Surety Bonds
What are Surety Bonds?
Strictly speaking, surety bonds are not insurance policies, although they are often offered by insurance carriers. These are trilateral agreements, meaning they are signed by three different parties each with a unique role in the contract. The Principal is the party in need of the contract, the second party is the one who requires this contract and called the Obligee, while the third party is the surety company often listed as the Surety.

Construction surety bonds are mainly of three types:
  • Payment Bonds: This type of surety bonds are signed to bind the Principal (contractor) for remuneration of certain subcontractors and workers involved in the project.
  • Performance Bonds: These contract surety bondsare signed to protect the Obligee (project owner) cover against financial losses caused by the contractor as a result of their failing to deliver services according to the terms of the contract. When this situation arises, the owner declares contract termination, and the Surety will be called in to meet the terms of the contract.
  • Bid Bonds: These bonds are required in the beginning of the project during the bidding process. They protect the project owner from losses in case a contractor who is awarded the project after the bidding phase fails to provide the other required bonds for performance and payments.
Who needs Surety Bonds?
Surety bonds are often used in private and public construction projects, where they are often referred to as construction surety bonds or contract surety bonds. For a given construction project, the Principal would be the contractor in need of the bond and the Obligee would be the project owner. By signing the bond contract, the contractor promises to provide services in line with the terms of the service contract and the surety company is expected to cover the damage or loss that result in the Principal's breach of contract terms.

In the public domain, there may be statutory requirements for certain surety bonds. According to these statutory requirements, the federal government is expected to ensure awarded bidders are capable of delivering on the project so that taxpayers' money is protected while the local and state governments ensure that appropriate payment bonds are present to protect suppliers and subcontractors.

In the private sector, requirements for surety bonds are at the discretion of the project owner. Some private owners demand it from contractors and so do most lending organizations. In fact, a principal contractor can also demand appropriate surety bonds from its subcontractors.
Surety Bonds coverage
If you look at it critically, surety bonds mainly hold the contractor (Principal) responsible for meeting the terms of the construction contract. In case of failure in the same, the bonds require the surety company selling the bond to take care of these responsibilities, providing the project owner (in private projects) and taxpayers (in public contracts) from loss of investment while also ensuring involved vendors and subcontractors' payments are protected.
What does Surety Bonds coverage include?
Surety bonds coverage includes cover for financial losses the project owner may have to bear due to the contractor's neglect of contract terms. In the public sector, the project owner is supposed to be the public and the federal, state and local governments involved are supposed to keep an eye on how well project terms are met. Construction surety bonds' coverage also includes cover for subcontractors and vendors for their promised payments.

Incidentally, a surety bond is fundamentally different from an insurance policy in many ways:
  • Surety bonds require prequalification so that any probable losses can be prevented while insurance comes into effect when losses have occurred
  • Surety bonds are three-party contracts while an insurance policy needs two parties to work
  • The contractor and the surety company bear risk in a surety bond while the insurance company bears risks in an insurance policy
  • Surety bonds provide complete cover for performance bonds while insurance policy covers losses depending on the policy limit
  • The Surety party reserves the right to be compensated by the contractor for indemnity of claim settling costs while the insurance company has no such rights in a typical insurance policy
  • Contract surety bonds are mandatory for public contracts and voluntarily submitted in private projects, whereas an insurance policy is a non-mandatory manner of risk management for the insured party's losses
Typical areas of Surety Bonds coverage
Surety bonds primarily provide two major types of cover:
  • Cover for financial losses to the project owner resulting from the contractor's neglect of contract terms
  • Cover for payments to subcontractors and vendors for their due payments
While surety bonds assure 100% coverage for performance bonds, they provide 100% cover for payment bonds only according to the penalties stated in the bond contract.

With such complex situations - and potential losses - involved in the process, you should make sure you only work with trustworthy bonds sellers. With a nationwide networks of commercial insurance providers, we can help you get thorough coverage for your surety bonds for construction projects in both the public and private domains.

To get more information about what your insurance policies should look like, contact one of our agents right now.