Understanding an insurance bond doesn’t have to be as complicated as it sounds.
Read on to learn more about bond insurance and get all your questions answered about whether it’s the coverage your business needs.
What Is an Insurance Bond?
While often referred to as an insurance bond, the real story is that bond insurance is unlike the other business insurance policies you might secure for your business.
When you purchase an insurance policy, you enter into an agreement with the insurance company. You pay insurance claims, and they will pay if you need to claim on the policy.
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When you purchase bond insurance, you enter into a three-way agreement that provides financial protection for the parties involved. The business buying an insurance bond is helping to prove their financial security and trustworthiness. More on this shortly.
Surety Vs. Bond
It’s not uncommon for people to use the term surety and bond synonymously. In fact, while they’re related, they aren’t the same thing.
First, there are many different types of insurance bonds. A surety bond is one type of bond. Instead of insurance, it’s more of a contract between the parties involved.
In the case of a surety bond, the contracts help to prove the financial worthiness of the party purchasing the surety bond.
Bonds are often called bond insurance because they still offer some protections for the parties involved. A claim could be made with other types of bonds, like with your additional business insurance, if your business experiences a loss.
Parties Involved in a Bond
To better understand how a bond works, you need to know about the three parties entering a bond agreement. Unlike regular insurance, where two parties are in a contractual agreement, there must be these three in bond insurance.
Obligee
The first member of the bond insurance triangle is the obligee. This is the party that’s protected in a surety bond. If the principal cannot pay what is owed or due to the obligee, the insurance company will pay on their behalf.
In essence, bond insurance reduces the obligee’s risk of getting paid.
Insurance Company
The insurance company enters the agreement to offer a financial guarantee to the obligee. They insure the principal, who pays them a premium. The insurance company doesn’t plan to pay the obligee; they just reduce any risks the principal might create.
If the principal defaults or can’t pay their financial obligations, the insurance company will pay on behalf of the principal.
Principal
The principal is the party seeking the bond. The relationship between the insurance company and principal is unique from other types of insurance. The principal pays premiums almost like a deposit toward what the insurance company might need to pay.
In a surety bond, if the insurance company pays the obligee on behalf of the principal, then the principal will be responsible for paying back the insurance company. The principal needs to remain in good standing with the insurer.
How Does an Insurance Bond Work?
A bond company generally offers either a surety bond or a fidelity bond. When purchasing the bond, the principal can ensure the obligee meets their obligations.
The surety company offers the obligee bond guarantees that if the principal can’t meet their contractual financial obligations, then they will step in and pay on their behalf.
This helps a business that might be young or have a murky financial history prove trustworthy. The principal pays the premium, so the obligee doesn’t face financial risk in doing business with them.
In a fidelity bond, the protections are actually for the principal. If they experience employee theft, for example, the fidelity bond covers their losses.
It becomes a covered loss for the principal. This would be a time with bond insurance when the principal would make a claim.
Business Insurance for Small Businesses
It’s easy to be confused between the several types of business insurance you might have and bond insurance. Most businesses have coverage that includes:
- Professional liability insurance
- General liability insurance
- Workers compensation insurance
- Commercial property insurance
- Commercial auto insurance
All of these provide protection if something goes wrong. Yet, they don’t work to reduce your risk, which is crucial for bond insurance.
Bonded Insurance for Small Businesses
The key element in understanding how bond insurance differs is understanding the three parties. The bond insurance helps protect the obligee and reduce their risk.
If, for example, the principal doesn’t finish a job in the expected time frame, the bond covers costs. If the principal can’t pay a balance due in the right time frame, then the insurance company pays the obligee because the principal is bonded.
Bond requires all three parties, which is a key difference from business insurance.
What’s Covered Under Bond Insurance?
You might wonder what a bond covers. Part of the answer to this question involves knowing what type of bond you’re dealing with.
Remember, the goal of an insurance bond is to reduce the risk for the obligee. In this case, the bond might minimize the risk in contractual obligations. It could be a payment bond that ensures payment for the obligee.
Risk management is a key component in bond insurance. A fidelity bond reduces the risk for the principal instead of the obligee. More on this shortly.
What Does Bond Insurance Not Cover?
While bond insurance can provide significant protection against risk, it doesn’t offer liability protection. If your business is sued, you need professional liability coverage to handle settlements, judgments, or legal defenses.
For all the ways your business insurance covers you, it doesn’t reduce your risk like bond insurance does. Regular business insurance covers liabilities, while bond coverage protects against risk.
