Discover how surety bonds work, why they matter, and how to obtain them.

Key takeaways:

  • Surety bonds provide a financial shield for customers against poor business performance.
  • These bonds only protect customers, not businesses.
  • Surety bonds have multiple forms and diverse applications over a wide range of professions.

If you’re a customer, you want businesses to have surety bonds. If you’re a business, you want customers to know you believe in them. They provide an added layer of transactional security for individuals and organizations across the business spectrum. Let’s define these guarantees, their practical applications, and their importance in establishing greater customer confidence.

What are surety bonds?

Surety bonds are written, legally enforceable agreements between three parties drafted to ensure that promises made under contract are kept. If not, there’s a guaranteed financial buffer in place to protect the customer.

The first party is the surety, or the bonding company, which provides the surety bond through an agent or broker. The second party may be a contractor or business providing a product or service (the principal), with the third party being the recipient of services or goods (the obligee).

In some instances, the obligee is the customer. They could also be whatever entity deems the bond legally necessary such as a local, state, or federal governing body.

Surety bonds are like insurance; they’re a form of risk management and a shield against financial loss up to the limit of the bond, but this is only for the third party. It’s important for businesses to understand that surety bonds are not insurance that will protect their second-party interests.

Different types of surety bonds

Surety bonds take many forms. Contract bonds are also called “construction bonds” and cover multiple service aspects:

  • Bid bonds ensure companies which successfully bid for work pay in full and honor bid terms 
  • Payment bonds guarantee payment for all parties executing the work
  • Performance bonds ensure businesses honor the agreed upon standard of performance 
  • Ancillary bonds cover service aspects beyond payment and performance, such as maintenance on completed work

Then there are commercial surety bonds, which ensure businesses follow applicable codes, regulations, and statutes related to their service. Many types of commercial bonds exist: auto dealer bonds, agricultural bonds, mortgage broker bonds, and so forth.

Fidelity bonds are available as:

  • Business service bonds which protect customers while a business is performing a service on the customer’s private property
  • Employee dishonesty/theft bonds to protect the business itself against these outcomes
  • ERISA bonds to protect beneficiaries of profit-sharing or pension plans from fraudulent actions by plan administrators.

Court bonds take probate, trustee, and appeal forms:

  • Probate bonds ensure the ethical and legal execution of duties.
  • Trustee bonds manage assets and property within a trust and distribute to the right people
  • Appeal bonds help defendants delay payment of a court’s judgment against them until the appeal is reviewed and settled. Courts can claim against the bond if defendants don’t pay.

Next, let’s consider a couple of examples which illustrate surety bonds in action.

How surety bonds work in everyday life

A building contractor commits to a project under agreed parameters but can’t honor that commitment. Perhaps the work isn’t completed, or results in damage or theft to the third party’s property.

If all of these occurred, the contractor would have violated the terms of their bid, performance, and fidelity bonds (should all three types be active). The obligee can then recoup any financial losses from the surety up to the bond’s limit, with the principal repaying that amount back to the surety.

Another example is an estate administrator. They would be bound by the terms of a trustee bond to ensure that every beneficiary gets what is left to them. Any administrator error or dishonesty would be a breach of bond terms, and the obligee could make a claim to the surety to seek their legal due.

Getting your own surety bond

Small businesses as defined by the Small Business Association (SBA) can contact the SBA, which guarantees surety bonds for select surety companies, making it easier for small businesses to obtain them.

Successful bond applications must be signed by the principal and the obligee, with the principal also signing an indemnity agreement that they’ll pay back to the surety the amount of any bond claims.

Not every business requires bonding. Sometimes, a business’ occupational license is sufficient. Contact the regulatory bodies which govern your business about what your bond status should be.

The cost of surety bonds

The principal must pay a premium to secure any type of bond. In broad terms, surety bond premiums’ cost is decided after a risk assessment, and is typically a percentage based on the bond’s type and coverage amount.

Much like a loan, a small business must satisfy the surety company’s standards based on factors like credit history, reputation, financial stability, and capacity to complete the service they’re offering. These factors could lead to different premiums case-by-case, and more or less of the associated paperwork depending on the business and surety company.

Surety bonds usually have expiration dates of one or two years. Securing another one later may result in higher or lower premiums based on the principal’s current risk status (which may have changed). Contract bonds often must be consecutively renewed for as long as the principal is working for the obligee, though this renewal typically doesn’t require reevaluation by the surety.

Get more protection from NICRIS

Surety bonds are a customer’s guarantee of protection and a way for businesses to project a professional and responsible image. At NICRIS, we ensure our customers are protected as comprehensively and cost-effectively as possible with insurance.

The NICRIS Insurance team is always here if you want to send us a message or want to get an instant quote on term life, renters, home, car, or motorcycle coverage.