What is a Surety Bond?
Surety or suretyship is a very misunderstood topic, and is often thought of as insurance because so many insurance companies handle surety. Surety is actually viewed as a form of credit and at its root surety is a simple concept; The Surety Company promises to become obligated to the Obligee for the debt, obligation or conduct of the Principal. If the Principal fails in its obligation the Obligee may make a claim to the Surety company to recover losses. Since a surety contract is a form of credit, the Surety Company will require the Principal to reimburse them for the loss.
How is Surety Different From Insurance?
There a two fundamental differences between insurance and surety. First, in an insurance policy, the insurer takes the entire risk (less the deductible). In surety, no responsibility passes from the principal to the surety company; the principal, by paying premium, gets a surety company to accompany him/her as a guarantor of the fulfillment of a promise. The principal still retains all of his/her responsibility in respect to the obligee. Second, insurance companies collect premiums knowing that a certain percentage will be paid out in claims. A surety company’s premiums are really service fees charged for the privilege of using a surety company’s reputation and financial responsibility as backing. These fees are not the consideration as in insurance. The consideration in suretyship is the contract or obligation between the principal and the obligee. On this basis, it is not contemplated that any portion of the surety bond premium will be used to pay claims. So, payment of a surety claim does not relieve the principal of their duty. In most cases, the principal then become obligated to pay the surety company.