Surety Bonds 101
- General Questions
- Surety Bond Costs
- Surety Bond Process
- Insider Surety Bond Tips
- Auto Dealer Licensing
- Collection Agency Licensing
- Contractor Licensing
- Freight Broker Licensing
- Health Club Licensing
- Money Transmitter Licensing
- Mortgage Broker Licensing
- Telemarketing Licensing
- Contractor Bonding Guides
- Fidelity Bond Guides
- Surety Tools
- Surety Bond Categories
What is a Surety Bond? A Complete Guide
Surety bonds are legally binding contracts that ensure obligations will be met between three parties:
- The principal: whoever needs the bond
- The obligee: the one requiring the bond
- The surety: the insurance company guaranteeing the principal can fulfill the obligations
This detailed article will provide you with an understanding of what surety bonds are, how they work, what risks they bring to your company/personal assets, and how they can benefit you.
A Simple Surety Bond Definition
Surety bonds are an insurance policy for the party requiring the bonds (the obligee).
In most instances, the obligee is a government agency and the bond is in place to protect the government and its citizens.
The obligee requires the principal (you) to obtain and pay for the surety bond.
Which Bond Do You Need?
There are three types of surety bonds that can be required of you:
- License and permit bonds needed for various professions to operate legally such as auto dealers, contractors and other occupations.
- Contractor bonds required for public construction projects.
- Court bonds required by the courts for various purposes.
If you're unsure of which bond type you need, you can use our find your bond tool. People will sometimes incorrectly refer to surety bonds as an “indemnity bond” (a generic name) or a “security bond” (a mispronunciation of surety bond and not an actual bond type).
How Does a Surety Bond Work?
Surety bonds work as a form of insurance to the obligee, as they are the beneficiary that can file a claim if the bond's promise is not met. It is a form of credit to the principal, as claims must be re-paid by the principal to the surety.
When you’re required to get a surety bond you are expected to abide by the terms of the bond (if you don’t, claims occur). When it comes to surety bond claims, you are expected to pay every penny, plus legal costs. The bond is backed by the surety, but the surety will require an indemnity agreement (also known as a general agreement of indemnity) to be signed by your company and all owners personally.
Indemnity agreements pledge your corporate and personal assets to reimburse the surety for any claim(s) and legal costs associated with them. Read our guide to learn more about how indemnity agreements work.
The surety is only saying "you're good for it" if any claims arise. If they are wrong and cannot collect payment from you directly or through the courts, they are ultimately responsible. That is why they need to underwrite the likelihood of you causing a claim and your ability to re-pay them.
Now that you know how surety bonds work, you may be asking yourself “what is a surety company?”; you can read our article to learn the definition of sureties, how they work and how to choose the right one for you.
The Consumer’s Guide to Surety Bonds E-Book
If you want the most thorough answers available to all of the fundamental questions related to getting a surety bond, you can download our free "Consumer's Guide to Surety Bonds" e-book. The topics covered in the e-book include:
- How surety bonds work
- How indemnity agreements affect you
- The various surety bond types required
- Surety bond pricing
- How to get bonded
- How claims affect you
This e-book was created with first time applicants in mind, and is an excellent resource if you're unfamiliar with how surety bonds work, pricing and how they can greatly affect you or your business.
How to Obtain a Surety Bond
First you need to determine which bond you need, and there are thousands of different bond requirements throughout the U.S. If you purchase the wrong one, it will be rejected by the obligee.
How Surety Bonds Benefit You
As mentioned above, surety bonds are a form of credit to you (the principal). The benefits of surety bonds can be better understood by reviewing the alternatives to obtaining a surety bond.
Posting cash directly with the obligee or with a trustee is an alternative on occasion. Some obligees will also accept an Irrevocable Letter of Credit in lieu of a surety bond.
Unfortunately, all of these alternatives have several downsides in common:
"What's a Surety Bond?" Infographic
- 100% Collateral - These options require 100% collateral. In other words, you are providing them your assets to make the guarantee.
- Higher Costs - You won't have to pay for a bond premium, but the lost investment income (even in conservative investments) from posting 100% collateral is more than the surety bond costs for most.
- Decreased Capital - Posting your own assets in lieu of a bond decreases your liquidity.
- False Claims - False claims may be paid without adequate investigation on your behalf. Giving your money directly to the obligee to decide when they want to use it for an insurance claim is risky business. An insurance company would never allow you to make decisions as to when you may collect on insurance claims and neither should you.
- Increased Default \ Bankruptcy - Lessening your working capital increases the likelihood of your company defaulting on a contract or going bankrupt.
After reviewing the alternatives, most begin to realize that the bonding company (or the surety) making a guarantee on your behalf for a small percentage of the bond amount is a much better option than parting with your liquid cash.
The indemnity agreement that requires you to back the surety with your corporate and personal assets also begins to make more sense. The surety is extending you surety credit with only a signature as collateral. When a bank extends you credit on a mortgage, they have your home as collateral.
How to Protect Your Personal & Corporate Assets
The best way to protect your assets from bond claims is to avoid claim activity in the first place. The bond is a legal document signed by you and the surety, backed with your assets. Therefore, it is imperative that you know what the bond is guaranteeing you will or will not do.
Unfortunately, bond form language is written in legal language that is difficult to understand without a law degree. Many bond forms make reference to state statutes as well, requiring further research.
Your surety bond agent should be able to explain specifically what your bond guarantees. If they can’t, they likely won’t be a very good claims advocate for you after the bond purchase is complete.
"What is a Surety Bond?" Quick Video Overview
If you don't have the time to read about surety bonds, watch our quick 90 second video which covers how surety bonds work.
What is My Bond Guaranteeing?
What your bond guarantees is dependent on the bond type and the bond form’s language. While it is extremely important to understand what your bond is guaranteeing, it is beyond the scope of this article. There are thousands of different bond forms for a variety of bond types required throughout the country. Some of the more common states that require many different types of surety bonds include California, Florida and Texas. You can see all surety bond requirements by state here.
Some common surety bonds that are required to obtain a license include auto dealer bonds, contractor license bonds and freight broker bonds. You can take a look at the full list of license and permit bonds here.
Short of becoming a bond expert, there is no way for you to determine with certainty what your bond is guaranteeing (even if we provide a surety bond example form for you to review). The good news is your bond agent should be able to explain the specifics in easy to understand terms. However, it isn’t reasonable to expect them to have all of the thousands of bond requirements throughout the country memorized, but at a minimum, they should be willing to take the time to research it and get back to you.