Featured / Insurance Protection

Are Bonds a Form of Insurance?

In the business world, there are various scenarios that may require posting a bond such as a construction project on which you are bidding or to a government agency for a license or permit. A bond is a guarantee that you will provide the services or products required by a contract.  Many people simply call their insurance broker and ask for a bond without really knowing the implications. Is a bond the same thing as an insurance policy?

To put it simply, NO. With an insurance policy you pay your annual premium each year, and if there are claims, the insurance company will make payments on your behalf.  Your rates may go up the next year, but the insurance company will not bill you for the claims they pay, that’s why you have insurance. Sureties are much different, you will be charged 1 – 3% for the total bond and if there is a payment on your behalf the surety will promptly send you a bill for the full amount paid.

Bonding 101:

There are three parties in any surety relationship:

  • Obligee – the person or entity requiring the bond
  • Principal – the person or entity that needs to produce the bond
  • Surety – the bonding company that will post the bond on your behalf

Why would an obligee request that you provide a bond?

Let’s say you are a land developer that wants to build 30 homes in a local township. The township (obligee) would request that you post a sub-division bond for the amount of all the improvements that need to be made to the land in order to build the 30 homes. This bond will protect the township and its citizens from having a developer break ground and not finish the plans. This happened a lot back in 2008-2009 when the financial crisis hit. There were countless projects started that builders had to walk away from. Then the township and its citizens were left with an unfinished project in their town. If a bond was required before the developer broke ground it would have guaranteed that the project would come to fruition, even if the surety had to pay another contractor to finish the work. You will notice that a bond does not protect the principal, it only protects the obligee.

Obligee’s typically offer several alternatives to bonds because not every business can qualify for a bond.  Instead of posting a bond you are typically given the option of posting cash in an escrow account or you could go to your bank for a letter of credit which will be given in favor of the obligee. In our experience, these options are good, but if you can qualify for a bond it is a better alternative.

There are two main reasons why posting a bond is a good alternative:

  1. Bonds preserve your liquidity. By paying 1 – 3% for a bond you can keep your cash in the business, rather than posting it as collateral. Over the past 90 years, the S&P 500 has had an average rate of return of 9.8% so even if you can’t use the cash in your business it would be better to post a bond and invest the difference in the market.
  2. Sureties provide an extra layer of protection in the event of a false claim. If you are not meeting the requirements in the contract, the obligee has a right to draw on the financial guarantee you posted. If you posted cash or a letter of credit, the trustee or financial institution will disburse the funds requested by the obligee. However, if you posted a bond, the surety will work with you and the obligee to find an equitable resolution before making a payment on your behalf. This is very important because your company assets are on the line when posting cash or a bond. A bond puts protections in place in the event something goes wrong.

If you need a bond make sure you choose a broker or surety that takes the time to explain all of the implications of posting a bond. Simply finding the cheapest rate or fastest turnaround time may not be the best option for you or your business if there is a claim, especially if you thought bonds were the same as insurance. The team at Univest Insurance is here to help your business control its risk, call us at 215-362-7000 to have a conversation.

 

Insurance products offered through Univest Insurance, LLC, a licensed insurance agency affiliate of Univest Financial Corporation, are obligations of and underwritten by unaffiliated insurance companies. They are not insured by the FDIC or any other agency of the United States and are not deposits of or guaranteed by any bank.