Be honest. You’re most likely here because you need to obtain a surety bond, but you don’t really know what it is or how to get one. Whether you are a business owner, a contractor or simply curious, understanding the basics of surety bonds is important since they play an important role in many businesses and projects. We sat down with members of the bond department at Auto-Owners to get the inside scoop.
Let’s discuss what surety bonds are, the common types and some practical examples to help turn your confusion into confidence.
So, what is a surety bond?
Unlike insurance, which is a two-party agreement, a surety bond is a three-party agreement/contract. It is a promise to be liable for the debt, default or failure of another. Think of it like a safety net for a project or agreement.
There are three parties in a surety bond:
- Principal – the person or business who needs the bond
- Obligee – the person or entity that requires the bond, usually a government agency or a project owner
- Surety – the company or insurance company/surety that backs the bond and promises to pay if the principal fails to meet their obligations
To make it simpler, let’s look at an example.
Let’s say you are opening a new restaurant. In order to operate, the local government requires you to obtain a license bond to ensure that your restaurant pays taxes on alcohol sold. If the restaurant fails to comply, the insurance company/surety you chose to obtain the bond from has to compensate the local government and then seeks reimbursement from you, the restaurant owner. In other words, the surety company is protecting the obligee NOT the principal.
So, in this example, you (a hypothetical restaurant owner) are the principal, the local government requiring the bond is the obligee and the insurance company backing the bond is the surety.
What are the different types of surety bonds?
Surety bonds include contract bonds and non-contract bonds, which are also known as commercial bonds. There are five different categories a commercial surety bond could fall into:
- Public Official
- Contract
- License and Permit
- Court and Fiduciary
- Miscellaneous
If you need a bond for something you are doing in your business or personal life, a government entity or general contractor will notify you that one is required to move forward with your project. For example, if you want to sell your vehicle, but you’ve lost the title, the Secretary of State will tell you that, in order to proceed, you will need to obtain a Lost Title bond to give assurance to the buyer that you did in fact have a clear title at one point.
Here are some other scenarios that might come up in life that would require a bond:
- You were to become the guardian of a minor
- If you were to misplace a cashier’s check or stock certificates
- You were to become an administrator of an estate
- If you were to become an elected official such as a mayor or city council member
So, how do you obtain a surety bond?
It starts with an application. The principal applies for the bond and provides the required financial information, which varies by the risk of the exposure. Then, the surety evaluates the principal’s ability to meet obligations through an underwriting process. If approved, the surety issues the bond and the principal pays a premium. If the principal fails to meet obligations, the obligee can file a claim. The surety compensates the obligee and seeks reimbursement from the principal.
Surety bonds provide peace of mind and financial protection for both the obligee and the principal. For the obligee, it ensures that projects are completed and regulations are followed. For the principal, it can help build trust and credibility with clients and regulatory agencies.
Surety bonds are vital for mitigating risk, enhancing trust, and ensuring compliance across various industries. Understanding their basics can help you navigate the complexities should you ever need to obtain a surety bond yourself. For more information, contact your local independent agent today!
