Surety bonds are legally binding contracts that ensure obligations will be met between three parties:
- The principal: whoever needs to obtain the bond
- The obligee: the one requiring the bond (often a government agency)
- The surety: the insurance company guaranteeing the principal can fulfill the obligation
In short, a bond provides a financial guarantee to the obligee in the event that the principal fails to conduct themselves per the terms outlined in the surety bond. They are in place to protect the government and its citizens from certain losses.
The information below dives deeper into the subject of surety bonds, including who needs them, what types are available, and an example of how a surety bond works in a real-life situation.
If you don't have the time to read about surety bonds below, watch our quick 90-second video which covers how surety bonds work.
What is a Surety Bond Used For?
A surety bond's primary purpose is to act as a financial guarantee for government entities and the general public. If the bond's requirements are not met, such as not performing contracted work or failing to pay suppliers, vendors, or subcontractors, a claim may be filed against the bond.
Think of a surety bond as a form of credit to the principal. Whether claims are made by the public or the obligee, they must be repaid by the principal to the surety—as outlined in the indemnity agreement that every bond holder is required to sign.
An indemnity agreement, also known as a general agreement of indemnity, includes your business and all owners. Indemnity agreements pledge your corporate and personal assets to reimburse the surety for any claim(s) and legal costs that may arise.
Read our guide to learn more about how indemnity agreements work.
"What's a Surety Bond?" Infographic
Surety Bond Benefits
From a principal standpoint, surety bonds are often used for their advantages over bond alternatives. Some obligees allow you to post cash instead of a bond, often in the form of a single lump-sum payment to a custodian or trustee that is on hold to cover claims. In other cases, a letter of credit may be posted instead of a surety bond.
However, surety bonds have many advantages over these bond alternatives, including:
- Non-Asset Collateral - The surety provides the guarantee for you, so you don't have to use your assets to make the guarantee. For example, if you have a claim to pay and you used a mortgage to pay the up-front cost, the financial institution uses your home as collateral if you cannot pay through other means. Surety bonds can help you avoid these asset seizing situations.
- Lower Costs - Although you save the expense of the bond premium when you use an alternative, you face other challenges. For instance, you could lose investment earnings, even from a relatively conservative portfolio, by posting cash as your bond. In most cases, this is a bigger financial burden than paying the cost of a surety bond.
- Increased Capital - Posting your own assets, including cash, in lieu of purchasing a bond decreases your liquidity. This can make it more difficult to get financing or cover major expenses in the future. Also, lower capital reserves could lead to your company defaulting on a contract or going bankrupt.
- Claim Investigation - A surety works through an investigation process when a claim against a bond is made. This is not often the case when you post assets or cash to cover an obligee's requirement. You could inadvertently pay for claims that are not valid when using an alternative to a bond because you do not have claims advocates on your side.
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Surety Bond Example
Here's a quick example of what a surety bond is used for in the case of contractors.
Need for a Bond
Let's say a business owner (the principal) has just moved to Georgia and wants to start a small business in the construction industry. He decides he wants to be a general contractor. However, the State of Georgia (the obligee) dictates that you need a general contractor license to take on construction contracts over $2,500. There are many requirements to obtain this license, and one is a $25,000 contractor surety bond that acts as a financial guarantee.
Applying for a Bond
The business owner applies for a bond through a surety company (the surety). A quick underwriting process assesses how much of a risk he is by looking at factors like his credit score, financial statements, previous bond history, and moral character. This business owner is an excellent candidate and secures a surety bond premium of 2%, meaning he pays a flat fee of $500.00 to obtain the bond from the lender.
Claim Against a Bond
The business owner’s application is a success. They now have a General Contractor Limited Tier License, which means he can take on work with a contract price of up to $1,000,000. Fast-forward half a year later, and it is found that his workmanship on a residential home is faulty. It isn't the standard agreed upon in the contract between him and the project owner. The project owner puts in a claim against the bond. The investigation finds that the business owner failed to uphold their contractual obligations, so the surety pays out to the project owner. The business owner is now on the hook for paying back the surety.
What Bond Do I Need?
There are many types of bonds available, from commercial surety bonds to contract surety bonds. However, you only need a bond if you're being required to obtain one—which you will be notified of depending on the circumstance.
Some of the more common bond types are required to get a business license, such as auto dealer bonds, contractor license bonds, mortgage broker bonds, and freight broker bonds.
Types of Surety Bonds
In general, three categories of surety bonds exist that may be required as part of doing business. These broad surety bond types include:
- License and permit bonds - these types of bonds are required for various professionals to operate legally. Auto dealers, licensed contractors, and freight brokers are some examples of professionals required to secure a license or permit bond.
- Contractor bonds - individuals or businesses working on public construction projects are likely required to obtain a contractor bond.
- Court bonds - certain courts require these bonds for a variety of purposes, such as probate or judicial bonds.
Obtaining the Right Bond
It can be challenging to know which type of bond you need, but you can take these steps to ensure you're getting the right bond:
- Contact your state or local licensing authority or the obligee requesting the bond to ask which category of bond you need, and in what amount
- Use our bond analysis tool for free to determine which bond you need
- Contact us directly for assistance with figuring out your specific bond needs
Additionally, it may be beneficial to review common bond types and what they guarantee, such as bonds required in California, Florida and Texas. You can see all surety bond requirements by state here.
It is also helpful to understand the various bond categories, as we laid out above. Some common surety bonds required for licensing include auto dealer bonds, contractor license bonds, and freight broker bonds. You can look at the full list of license and permit bonds here for more specific information.
Who Can Issue Surety Bonds
Qualified insurance companies and surety bond providers can both issue surety bonds. However, bonding companies are often advantageous with lower rates and better support.
In the event that a claim is made against your bond, a company specializing in surety bonds is more knowledgeable and practiced in the process. They can answer your questions and guide you through the claim investigation with ease.
Now that you know where to get a surety bond, you may be asking yourself, "what is a surety company?"; read our article to learn the definition of sureties, how they work, and how to choose the right one for you.
You can also take a look at our most frequently asked surety bond questions.
How to Get a Surety Bond
Fill out our online application form to obtain a free bond quote. Our quotes are no obligation, take 5 minutes, and you will be able to lock your rate for the next 90 days (in case you want to purchase the bond).
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 securing a surety bond, download our free "Consumer's Guide to Surety Bonds" e-book. 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 designed to educate consumers, specifically first-time applicants. It is an excellent resource if you are unfamiliar with how surety bonds work, the pricing of surety bonds, or how bonds affect you or your business.