Comparing Surety Bonds and Fidelity Bonds
For a business owner, the most common types of bond insurance are surety bonds and fidelity bonds. Both protect against risk, but they protect different parties.
In simple terms, a surety bond protects the performance of a business, while a fidelity bond protects the business or business owner.
Returning to the three parties, the obligee, insurance company, and principal, the obligee sees reduced risk with a surety bond. The surety bond provides protection if work isn’t completed or bills aren’t paid.
A fidelity bond acts on behalf of the principal. It protects them from risks inside their own business. An employee might steal from the business.
You can also get a third-party fidelity bond, which would protect a customer from the dishonest actions of an employee.
Types of Insurance Bonds
There are many types of bonds and even many types of surety and fidelity bonds. Let’s take a closer look at some of the types of insurance bonds.
Public Bond
A public bond is often issued to a person handling public duties. This would be especially true of a public official who oversees money. The bond protects that the public official will handle their tasks, especially money, in good faith.
Contract Bond
A contract bond is commonly used in the construction industry. A contract provides a guarantee for the obligee in several possible ways, including:
- A bid bond guarantees the bid specs will be met
- A performance bond guarantees work is completed on time and within budget
- A payment bond guarantees that any contractors or vendors working with the principal get paid
Each of these is a type of surety bond.
License or Permit Bond
License and permit bonds are sought by contractors who need to work with a government agency. The license or permit bonds are bonds including:
- Mortgage broker or lender bonds
- Professional licensure bonds
- Notary bonds
- Private investigator bonds
- Auctioneer bond
- Street repair, drain laying, demolition permit bonds
- Travel agency bond
- Collection agency bond
Often, a city, municipality, or public office will require one of these types of bonds to approve a license for a specific activity.
What Businesses Should Consider Bond Insurance?
What businesses need to get bonded? Certain businesses are more inclined to need bond insurance because of either the type of work they do or who they work for.
A majority of bonds are sold to businesses in these industries:
- Construction industry
- Government agencies
- Janitorial services
- Temporary staffing companies
Some might seek surety bonds to reduce risk for the obligee, often a government entity. Many of these same types of businesses will also seek fidelity bonds, protecting them from risks associated with employee behaviors.
How Bond Insurance Can Help a Business
Often, being bonded is a condition of employment for someone. So, a business seeking a contract for work won’t secure the work unless it becomes bonded.
In the case of a license or permit bond, getting bonded is often a condition of getting a license. This is especially true for many government agencies.
When you understand that getting bonded is associated with lower risk, you can better understand how a surety or fidelity bond would benefit a business.
How to Get Bond Insurance?
You might wonder how you qualify and purchase a bond. Some bond businesses only work selling bonds. Not all of these are ethical and will provide the assurances for the risk you might seek.
One of the best tips for buying bonds is to seek assistance from your trusted insurance agency. Many of the same agents who sell you a business insurance policy will also sell surety bonds.
You’ll need to discuss how much bond you need, and the agent will consider things like your credit history to establish a cost for the bond.
5 Important Frequently Asked Questions
Do you still have questions related to bond insurance? Here are five commonly asked bond insurance questions and their answers.
1. Is Bond Insurance Like Other Insurance?
Bond insurance is different from other types of business insurance. It doesn’t address potential liability. Instead, insurance bonds help to address potential risks.
These risks might come from work a business is doing or internally from employees.
2. Who Benefits from Bond Insurance?
Bond insurance can offer a benefit to both the obligee and the principal. Surety bonds reduce risk and provide security for the obligee. Fidelity bonds can benefit a business by lowering potential adverse risks from employees.
3. How Do You Know If You Need Bond Insurance?
Mostly, the answer to this will depend on the type of bond.
Often, with a surety bond, the obligee requires a bond. This could be a requirement of the contract or a necessity to get some type of license.
If you’re concerned about the behaviors of employees and feel your business could be at risk, then a fidelity bond makes sense.
4. What’s the Cost of Bond Insurance?
What are the cost factors of purchasing a bond?
The bond cost has a couple of factors. First, the cost of the bond will depend on the amount of the bond. Second, credit history or a less-than-perfect credit score might impact the bond cost.
Bond Insurance, A Different Type of Insurance
One unique type of insurance is an insurance bond that works to reduce risk for either an obligee or the principal buying the bond. Consider bond insurance for your business if you want to protect yourself or need it for licensing.
Learn more about how bond insurance can help you, and let us ensure all your insurance needs are in place.
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