Most people have an idea of what insurance coverage is and how it works, but the same cannot be said for surety bonds. While both insurance and surety bonds offer a degree of financial protection, their differences outweigh their similarities. Whether you are on the path to becoming a licensed contractor, have a need for an alternative to insurance, or simply curious about how insurance and surety bonds work, the following information breaks down the differences between the two with ease. Understanding this information helps lay the groundwork for making an informed decision for business or personal insurance and bonding needs.
Understanding Who’s Involved
The most significant difference between surety bonds and insurance coverage are the parties involved in the process. First, surety bonds have three major players, including:
- The obligee, which is the person, organization, or municipality (city or county) requiring a surety bond to be in place
- The principal, which is the person or business required to have the surety bond in place
- The surety, which is the company offering the bond to the principal
Insurance differs from a surety bond because instead of having these three parties involved in the process, insurance coverage only requires two players. For an insurance contract, there is the individual or business taking out the insurance coverage, and the insurance company offering the coverage.
How Each Works in Practice
In addition to the difference in the parties involved in surety bonds and insurance agreements, there are also significant differences in how the two operate in practice. Surety bonds are a promise made by the surety company to cover a claim made by the obligee, on behalf of the principal. If work is not completed as agreed, like in the instance of a construction contractor or mortgage broker, the organization or municipality can make a claim against the individual and receive funds from the surety if the claim is successful. The principal is then responsible for repaying the claim back to the surety. The simplest way to comprehend this is to think of a surety bond as a form of credit to the principal.
Unlike surety bonds, insurance coverage is meant to pay for a claim due to damage, theft, death, or liability. The individual or business covered by insurance pays a premium to the insurance company for a set amount of coverage. If a claim is made against the policy, the insurance company pays up to the limits of the coverage. There is no requirement for the insured individual or business to repay these funds. Insurance, then, is a true transfer of risk to an insurer, instead of a form of credit for the insured.
The Cost of Coverage
Another stark difference between surety bonds and insurance policies is the cost associated with putting one or the other in place. Surety bond costs are calculated as a percentage of the total bond amount. However, this percentage is different for each principal applying for a new bond. Surety companies evaluate the credit history and financial standing of the individual or business to determine what percentage of the bond will be required as the final price. For those with less than ideal credit, a higher percentage is necessary. However, bonds renew periodically, so those who are able to improve their credit standing over time may have a lower cost for their surety bond.
Insurance policies are priced based on the amount of risk the insurance company takes on. This is determined by the claims history of the individual or business applying for coverage, as well as other risk factors specific to the type of policy considered. Insurance premiums can run the gamut as far as total cost to the insured because of the multitude of factors used to calculate risk. In some cases, securing a surety bond can be more cost-effective than getting a new insurance policy.
Understanding the differences between surety bonds and insurance coverage is helpful in making smart decisions as an individual or a business.
About the Author:
Eric Weisbrot is the Chief Marketing Officer of JW Surety Bonds. With years of experience in the surety industry under several different roles within the company, he is also a contributing author to the surety bond blog.
The difference between the two are well explained and very much engaging for all the readers. I really like the content and the way it is represented.