Let’s say a school would like to do business with John’s Construction Company to build a new gymnasium. If only there was a way to guarantee the company will do the work they said they would do for the school.
This is where surety bonds come in. A surety bond is a financial guarantee of someone’s performance. It is a three-party contract between the Principal, Obligee and Surety.
- The Obligee is who requires the bond.
- The Principal is who’s required to get the bond.
- The Surety is who takes on the risk of the Principal’s performance according to some defined specifications between the Obligee and Principal in exchange for the surety bond premium.
Here are a few common examples:
Jane Doe, Inc. runs a national sweepstakes giving anyone who buys one of its widgets a chance to win a $10,000 prize. The state of Florida requires a sweepstakes surety bond, so Jane Doe, Inc. must post a surety bond with the state. The bond guarantees that if a Floridian wins the prize, Jane Doe, Inc. will give it to them. If they win and the company pays out the prize, nothing happens with the bond. If they do not pay, the state can make a claim on the bond. In that case, the surety carrier pays the $10,000 to the state, who then can give it to their resident and thus protect them. Then it’s up to the surety carrier to get indemnified (or paid back) by Jane Doe, Inc. So the bond is a financial guarantee that Jane Doe, Inc. will perform according to the sweepstakes rules. In this case, the state is the Obligee and Jane Doe, Inc. is the Principal.
Another common example is Bob Owner wants Contractor ABC, Inc. to build a new building according to the prepared contract and plans. Before starting work, Bob owner requires Contractor ABC, Inc. to post performance and payment bonds. The performance bond guarantees Contractor ABC, Inc. will complete the work according to specifications. The payment bond guarantees Contractor ABC, Inc. will pay all subcontractors, vendors, suppliers, etc. used to get the job done so no liens are filed. If Contractor ABC, Inc. does all the work as agreed and pays everyone then nothing happens other than job well done. If not then Bob Owner can make a claim on the bond. The surety carrier may be required to pay Bob Owner an amount of cash that allows them to hire another contractor to finish the job. Or the surety carrier may be required to find someone themselves to get the work completed. Either way the bond protects Bob Owner and helps financially guarantee his building gets built. Again, if a claim is paid out it’s then the surety’s responsibility to get indemnified by Contractor ABC, Inc. In this case, Bob Owner is the Obligee and Contractor ABC, Inc. is the Principal.
In the case of a state licensing bond to get your professional license, the bond is guaranteeing that you’ll follow the state’s laws & regulations concerning your professional license. The bond is required for the state to protect their residents if you do not. The state is the Obligee and you would be the Principal.
What’s a surety bond is not
Surety vs Insurance
Surety bonds are not insurance. Insurance carriers take on the risk of unpredictable events that may or may not occur. Surety carriers take on the risk of defined performance.
Let’s go back to Jane Doe, Inc. and say its promotion is the chance to win $1,000,000 for a hole-in-one during a golf tournament in Florida. They would buy an insurance policy to cover themselves if someone actually made a hole-in-one. The insurance policy would pay them that money if someone actually did it. So they would exchange the insurance policy premium for the insurance carrier to take on the risk of covering the full payout. This allows them to offer a large prize without actually putting that amount of their own money at risk. They would post a $1,000,000 surety bond with Florida only to guarantee the prize was actually given to the winner if there was one. Jane Doe, Inc. is posting the bond simply because Florida is making them do it in order to run the promotion in its state. The surety bond is covering just the performance of awarding the prize itself and the surety bond premium is what the surety carrier charges for taking on that risk. The bond doesn’t pay anything if someone makes a hole-in-one, only if Jane Doe, Inc. doesn’t actually give the winner the prize.
Read more about surety vs insurance here.
Performance Quality Guarantee
While surety bonds guarantee someone’s performance, they do not guarantee the quality of that performance, assuming all the performance criteria are met. For example, a bond would cover something is built to code but does not guarantee it’s built as great as possible. Also, bonds guarantee financial advisors will follow the laws and regulations for their license, but it does not guarantee any level of which they make you money.
There are thousands of different types of surety bonds and new ones being created constantly. This makes sense considering all the different work people do for others. For something to be a bondable event you simply need defined, measurable, predictable performance criteria.
Even though insurance is in our name, surety bonds are all we do at Alpha Surety. If you have any additional questions about surety bonds or your specific need then please call or contact us. We are here to answer your questions and help you fully understand surety bonds.