It's a common question from most business owners and service providers: What is the difference between a surety bond and insurance?
A surety bond’s function sounds similar to insurance. Yet, a surety bond is a different instrument and it's important to know the difference for your business and requirements.
In this short article you'll learn:
- Who is protected?
- Who pays the money to get protection?
- Who collects the money if a claim is paid out?
- Who handles claims?
- When do you need a surety bond and insurance?
By the end of this article, you'll know the difference between a surety bond and insurance. Plus you'll have the confidence purchasing your surety bond. Let's get into it.
What Is A Surety Bond Compared To Insurance?
At its highest level, think of a surety bond as a financial guarantee backing the promise or performance you’re making to service your end customer or entity.
Unlike insurance, there are three parties involved in a surety bond. Read more about the details and obligations of a surety bond.
For example, if you're an auto dealer, you're making the promise to:
- Properly transfer title of the new vehicle
- Handle customers' deposits correctly
- Proper payment of any fines imposed by the Commissioner of Motor Vehicles
- Abide by the rules of the dealer’s license
If you're a general contractor, you're making the promise to:
- Complete the requirements of the job fully
- Follow the rules and regulations for the job you are completing
- Handling of deposits and payments to third party contractors
- Adhere to the rules and regulations of your contract license
- Plus more.
Insurance is protection for accidental damages on your business or to protect you from accidents on your property.
Who Is Protected?
When it comes down to it, a surety bond protects the end consumer or government from “fraudulent” behavior by the hired company.
Insurance is used to protect against accidental loss, an injury, accident, loss of equipment… not out-right poor behavior or actions.
Let’s look at some detailed examples.
There are tens of thousands of different types of surety bonds, but in a general sense...
A surety bond protects the "person", "government", or “entity” receiving the benefits of the service.
Confused? Here are some examples.
|If a company needs goods shipped across the country... the owner of those goods is protected from any fraudulent behavior of the freight broker… the person who hired the transportation company.||Insurance is purchased by everybody for multiple protections. The shipper has insurance on the trucks. The company shipping the goods, has insurance on the replacement cost of the goods being shipped.|
|A government will hire a suite of contractors for a road project... the government is protected by a surety bond if the contractor doesn’t complete the job… doesn’t pay subcontractors or mishandles licenses.||Governments do have insurance polices for accident loss or damage to city owned assets. And you can bet the a contractor is going to have insurance on equipment and the people working for him or her.|
|Most state governments require auto dealers to purchase a surety bond. This bond not only protects the government from potential tax issues, and customers in the case the auto dealer misrepresents information about a car's past, title, or other situations.||An auto dealer will have many insurance policies to protect the business. An obvious one is insurance to protect their vehicle inventory to protect it from natural, accident, or theft damages.|
Who Pays The Money To Get Protection?
The service provider pays for the surety bond.
As the service provider, what you pay for a surety bond is a fraction of the surety bond’s value. If you have good credit and credit is required... the cost of a surety bond could be 1% but go up to 10% based on bond specific factors. Many surety bonds are based on the personal credit of the owners of a business while other surety bonds are available at fixed prices.
Surety bonds are paid (the premium) at the start of the bond term. And, like an insurance policy, for most bonds you’ll have to renew on a bond specific interval.
The cost of most surety bonds are far less than other business insurance policies
You also pay for insurance.
While you can pay off insurance premiums for the year, most people pay on a regular interval, typically monthly. This monthly interval does not end unless you cancel the insurance plan or fail to make payments.
As you already know, insurance premiums are very expensive because the insurance company's risk of a claim is far greater than a claim against a surety bond.
Who Collects The Money If a Claim Is Paid?
As mentioned earlier, the person or entity receiving the service or expecting you to adhere to the laws would receive the payout of a claim on the surety bond.
A surety bond is guaranteed. It’s underwritten by a surety, the company who guarantees to pay when a claim is made and approved.
You, the service provider, are still on the hook for the ultimate value of the claim made due to indemnity requirements when purchasing the surety bond. If the surety pays out the claim you may also be responsible for additional fees related to the claim investigation.
It’s not just the money. Claims against your business can result in your license being canceled in the worst case. Any claim against your business will likely increase your premium when you renew your bond and will make getting bonded in the future much more difficult and expensive.
With insurance, you're paid if something happens to you or your business that's covered by your insurance policy. And like surety bonds, if you make a claim on your insurance policy, your premiums may go up and getting better insurance plans in the future can become more difficult as well.
Many insurance policies can be cancelled at any time with proper notice.
Who Determines When Claims Gets Paid?
Let's keep this high level. First a claim needs to be made against your business.
Once a claim is made, the surety will have a claims analyst investigate and determine if the claim is legitimate.
If the claim is approved, money is paid to the claimant. Remember, when you get the bond, you sign an indemnity agreement stating you’re liable to reimburse the surety for the bond amount and any accrued legal fees to the surety.
With insurance, you make the claim to your insurance company for any damages you've sustained.
You've probably gone through this process before with auto insurance or home insurance. Once a claim is made, the insurance company will verify the coverage and an adjuster will determine an amount to be paid (if any). Depending on the results, some companies may hire a public adjuster to get an alternate estimate for damages.
Now You Know The Difference Between a Surety Bond vs Insurance
If you're reading this article, you know you need a surety bond. It's most likely required as part of the licensing process.
Now you know the difference.
- A surety bond protects your customer and possibly a government from business negligence on your behalf.
- You pay a small premium for the surety bond one time on a renewal schedule (usually every year).
- If a successful claim is made, you have to pay the amount of the claim back to the surety.
- Insurance is mainly purchased for your own protection or protection against accidents.
- Although insurance policies are required to purchase insurance policies (for example liability insurance among other types).
- Insurance is considerably more expensive and usually chosen to be paid for on a more frequent basis to spread the cost out.
We’re here to help you get the surety bond you require fast and as inexpensive as possible so you can get on with your business.