If you work in the construction industry or own a contracting company, you may have heard the term “surety bond” floating around. What is surety bonding? Is it like business insurance? The answer is yes – and no. Surety bonds are not insurance, but like insurance, they provide protection – but for the client, and not for the business.
In layman’s terms, a surety bond is like insurance in that it’s an agreement between parties, but a surety bond involves three parties: the principal, the obligee, and the surety. As the business owner in this arrangement, you would be the principal and your client would be the obligee.
Surety bonds get much more complicated than that. Read on for information about surety bonding.
How do surety bonds work?
With a surety bond, there’s an agreement between three parties: the business owner, the contractor or subcontractor being assigned to the specific project, and the client and/or company. These are referred to as the principal, the surety, and the obligee. A surety bond is typically issued by a company that wants to ensure that the work being done on a project is completed properly. Often times a surety bond will be issued in the event of large, complex construction projects so that the client can be guaranteed that the contractor will fulfill their contractual obligations. This is especially true when a government body is the client.
Basically, surety bonds are insurance for the client, not the business owner. A surety bond can ensure that the client isn’t left empty-handed if you (the principal) are unable to fulfill the terms for the client. This is when a “default” occurs.
If a default does occur, the surety enters – a “Performance” bond will kick in to ensure that the work can be completed. Then something known as a “Labour and Material Payment” bond follows to pay the subcontractors who were hired for the task. There’s another last difference between bonds and insurance at this point: after the bonds have covered the costs, you will be required to pay back the entire bond amount to your surety provider.
Why have surety bonds?
There are two major reasons why surety bonds are purchased and issued.
Reason number one: They act as security for your client. Surety bonds are like a type of insurance used to protect your client, not the business. It isn’t a replacement for insurance, but it’s a good way to secure your client’s peace of mind that the work will be complete – no matter what. As a business, you will still want to invest in a business owner’s policy as there are plenty of other risks your business could be exposed to.
Reason number two: It shows that you, as a business, take every measure to ensure your client’s needs are fulfilled. Some clients won’t work with you unless you have some sort of agreement that will guarantee the work is completed as per your contract. Many project requirements will contain a clause that states you need a construction or surety bond.
What types of surety bonds are there?
There are a few types of surety bonds that exist, mainly within the construction and contracting world. Here are a few examples of surety bonds:
- Bid bonds – Placing this type of bond ensures that you can accept the potential work for a job, and that you are serious about it. If you get the job and fail to do the work, the project owner may then make a claim on your bid bond.
- Supply bond – As a supplying company, a supply bond is used to ensure that you are held accountable. The bond can cover the purchaser’s loss if you fail to provide the materials and equipment necessary for a job.
- Maintenance bond – This bond is used to ensure quality workmanship for a job. These bonds may still stand for a certain period after a job has been completed.
- Performance bond – This bond replaces a bid bond once a job has been taken. If you fail to do the work as detailed in the contract agreement, the project owner may make a claim.
- Payment bond – Also referred to as a “Labour and Material Payment” bond, this offers subcontractors and suppliers financial security if the main contractor is unable to pay them for the work that they did.
This isn’t an exhaustive list. There may be other surety bonds available for purchase through an issuer, including landscape contractor bonds, site improvement bonds, sewer tapper bonds, and blanket sidewalk repair bonds.
How long does it take to secure a surety bond?
This is a great question. There are a few different processes that companies can go through to obtain a surety bond. There are 2 very common options that we typically see.
- Rapid Bond Application– We’ve seen these approved in as fast as 2 hours. This is just as it sounds… contract bonds made quick and easy. The underwriting process is much faster, and the approval process is much less rigorous than a traditional contract bond process.
- These are typically utilized for contractors/businesses that have not been in business for a long period of time, meaning the bonding companies can only look so far back into their company financials.
- Typically used on construction projects less than $250,000.
- Since the bond underwriting happens much quicker, the pricing is also higher than a traditional bond. However, it is still affordable in most circumstances.
- Traditional Bonding & Underwriting-The timing is all dependent on the prequalification of a contractor. If you’ve done your due diligence, worked with the bonding company, and set up your prequalification limits, the time it takes to approve a bond is dramatically cut. If you’re prequalified, we’ve seen bonds get approved the same day as the request. Some more complicated projects can take a few days. If you’re not prequalified, be prepared to be disappointed in the turnaround time. It can take 30 or more days for a bonding company to fully underwrite/understand an organization and to give its blessing. Be prepared and do your homework prior to bidding or entertaining projects that require commercial bonding.
- Most common type of bond with larger contractors and projects. Full company financials are looked at, along with personal financials of any owner of the companies looking to purchase the bonds. Verification of expertise and capability of the contractor to complete the project properly are reviewed.
- These are more common in public sector projects, such as government jobs and new school construction. Many private-sector jobs require bonding as well, so it’s not limited to public sector construction projects.
- Typically utilized by contractors with longer history, better financial stability, and proven capability to complete the projects they’re seeking the bond for.
- Used for larger projects. Typically for projects over $1,000,000 in cost. We’ve even seen projects over $20,000,000.
How much do surety bonds cost?
Depending on the type of bond being issued, the amount of coverage, project experience, your business’s credit history, and your business’s financial history, your surety bond costs may vary. On average, a surety bond will cost between 1-3% of the total bond being issued. In the example of a $75,000 bond, you might pay between $750-and $2,500.
You can purchase a surety bond through a surety bond provider. To do so, you may be required to provide various statements, such as financial statements, references to past project owners, and references from a bank. Ask for a quote to determine how much you may pay for your surety bond, approve it, and pay the initial premium amount. Afterward, you will be sent the bond by your provider.
You can apply for a surety bond with Hitchings Insurance Agency to make the process easier. Although surety bonds may seem complicated, the process to get one doesn’t have to be. Get in touch with a representative today to get started.