What is a Surety Bond and How it Differs from Insurance – Contractors

In the world of business, there are several tools which can be used to provide protection against financial loss. Both surety bonds and insurance offer a safeguard to individuals working in construction an certain trades, but there are subtle differences between the two which should be understood. If you’re working as a licensed contractor or tradesman, knowing what a surety bond is, how insurance differs, how each is priced, and the requirements for having one – or both – in place is a necessary part of operating a sound business. Here’s what you need to know about surety bonds and insurance.

What is a Surety Bond?

It is common to confuse a surety bond with an insurance policy. However, a surety bond works differently than insurance even though both offer a form of protection. With a surety bond, a contractor or tradesman purchases coverage from a surety agency which is meant to protect the project owner, not the contractor himself. This protection is to safeguard the project owner from fraudulent practices or incomplete work.

When a claim is made against a surety bond, the surety agency holding the bond for the contractor or tradesman pays out the claim, up to the limits of the bond. Unlike an insurance policy, a surety bond claim is then repaid by the contractor back to the surety agency.

Understanding Insurance Coverage

Insurance policies for contractors and tradespeople differ from surety bonds in several ways. First, an insurance policy is not meant to provide protection to the customer of a contractor, but instead, it offers protection to the contractor himself. When damage to a building or project site takes place, or theft occurs, insurance coverage is there is help offset the financial loss. The customers of contractors and tradespeople do not receive any benefit from insurance in these cases.

 

Additionally, insurance coverage benefits paid out to a contractor once a claim is made have no requirement of repayment. The insurance company takes on the risk of loss, up to the limits of the policy coverage, and the contractor is protected should an event take place in the future. Several different types of insurance policies are available to contractors, including general liability, workers’ compensation, and builder’s risk insurance.

Differences in Pricing

Above and beyond the differences in protection offered by surety bonds and insurance policies, differences also exist in the pricing structure of each. Surety bonds are priced as a percentage of the total bond amount. This percentage is also determined by the risk factors associated with the contractor and his or her business. For instance, an individual with bad credit history, including late payments to creditors, tax liens, and court judgments, will pay more than a contractor with a strong credit score and clean credit history. These financial factors play a role in surety bond pricing because a bond is essentially a form of credit extended to the contractor.

 

Insurance coverage, on the other hand, is priced based on the amount at risk for the insurance company. For example, a general liability policy for a contractor ranges in price depending on the claims history of the individual as well as the total amount of coverage requested. Contractors who work on high-risk projects, those who have a long history of claims made against other policies, and those who have been in business a short amount of time will pay higher premiums than contractors who do not show these traits.

Requirements for Either

In nearly all states, counties and cities require licensed contractors to secure a surety bond to operate their business legally. The amount of the bond varies greatly from one location to the next, making it necessary for contractors and tradespeople to look into their state’s requirements for bonding. Insurance coverage is not always a requirement for contractors, but it may be a need regardless. Insurance policies can significantly reduce the risk of financial loss to the business, helping contractors stay afloat should a disaster or theft take place.

Construction contractors and tradespeople need to evaluate their business needs to determine whether a surety bond, insurance coverage, or a combination of the two protection strategies is needed. It is also necessary to determine the cost of a surety bond and insurance, and plan ahead for this expense. Having the right protection in place not only satisfies legal requirements to operate a business, but it also lays the foundation for safeguarding project owners, customers, and the business over time.