates to pricing and cost. Surety bonds are a form of credit to the bondholder, and the surety agency offering the bond needs to feel confident that, should a claim be made, the claim amount can be repaid by the bond owner. Because of this unique structure of credit, surety bonds are priced based on the credit history and claims track record of the business owner. When credit has been an issue in the past, a bond may be priced higher than if credit is strong. Fortunately, business owners only pay a percentage of the total bond amount, making the requirement less of a burden than most anticipate.
Insurance is priced differently. An insurance company offering coverage bases the cost of insurance on the amount and type of coverage requested, alongside the amount of risk the company takes on in the process. If an individual has a track record of high-risk behavior, most often noticeable through claims history with other policies, the cost of insurance is likely to be higher. However, insurance premiums are less reliant on personal or business credit and financial standing, making them different from surety bonds.
Business owners can do themselves a favor by understanding the differences between surety bonds and insurance coverage. The former offers a type of credit to the bondholder, with a promise to pay a third party should a claim be made in the future. Conversely, insurance offers financial protection to the insured, without the presence of a third party. Surety bonds are more likely to be a requirement of operating certain businesses, while insurance is typically an option. Finally, surety bonds are priced differently than insurance. Those who recognize these differences can make more informed decisions about which is needed to help protect their business.
Eric Weisbrot is the Chief Marketing Officer of JW Surety Bonds. With years of experience in the surety industry under several different roles within the company, he is also a contributing author to the surety bond blog.