A surety bond is an instrument guaranteeing that someone is going to do something; it protects against losses when one party fails to meet its obligations. There are two basic types of surety bonds; Commercial (which can take the form of tax bonds, fidelity bonds, customs bonds, appeal bonds, etc.) and Contract (which guarantee construction contracts). The majority of federal, state and municipal construction contracts, whether they are for vertical or horizontal construction, are required to be bonded in order to protect the public funds being used for these projects.
Many surety companies are subsidiaries or affiliates of insurance companies. However, insurance and surety are very different. Insurance is a two party contract that protects the policyholder from a loss covered by the insurance policy provided by the insurance company. Surety is a three party contract that protects the Owner from default by the Contractor. There are two types of bonds that are critical to any bonding of a construction contract:
- Performance Bond – guarantees that the contractor will fulfill the performance obligations of the contract; construct a sewer line, build an addition, pave a road according to the specifications in the contract
- Payment Bond – guarantees that the contractor will pay his obligations to employees, subcontractors and suppliers of the liers of the project
Unlike insurance, where losses are anticipated, surety is underwritten so as to have zero losses. As such, the underwriting process is rigorous. Among other criteria, the surety agent and surety carrier review the following of the contractor:
- Financial Statements
- Personal Financial Statements of company owners
- Bank Relationships
Based upon their analysis, the surety may or may not provide the contractor with the desired surety program. It is the surety agent’s job to match up the contractor with the surety that best fits its needs.
Do defaults occur? Unfortunately, yes they do. According to the Surety & Fidelity Association of America, since 1995 over $10 billion has been paid to owners as a result of the defaults.
In this tough economy many private construction project owners are turning to surety bonding as a way to protect themselves from contractor defaults. In fact, many construction project lenders are requiring that any funding of a project be subject to the bonding of the contractor building the project. The additional cost for the bonding is nominal in relation to the protection it provides.
We are members of the National Association of Surety Bond Producers (NASBP) the professional organization for agents that also specialize in surety bonding.