In our last installment we began comparing surety bonds and insurance. Many people are under the misconception that because of the similarities between surety bonds and the fact that often insurance companies offer them that they too are a form of insurance. This however is not true. As we previously discussed surety bonds are an agreement between three parties as well as that with a surety bond a loss is not expected instead a guarantee in case an obligation is not met. Insurance on the other hand is an agreement between two parties where a loss is expected. At some point you expect an insurance policy will pay out whereas with a surety bond you don’t expect to ever have to receive a payout.
A company offering surety bonds expect to recover any losses occurred. If the principal defaults on the contract and the surety bond have to pay the obligee the surety expects to get repaid from the principal. The surety has loaned assets to the principal and therefore will seek reimbursement. Insurance claims are never expected to be repaid. In fact with an insurance policy a claim is expected. The whole purpose of insurance is to cover any losses the insured has experienced.
When the premium is paid on a surety bond it is acting as a service charge for the bond by the principal. In fact surety companies get to be incredibly selective when choosing companies that they agree to bond. This is because bonds serve as a non-collateral loan unlike a car or mortgage payment. A surety company asks for a fee anywhere from half a percent to three percent of the contract amount. The fee will be dependent upon the financial strength of the principal. The premium is usually paid on an annual basis.
This is different than insurance premiums in that the premium that is paid is to cover the expenses and losses that are expected to occur. An insurance policy is something that nearly everyone can be issued. The premium that is paid will depend upon the risk of the person or people being insured. The greater risk to the insurance company the higher the premium.
As previously stated, surety companies are incredibly careful when choosing companies that they bond. Years of running a successful business, financial stability and a record of completing projects on time and within the projected budget allotted within the original contract. Agents handing out surety bonds are trained to ensure they don’t make loans that will default.
Insurance agents however are a lot more flexible when it comes to writing insurance policies. Insurance companies offer up a higher volume of business in order to make a profit as well as cover any losses experienced. This allows agents to be flexible with whom they offer insurance policies to. Although as an example, if a car owner is seeking insurance and they have been in multiple accidents they will pay a higher premium then a client who has not been involved in an accident or had a previous ticket.
There are key distinctions between surety bonds and insurance policies. Although they function differently they both meet a need that protect someone from experiencing a loss.
Most people assume that because surety bonds are offered through an insurance company that a surety bond is a type of insurance policy. This however is untrue. Even though surety bonds and insurance policies have a few insignificant likenesses they are not the same thing at all. In this installment we will discuss the differences between surety bonds and insurance.
The first difference between surety bonds and insurance is the number of individuals involved in the agreement. With a surety bond there is a three-party agreement that connects the bond issuer, who is known as the surety, with the second party, who is the principal, into a financial guarantee to the third party, who is known as the obligee. The agreement states that principal fulfills the obligations set forth in the contract. The principal relies on the monetary power of the surety in order to acquire a contract with the obligee.
The difference with insurance is that the agreement between two parties; the two parties being the insurance company and the insured. This arrangement is in place to guarantee that if the insured has a loss or is damaged the insurance company agrees to pay an amount set forth in the original policy.
Another distinction between surety bonds and insurance is that losses are not to be expected under a surety bond. The contracting company to which the bond is issued needs to be financially stout and secure to be eligible for bonding. The surety company carries out a thorough background check into the contractor’s character, their credit worthiness, the talent and capability to finish a project as contracted.
It is also important that they meet the specific check points in place within the contract. A surety bond is sought out because the contractor is asked to provide one because the project owner mandates it. The surety bond amount decreases as certain check points, which are stated in the contract, are met. Less surety is needed as the job gets closer to the agreed upon end. As each stage is completed the contractor is required to carry less surety to meet their obligation to the project owner.
An insurance policy is purchased because a loss is eventually expected. The insurance policy rates are always changing and need to be adjusted based on the law of averages, expenses and losses. A perfect example is when purchasing car insurance. The rates are high at first because the expense is greater to cover the amount owed on the car loan. If the car is in an accident a large amount of money is needed to cover the expense of repair or to cover the payoff on the loan. As time passes the amount owed becomes less and less, the expense to repair the car decreases and because of all of these factors the insurance policy costs decrease.
In our next installment we will look at more comparisons between surety bonds and insurance companies. These two very different industries and products have qualities that are similar but they are indeed two very different things when side by side comparisons are completed.