What is an Insurance Bond?

So you have general liability insurance, professional liability insurance, worker’s compensation insurance, commercial auto, commercial umbrella, cyber insurance and more -- you think you are all set with a comprehensive business insurance policy.

But did you know if you are in a certain profession, you might need more than those business insurance policies?

I know it sounds crazy, right? But doing business for or providing services to another party can be complex, and sometimes it involves additional risk mitigation tools.

That’s where bonds come in.

What even are bonds, you ask?

That’s where we come in. At Berry Insurance, our team is expert in the bond area, issuing hundreds to our clients per year, so we can walk you through it.

But bonds can be confusing, so buckle in and let’s dive into what you need to know.

What is an insurance bond? Is it an insurance policy?

Although they are generally lumped in the insurance category, bonds are actually not technically insurance.

Here is the difference between the two:

An insurance policy is an agreement between the insured (you) and the insurance company, whereby the company agrees to pay for certain claims in return for you paying a premium. 

A bond (also called surety bond) is an agreement between three parties - the principal (the person purchasing the bond), the obligee (the person who receives the benefit) and the insurance company.

An insurance bond is not meant to pay for claims. It is meant to provide a financial guarantee that the person or entity purchasing the bond (the principal) will reimburse the obligee should the principal default, fail to fulfill its obligations, or a claim is made.

In other words, an insurance bond is meant to prove or support the financial stability of the entity purchasing the bond. It affirms that the principal will be able to repay the bond company if it pays out a claim.

In most cases, when bonds are written, loss isn’t generally expected. They are intended to work as an extra layer of protection just in case the bond purchaser (the principal) is liable for not meeting the terms of any work-related agreements.

What is the point of a bond?

When considering the three-way relationship of a bond, you might be wondering why it can’t just be a two-way relationship between the obligee and principal. If the principal is responsible for paying anyways, why does an insurance company need to get involved? And why would the insurance company want to take on the risk if there’s potential for the principal not paying them back?

Well, there’s something in it for each party.

For the obligee: a bond ensures they will not be liable for anything if the principal doesn’t meet contract requirements or pay its employees. The obligee is requiring a bond to ensure the insurance company will pay them if the principal cannot.

For the insurance company: they are paid a premium for the bond (kind of like interest on a loan). They’re not expecting to have to pay anything to the obligee, but they make some money out of the deal simply by being paid a premium by the principal.

For the principal: the bond ensures the insurance company will pay if they themselves cannot. However, the expectation is that they will pay the insurance company back. Why would they pay the insurance company back instead of letting them take care of it? Well, the principal needs to maintain that relationship with the insurance company. If the principal doesn’t pay back, they won’t be able to be bonded again, which likely means they won’t get any more jobs.

What types of bonds are there?

I warned you, bonds are pretty confusing, but let’s look at some examples of bonds to help you understand when and why they might be necessary.

There are many types of insurance bonds available, but the most common are public official bonds, license and permit bonds, fidelity bonds, and contract bonds.

A public official bond is designed to guarantee that you will faithfully perform the duties of your office (whether elected or appointed). Typically these are issued to persons responsible for handling money. 

Some common examples of public official bonds are:

• Tax Collector
• Treasurer/Assistant Treasurer
• Town Clerk
• Constable
• Subordinate handling money

A contract bond is used to guarantee fulfillment of your construction contractual obligations.

Some common examples of contract bonds are:

• Bid Bond: guarantees that if you are awarded a job, you will comply with the bid specs. (This bond typically does not cost you anything!)
• Performance Bond: requires the contractor to finish a job on budget and on deadline. (usually combined with a Payment Bond)
• Payment Bond: provides your subcontractors and vendors a guarantee that they will be paid for their work on the job.

A license and permit bond is used to satisfy the requirements of a government agency, such as your local city or town. 

Some common examples of license and permit bonds are:

• Professional licensure bonds (i.e. real estate, insurance, etc.)
• Mortgage broker or lender bonds
• Notary bonds
• Private investigator bonds
• Auto dealer bonds
• Street repair, drain laying, demolition or street opening permit bonds
• Auctioneer bond
• Collection agency bond
• Travel agency bond

A fidelity bond can be used to protect your business from fraudulent acts committed by your employees. 

Some common examples of fidelity bonds are:

• Employee theft/dishonesty bonds
• Janitorial service bonds
• ERISA (Employee Retirement Income Security Act) bonds
• Probate or Executor bonds

Does my business need to be bonded?

As a business, you may need one or all of these insurance bonds, depending upon your contractual and regulatory requirements.

You may be legally required to be bonded per the state, an industry association, or a contract you’ve signed. 

In addition, if you perform services in someone else’s home or business, or you or your employees have access to money, you may wish to be bonded for extra protection. 

Finally, if you are involved in any construction work, you may also benefit from the additional protection from an insurance bond.

How do I get bonded?

So you think you might need a bond -- what are the next steps?

First, you’ll need to reach out to your insurance agency or carrier to find out exactly what you need. 

Depending on the bond, you could either need to complete a simple application, or a more lengthy one.

You may be asked to provide financial statements, resumes for owners, bank references, and details regarding current projects and works in process.

Once your agent compiles all the necessary information for you, he or she will process it and issue your bond.

But keep in mind, if you need to get a bond to satisfy regulatory or contractual obligations, you should do it as soon as possible. The process of obtaining a bond could take as little as a day or as much as several weeks. 

How much does a bond cost?

We wish we could give you a definitive answer here, but because all bonds are so different and priced based on various factors, it’s difficult to be specific.

The cost of a bond depends on many factors, including the type of bond needed, industry experience, the financial stability of the entity or employee being bonded, credit score, and more. 

Mostly however, it depends on the contract amount of the bond. Most bonds cost somewhere between .5% and 20% of the value of the bond.

Cross your t’s and dot your i’s

You do a lot to protect your business. Bonds are just another risk management tool to ensure you are properly meeting all your business obligations. 

There are so many types of bonds, and just as many scenarios for why you might need one, so if you’re still confused, we don’t blame you. Reach out to an insurance agent to discuss your specific situation and determine what you might need.

While you’re thinking of contacting your insurance agent for a bond, it may also be a good time to review your entire business insurance policy to make sure you don’t have any other gaps in your protection.

Check out this article Why You Should Review Your Commercial Insurance Annually, to know what to keep in mind when checking your policies for gaps or inaccuracies.