If you ever find yourself trying to decipher whether surety bond and insurance are the same, this post will give you the right resolution.
SPOILER ALERT: No. They are not the same.
There has been a long-standing misconception about their similarity, mainly because they both provide security. Add to that fact is the issuer of both surety bond and insurance; and that’s none other than an insurance company.
But the bottom line is, surety bonds and insurance contracts are underwritten in different premises and they perform in different ways as well.
Still confused? Let’s dive into a quick comparison of the two in terms of parties involved, beneficiary, payment, losses, and sources of funds.
Insurance is a two-party contract. It is an agreement between the insurer and the insured (client). A surety bond, on the other hand, has three parties, namely:
Principal – the party who is asked to purchase the bond and the party who will fulfill the legal obligations stated on the bond.
Obligee – is the party to whom the principal owes an obligation to.
Surety – the party that will guarantee that the principal will fulfill the obligations.
The beneficiary of an insurance is the insured while the beneficiary of a surety bond is the obligee.
Let’s create a mock scenario. Let’s say you have a janitorial business that you have insured. If a fire breaks out and your office gets destroyed, your insurance will protect you by covering the repair.
Since janitorial services involves employees going to the house of clients. Even if you’ve filtered the good ones from the selection process, there might still be an employee that will commit theft or any misconduct while inside the client’s property.
A surety bond will protect your client from this. Your client will be eligible to receive compensation if your employee stole or damaged something.
An insurance has a recurring monthly billing. For surety bonds, the principal will only pay the bond premium once. Only when the bond is renewed will the principal make another payment.
Some bonds are renewed per year, other every couple of years or so, while others are continuous in nature. The last one will be valid until the bond is cancelled.
Bond premium is the fee that the principal will pay the surety by allowing the principal to use the capital and credit rating of the surety.
Bond premiums are heavily dependent on the principal’s credit score. The better the score, the lower the bond premium. If the principal has excellent credit score, the bond premium will usually be just 1% of the bond amount. So if your bond amount is $10,000, you only need to pay $100 as bond premium.
Losses are expected in insurance contracts. However, insurance companies still control their potential losses by using the law of large numbers. They rely on this to estimate future claims. The law of large number simply means that the larger the pool of insured similar risks, the more predictable the losses will be.
In surety bonds, the sureties do not expect any losses on the bonds that they issue. Sureties select applicants that have the ability to do the obligations that is asked of them. They do so by thoroughly checking the applicant’s job history, credit rating, and financial strength.
Sources of Funds
An insurance has only one source of funds. Also, when an insurance company pays a claim, the insured will not have to repay the insurance company back.
A surety bond, on the other hand, has two sources: the bond premium charged for the credit risk and the asset of the principal.
If the principal fails to do his or her obligations and a claim has been made because of it, the surety is legally bound to pay the obligee. But since a surety bond is a credit extended to the principal, the principal will have to reimburse the surety of such payments.