What are Surety Bonds? Learn Why You Should Have them for Your Next Construction Project
April 6, 2021
As a construction project owner, did you know that an insurance policy isn’t the only line of protection that you can include in your risk management program? Surety bonds are a unique risk transfer method that you can request from a contractor to reassure that the work you need done will be completed. Read below for a comprehensive rundown of what you need to know.
What is a surety bond? How does a surety bond work?
A surety bond is three-party contract. It is a pledge made by a surety to an Owner (obligee), stipulating that a third-party, such as a contractor (principal or obligor), will faithfully perform their obligations in an underlying contract between both the obligee and the principal.
How does this three-party contract work in practice? Consider this example: the surety assures that a contractor (obligor) will build a project for the owner (obligee) in accordance with the contract.
What happens when a surety bond is called?
A surety bond can be called when the obligee believes that the obligor has violated the underlying contract. Should they choose to proceed with a claim to the bond, the obligor will need to pay the required amount. For example, if a contractor defaults, the surety will need to pay the owner’s costs incurred in having the work completed to the amount specified on the bond.
How do you pay for a surety bond?
A surety bond is typically purchased by the obligor for the benefit of the obligee. Payment methods are dependent on the type of bond. Typically, they require either a down payment determined by a percentage value of the project, or an annual premium.
What are the benefits of surety bonds to project owners? Who else can use a surety bond?
A surety bond provides assurance that a project will be completed in accordance with the contract. This is called a performance bond. It can be extended to make sure, that suppliers and sub-contractors are paid through an additional surety instrument called a labour and materials bond. In addition, the surety typically undergoes a prequalification process with the contractor which provides reassurance that the contractor’s experience and finances meet or exceed the ability of the Contractor to complete the work stipulated in the contract.
Anyone who hires a contractor to perform work is in a position to use, and benefit from, surety bonds. For example, a general contractor might require a bond from a sub-contractor, making the general contractor an obligee and the sub-contractor an obligor.
How do surety bonds differ from typical insurance policies?
A surety bond is predicated on an underlying contract, while an insurance policy is independent of other contracts, and only covers certain losses that can be subject to exclusions. In contrast, surety bonds cover all defaults where the principal has violated its contractual obligations.
A surety bond is meant to benefit the obligee (i.e. a project owner) not the contractor. In fact, a surety may satisfy its obligation to the owner if a contractor defaults but it will look to the contractor for reimbursement of the amount of the default. Unlike an insurance policy, a claim can be made for an impending loss to the obligee, even if the obligor intentionally violated the contract! An insurance policy typically excludes losses that are intentionally caused by the insured.
Implementing surety bonds in your risk management program.
From working with underwriters to reviewing different bond types, surety can prove to be a complex landscape to work through – working with a specialty broker can help you navigate and find what you need.
At EQUA, our team of risk and insurance specialists have decades of experience in the construction industry – we have the level of expertise that is required to create unique, comprehensive, and actionable surety solutions for your next construction project.
Let’s get to work. Email email@example.com to get started.
Do you want to learn more about coverage and risk management options for your construction projects? Visit our Construction industry page.