Surety Bond vs Insurance: What's The Difference?
Surety bonds and insurance: are they the same? In short, no. But it is easy to see why many think they are. After all, they both protect from financial loss, are a form of risk management, and are needed to legally run certain types of businesses.
Additionally, surety bonds are often mistakenly referred to as insurance—which is where a lot of the confusion originates. However, that's where their similarities end.
Cut through the confusion and learn the difference between surety bonds and insurance—along with which one you need—in our expert guide below.
Differences Between Surety Bonds and Insurance
There are many notable key differences between surety bonds and insurance policies. To start, bonds are used to improve and uphold the standards of industries.
Whereas insurance ensures individuals and businesses have financial stability in the case of unforeseen circumstances. Additionally, insurance is elective in some instances where bonds are a hard requirement.
Other differences that set them apart are as follows.
Who is Protected?
Surety Bonds: Protects your customers, the general public, or government organizations from your negligence. This includes failing to follow laws, regulations, and contractual obligations.
Example - You open a small business as an auto dealer, and your state requires you to get an auto dealer bond. You fail to disclose a car was in a collision and mask the damages. The customer that bought said car has issues and makes a claim against the bond for financial recourse. The bond pays the customer to cover any financial losses.
Insurance: Protects you and your business from financial losses due to factors out of your control. This may include vandalism, theft, fire, and acts of nature—depending on your insurance policy.
Example - Your car dealership is robbed. The culprits stole two cars off the lot and both vehicles were found totaled. You file a claim with your insurance, which reimburses you for your losses.
Who Are The Parties Involved?
Surety Bonds: There are three parties involved in suretyship.
- Principal: whoever needs to purchase the bond and complete the task or obligation.
- Obligee: (often a government agency, state, or municipality) the one requiring the principal to get the bond.
- Surety: (us) the insurance company or surety company guaranteeing the principal can fulfill the obligation. They back the principal financially with the surety bond.
Insurance: There are three parties involved in insurance policies.
- Insured: the person that bought the policy.
- Policyholder: (insurance company) whoever offers the policy. Also referred to as a subscriber.
- Claimant: the person who files a claim for damages against the insured. In some cases, it may be the insured party filing the claim.
What Losses Can be Expected?
Surety Bonds: The surety pays for any claims initially. However, if you are the principal, the bond requirements outlined in your indemnity agreement state that you will pay the surety back for the full claim amount. This may also include the addition of court and legal fees in some situations.
Insurance: The insurance company pays out if a claimant successfully files a claim against an insurance policy. Unlike surety bonds, you do not need to pay back this amount. However, your insurance premium will more than likely increase.
What Risks Are Taken?
Surety Bonds: Surety bond holders always run the risk of having a claim filed against them—which they are then responsible for paying back in full. Additionally, surety companies also hold risk when it comes to bonds—and they only take risks that are qualified and safe.
When they issue a bond, they are guaranteeing that any bond claims will be paid while also gambling that the bond principal will pay them back. This is why they use an underwriting process for all surety applicants to calculate how likely they are to trigger claims and how likely they are to pay back claims.
Insurance: When insurance claims are successful, the insured person's premium is likely to increase. As far as the insurance company goes, losses are expected and their rates cover that. They are less selective with the policyholders they take on because of the loss expectation built into their business model.
- Initial Cost: On average, a surety bond costs 1%-10% of the total bond cost. This percentage is referred to as a bond premium or bond rate. For example, a bond that costs $50,000 will have a bond premium of $500 - $5,000 (providing the applicant has good credit). Bond premiums may be higher for those with less-than-optimal credit scores and for certain bond types.
- Claim Cost: A claim can be any amount up to the full bond amount. Therefore, for a $50,000 bond, the principal may be responsible for paying back up to $50,000.
Initial Cost: $50+ per month. The cost will greatly vary depending on how much coverage you need and which type of policy you require. Sometimes, you can secure a lower insurance premium by paying your insurance yearly in one large sum instead of monthly payments.
Claim Cost: The insurance deductible is an out-of-pocket expense required before an insurance company pays a claim. Again, the amount varies depending on the deductible amount outlined in the policy agreement and the policy amount. Additionally, a successful claim will usually increase the insurance premium.
Types of Surety Bonds
There are over 50,000 types of surety bonds, which seems overwhelming. However, you can easily find your state's surety bond requirements by contacting your obligee. Additionally, understanding the three main categories of surety bonds can greatly help.
- License and permit bonds – needed to secure certain licenses and permits for legal business operation. Examples of industries and professions requiring these types of bonds include auto dealers, freight brokers, mortgage brokers, auctioneers, and lenders.
- Contractor bonds - individuals or businesses (construction companies, licensed contractors, subcontractors, etc.) working on public construction projects are likely required to obtain a contractor bond. This category includes commercial bonds such as bid bonds, payment bonds, performance bonds, maintenance bonds, and construction bonds.
- Court bonds - certain courts require these bonds for a variety of purposes. This includes probate bonds and fiduciary bonds.
What about Fidelity bonds? These bonds are common but don't fall into the three main categories since they don't work like most bonds. Instead, they function like traditional insurance products—protecting the principal (business owners and their clients) from financial loss.
Types of Insurance
If you run a business, chances are you will need at least one type of business insurance policy. Or, in some cases, multiple. The most common types of insurance include:
- General Liability Insurance - Offers reimbursement to a business (or the claimant) in the event of property damage, bodily injury, or theft. It is one of the most popular small business insurances and is recommended for all business owners. In some cases, a general liability insurance policy may also be a requirement to obtain certain licensing.
- Auto Insurance - A policy to cover losses in the event of a car accident or other motor vehicle event that causes bodily harm or vehicle damage. Multi-vehicle policies are available.
- Business Interruption Insurance - This insurance coverage reimburses losses in the event of business closure due to theft, fire, or acts of nature (wind, hail, lightning). It is also commonly referred to as business income insurance.
- Commercial Property Insurance - Covers your business property and its contents (equipment, inventory, furniture) in the event of theft, vandalism, fire, or weather-related damage. If you operate your business out of your home, you may be able to add-on to your homeowner policy.
- Workers Compensation Insurance - Covers medical care, medical bills, lost wages, and disability for employees injured on the job. In most states, this insurance policy is required for any business with employees.
- Business Owners Policy (BOP) - If you need general liability insurance and commercial property insurance, inquire about a Business Owners Policy (BOP). It is often more affordable than two separate policies.
What Does It Mean to Be Licensed & Insured?
Being licensed and insured usually means you hold both the required surety bond and an insurance policy. This term ultimately signals to potential clients that you are a legitimate and professional business.
Licensed: Many occupations require you to obtain a license to operate your business. At times, a bond is required for this process—this surety bond works as a guarantee that you follow the rules of the license.
Insured: This means that you and/or your business are protected with an insurance policy. This often includes a traditional insurance policy from an insurance agent, such as general liability. However, it may also include a fidelity bond to protect your clients from your employees' misdemeanors.
Read How to Get Bonded and Insured for more information.