In general, a “Surety Bond” is a financial guarantee that a company or an individual will live up to specific obligations. It’s a three-party agreement between the Principal, the Obligee, and the Surety.
A Surety Bond acts as a safety net, shielding the obligee (the party requiring the bond) from potential financial setbacks. It provides coverage up to the bond's predetermined limit, should the principal (the party obtaining the bond) fail to fulfill their contractual obligations or commitments. Unlike insurance, where losses are absorbed by the insurer, a Surety Bond allows for the recovery of any paid losses directly from the principal.
The surety landscape is primarily dominated by two prevalent types of surety:
This type of Surety Bond is typically required for construction projects, ensuring that contractors adhere to the terms of their agreements. It safeguards against potential breaches, such as incomplete work, substandard materials, failure to pay subcontractors or suppliers, and especially the bankruptcy of the principal.
Commercial Surety Bonds are widely used in various industries to guarantee the performance of specific obligations. These bonds can cover a range of scenarios, including license and permit requirements, court-mandated bonds, and other commercial undertakings.
In essence, Surety Bonds serve as a risk management tool, providing an additional layer of protection for obligees while holding principals accountable for their commitments, fostering trust and confidence in contractual relationships.
Is Surety Similar to Insurance?
The answer is No. Despite some similarities, they are totally different concepts. Here are the key differences between a “Surety Bond” and an “Insurance”.
Insurance involves two parties - the insurer and the policyholder.
Surety Bonds involve three parties - the principal, the obligee, and the surety company providing the bond guarantee.
Insurance transfers risk from the policyholder to the insurance company.
Surety Bonds do not transfer any sort of risks. They provide a guarantee that the obligations will be met by the principal.
Insurance protects the policyholder from potential losses or damages like accidents, theft, or liability claims.
Surety Bonds guarantee that the principal will fulfill his/her obligations under a contract or permit. The bond will protect the obligee in case the principal fails to perform.
Insurance underwriting evaluates the risk of future losses to the insured.
Surety Bond underwriting evaluates the principal’s ability to perform the bonded obligation and his/her ability to reimburse the surety company if a claim is paid.
Insurance policies are “Bilateral Agreements” - the insurer promises the coverage and in return, the policyholder promises the payment of the premium.
Surety Bonds are “Unilateral Agreements” - the Surety promises to compensate the obligee for the failure of the Principal to fulfill its obligation and the Obligee promises nothing in return. In fact, in Canadian Commonwealth law, the bond is considered a deed that should be signed, sealed, and delivered (Except in Quebec)
So in conclusion, Insurance covers potential future losses, while Surety Bonds guarantee contractual performance. These two concepts involve different parties, risk transfer, and underwriting processes or criteria.