What are Surety Bonds?
A surety bond provides clients with a guarantee that the work will be fully completed by the contractor, as the bond is a promise to be liable for the default, debt, or failure to meet its obligations. Many public and private contracts require surety bonds to come into effect. A surety bond is typically a three-party contract which involves the following: One party (the surety) guarantees the performance of a second party (the principal) to a third party (the obligee). Surety bonds written specifically for construction projects are defined as Contract Surety Bonds. The Surety Company is a company licensed by a state department of insurance to provide surety bonds to third parties. The principal is the individual or entity (in construction, the contractor or subcontractor) on whose behalf the bond is written.
The obligee is the individual or entity the principal has a contract with and to whom the bond is given; in other words, the party that requires and receives the protection of the bond. For construction scenarios, it refers to the Project Owner or the Prime Contractor, i.e. if the owner is the bond’s obligee, the prime contractor is the principal, and in the case the prime contractor is the obligee, the subcontractor is the principal.
How are surety bonds different from insurance
For the most part, surety bonds are issued by insurance companies licensed by state insurance departments, which are different from traditional insurance policies. In the first place, and as explained in the aforementioned section, surety bonds are three-party Contracts, while traditional insurance policies are two-party Contracts, such as life insurance policies, or property insurance policies. The surety does not acquire the primary obligation, but is secondarily liable, should the principal defaults on its bonded obligation.
Sureties are not expected to suffer losses as the bonded contractor is expected to fulfill its contractual obligations. Sureties have a signed indemnity Contract from contractors to protect them from any losses resulting from having issued the bonds. Therefore, if a surety incurs expenses or payouts as a result of a claim(s), the bonded contractor (or any other of the indemnitors) is required to reimburse the surety.
|3–Party Contract||2-Party Contract|
|Risk transfer||Transfer of risk from you to insurer|
|Duty to obligee||Duty to insured|
|Regulated by States’ Departments of Insurance||Regulated by States’ Departments of Insurance|
|Coverage is obligation-specific||Coverage is usually term-specific and renewable|
Fee for prequalification services
No Losses Expected
|Penal sum of bond (fixed amount)||Policy Limits (- deductible)|
|Seeks to protect against loss||Seeks to protect against loss|
|Ensure compliance with state and federal regulations||Expectation of claims to be paid|
Where to get a Surety Bond?
When contractors are ready to position their businesses and obtain surety credit to qualify the project to get bonds and grow the business, they need to contact a professional surety bond producer develop that relationship. Bond producers are professionals who specialize in providing surety bonds to contractors, subcontractors, and other construction project members. They are the experts on surety and construction markets, and center their main activities on surety markets while positioning construction firms to qualify for surety credit. Bond producers provide crucial business advice and expertise to assist contractors in securing its surety credit association and, when applicable, increasing its surety credit. Contractors are expected to provide the information and documents required by the surety to evaluate a request for bonding. They encourage successful relationships between contractors and surety companies, based on trust, respect, commitment, and collaboration.
How much do Surety Bonds Cost?
Rates filed with the state insurance department is what determines the cost of a bond, which can vary from less than 0.5% to as much as 3%. In the case of small and emerging contractors with basic experience, the rate may range between 2% and 3%. Constantly, there are adjustments to the bond premiums based on the final contract price. If the price increases, there is an increase in premium; whereas, if the price decreases, the premium is also reduced. Contractor must include the cost of its bond in their proposals and change orders, regardless of how small, because bond premiums are usually reimbursed. Eventually, several small change orders may potentially turn into a large increase in the contract, potentially increasing the premium, and contractors are seeking to prevent the premium from coming out of their profit.
Surety Bonds in Construction
Industry are also referred to as Contract Bonds. The type of Contract Bonds are as follows:
- Bid Bonds
- Performance Bonds
- Payment Bonds
- Maintenance Bonds
What is Performance Bond Capacity?
Surety Bond Capacity is the total credit a surety bond company extends to the Contractor (Principal). It is the analyzed working capital and/or net worth, among other considerations.
Contract Surety Bond Requirements
- Last Fiscal Year – End Financial Statement of the company, and the most current interim statement available (if Fiscal Statement is 6 months old, or more). For Bonds exceeding 250K, please provide Financial Statements of the past 3 years.
- Contract of the project that requires a bond
- Copy of the latest company Tax Return in full (Individual return if sole proprietorship or Sub Chapter S)
- Financial Statements on owners (Stockholders). If possible, these should be concurrent with the company fiscal statement.
- Certificate of Insurance (COI)
- Resumes of key personnel
- Letter from Contractor’s bank including line of credit, security on line, current outstanding balance, past payment records and average balance information.
- Status of Contracts.
- Forms for specific bonds requests, either bid or final, and bonds provided. They should be completed to accompany the submittal of the documents, or completed when a subsequent bond is requested for an existing account.