Bonds

Understanding Bonds v. Insurance Policies

When talking about insurance, occasionally the term “bonds” will enter the conversation. Let’s talk about what bonds are and how they differ from typical insurance.

What is a bond?

A bond, sometimes called a surety bond, is an agreement that includes three parties: the person purchasing the bond, called “the principal”; the person who would receive the benefit, called “the obligee”; and an insurance company.

Here’s the important part: an insurance bond does not pay for claims. Instead, it provides a financial guarantee that the principal will reimburse the obligee if a claim is made, the principal defaults, or the principal fails to fulfill the predetermined obligations.

A bond is actually used as evidence that the principal is financially responsible and able to repay the bond company should that company pay out a claim. As you can see, a bond is not at all interchangeable with an insurance policy.

Generally, bonds are used in cases where loss isn’t expected. Bonds offer an extra layer of protection for the purchaser, usually in cases where the purchaser is held liable for not meeting work-related obligations.

Why is a bond a three-way agreement?

You may be wondering why an insurance company is involved at all in a bond. After all, aren’t the principal and the obligee the only two necessary parties? Well, each party stands to benefit from a bond.
The obligee’s stake:

A bond ensures that the obligee is not held reliable if the principal cannot meet contract requirements or pay its employees. Requiring a bond instead of simply signing a contract means the obligee can expect payment from the insurance company if the principal is unable to pay.

The principal’s stakes:
In a bond agreement, the principal knows the insurance company will pay if the principal cannot; but the principal does expect to pay the insurance company back. If the principal refuses to reimburse the insurance company, they cannot get bonded again, meaning their work will suffer.
The insurance company’s stakes:
Although the insurance company does not expect to pay anything to the obligee, meaning they won’t be reimbursed, they do make money at the beginning of the deal. The insurance company is paid a premium on the bond by the principal, similar to interest on a loan.

What types of jobs need a bond?

There are many different types of insurance bonds out there, but some of the most common are fidelity bonds, public official bonds, and contract bonds.

Fidelity Bond

A fidelity bond protects your business from fraud committed by your employees. A few common examples include ERISA (Employee Retirement Income Security Act) bonds, employee theft/dishonesty bonds, and janitorial service bonds.

Public Official Bond

A public official bond guarantees that you will faithfully perform the duties of your elected or appointed office. Most of these are issued to people handling money, such as tax collectors, town clerks, and treasurers.

Contract Bond

A contract bond is used in the construction industry to guarantee fulfillment of contractual obligations. A few examples are bid, payment and performance bonds.

Does my business require a bond?

Your business may require a bond based on state requirements, contractual and regulatory requirements, or an industry association. If you perform services in someone’s home or business, or if you or your employees handle money, you may want a bond as extra protection. Search for a bond that will fit your needs and start your application here. To search for a bond that will fit your needs and start your application, visit this page.