What is bond insurance, and how can it protect your business?

If you’re wondering what surety bonds are, here’s how they work, what protections they offer, and when it makes sense to buy them.   

What is bond insurance for a business?

A surety bond is one type of protection your business might need if you serve clients. It can cover you if a client claims your work is unsatisfactory or alleges theft or fraud. While surety bonds may be referred to as bond insurance, they aren’t an insurance policy in the true sense, though insurance companies often sell them.

Various types of surety bonds exist, including bid, payment, performance, and supply bonds.  In general, though, these bonds serve as a contract between three entities:

• Principal: The company buying the bond and providing a service to the obligee.
• Surety: The company issuing the bond.
• Obligee: The individual or company for which the principal is fulfilling an obligation.

How does bond insurance work

The principal purchases a bond from the surety company, which assumes liability if the principal is unable to effectively fulfill an obligation. “Essentially, a surety bond minimizes the risk of financial loss and ensures dependability in any agreement between business parties,” says Eric Weisbrot, Digital Marketing Manager at JW Surety Bonds.

For instance, let’s say an electrician successfully bids on a commercial rewiring project and subcontracts some of the work. The subcontractor is supposed to be paid $10,000 for their work. If the electrician fails to pay one of its subcontractors the $10,000 owed, that individual can file a claim with the surety, which will reimburse them. The electrician will then be required to pay the surety company back $10,000. 

Surety bonds can help assure obligees that the principal will complete the agreed-upon work satisfactorily or fulfill another obligation. They can also protect obligees against theft and fraud. These bonds convey a sense of legitimacy and trust for the principal purchaser. 

What does bond insurance cover

As mentioned, various types of surety bonds exist. Here are some examples of the available types and what they might cover:

• Bid bonds: If a contractor or other home service professional bids on a project, a bid bond can provide added security that they’ll complete the work if their bid is chosen. 
• Payment bonds: A payment bond helps guarantee that the principal will pay the obligee, as in the electrician example above. 
• Performance bonds: A performance bond helps ensure the principal will complete work satisfactorily and according to the original project scope. 
• Supply bonds: A supply bond provides some assurance to suppliers that the principal will pay them for any materials needed for a project. 

What bond insurance does not cover

While surety bonds serve as a guarantee in certain instances, they don’t cover everything. Here are some things that a surety bond typically won’t—but your insurance likely will—cover:

• Accidental injuries to one of your workers at a job site. Instead, your worker’s compensation coverage should pay for any related expenses.
• Property damage in a client’s home or yard. Instead, your business liability coverage should pay for any related expenses.  

Who needs bond insurance?

Several types of small businesses may need bond insurance, including those doing work for clients, and local or state governments, as well as businesses working on commercial projects. As you might imagine, surety bonds are common among service professionals bidding on and completing projects. 

“Contractors and construction companies are commonly asked to post a bond when working on medium and large sized jobs,” says Otto Larson, Vice President & Partner at Wallace & Turner Insurance. “Owners and general contractors will ask for Bid and Performance Bonds to guarantee that projects are completed, and completed on time. There are many other industries that require bonds as well.”

Other professionals, such as tax preparers, house cleaners, car dealers, mortgage lenders, and others, might also need them.   

Bonded vs. Insured 

If you’ve ever hired someone to complete a construction or renovation project, you’ve likely seen the language “bonded and insured” on a contractor’s website or business card. But surety bonds and insurance are two different things, though both can protect and provide legitimacy to businesses. Here are some key differences:

• Parties involved. There are generally three parties involved when it comes to surety bonds and two parties with business insurance: the insured and the insurer. 
• Protections provided. Bonds protect obligees, while insurance protects the insured. If, for example, a principal fails to fulfill a contracted service, the obligee can file a claim against the principal directly with the surety for compensation. Business insurance works differently in that the insured files a claim directly with their insurer. 
• Reimbursement. If a surety pays out a claim to an obligee, the principal is required to repay the surety for the total claim. This isn’t the case with insurance companies. For example, if one of your employees is injured and files a worker’s compensation claim, your business won’t need to repay the insurance company for the amount claimed.

Certain companies may only need insurance. Employers in many states are required to purchase worker’s compensation coverage. But others, like contractors, may need to be both bonded and insured. 

The takeaway 

Surety bonds can benefit both businesses and clients. They help businesses build legitimacy and trust and serve as a guarantee to clients that your company will uphold its promises. However, whether you need a surety bond depends on your industry, line of work, and local regulations. 

Generally, if you’re a home services professional, like a general contractor, electrician, house cleaner, or plumber, certain surety bonds may be required. Financial services professionals may also be required to purchase surety bonds.