Surety bonds are often misunderstood. For many, all they know about them is that they are an expense required to legally operate their business. There are many common misconceptions when it comes to suretyship, but lets review what a surety bond is prior to going over bond falsities.
A surety bond is a three party guarantee. The three parties are the principal (the person or entity required to obtain the bond), the obligee (whoever is requiring the bond of the principal), and the surety (the carrier backing the bond). A bond should be thought of as credit, not an insurance product for the principal. In the event of a valid claim, the surety will pay the obligee a specified amount and look to the principal for compensation for the claim. The principal pays an annual premium for the financial strength of the surety to write the guarantee rather than obtaining a letter of credit and tying up capital. You can read more about surety bonding in our Bond Information Section.
Now that we have an idea of what a surety bond is, lets begin with our myths of suretyship!
1) “I have never had a claim, I should get a bond at a great rate.” While the surety will be happy to hear you have never had a claim, it is not a selling point. Bonds are underwritten quite differently than regular insurance. When it comes to insurance, losses are expected. However, bonds are underwritten with the expectation of no losses. Therefore, if you ever trigger a claim, it is likely you will never obtain bonding again.
2) Premium will be reduced the longer a principal stays with a bonding company. False, surety bond rates rarely change unless the principal’s situation changes. Bonding companies have to file underwriting guidelines to each state they do business in so they can not discriminate. The rate filings are tedious and costly job and do not change often. Therefore, unless the principal’s situation changes (ie business financials, owner(s) personal credit, etc.), the rate will not change often.
3) You need to pay the full amount of the bond. Wrong again. Some people assume that surety bonds must be paid in full in order to obtain a bond, which is simply not true. While some bonds will require 100% collateral for higher risk cases, most will simply pay an annual premium which is a percentage of the total bond amount.
4) The principal is the beneficiary in the event of a claim. Sorry, but this could not be farther from the truth. As we learned earlier, the obligee is the beneficiary and the principal will have to pay the surety any funds paid out plus attorney fees.
5) “That’s too much! A $50,000 auto dealer bond only costs $250 year.” Anyone that has been in the surety bond industry for a couple years knows that rates have drastically changed due to historic surety losses around the turn of the millennium. Bonding companies have since changed their underwriting guidelines and have become much more conservative. The soft bond market is a thing of the past and so are ridiculously low rates.
There many other surety bond myths out there. Above are the misconceptions our agency most commonly hears. We do our best to educate our clients so they can feel more confident with the process of obtaining a bond. Feel free to post a comment if you have any questions or would like to add a common myth to our list.