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What is a surety bond?

A surety bond is a contract between three parties—the principal, the surety and the obligee (owner mandating the bond)—in which the surety guarantees the performance or obligations of the principal to the obligee. The surety bond is an instrument that protects the bond obligee, not the bond principal.

What’s the difference between insurance and a surety bond?

An insurance policy will compensate the policyholder when a covered loss is incurred. A surety bond ensures that the surety company will back up the principal (“contractor”) and complete the obligations of the contract to the owner (“obligee”) if a default occurs. Unlike insurance, no losses are expected in surety. Surety bonds are credit instruments, and are underwritten similar to how bank loans are underwritten.

What are contract surety bonds and the different types?

Contract surety bonds are written for construction projects. A project owner (the obligee) seeks a contractor (the principal) to complete a contract. Based on the requirements of the owner and the contract documents, the contractor requests a surety bond from a surety company. If the contractor fails to perform the duties outlined in the contract, the surety company generally has four options for fulfilling its obligation under the bond:

  1. The surety may find another contractor to complete the duties; 
  2. The surety may finance the principal through to completion of the contract;
  3. The surety may compensate the project owner for the financial loss incurred, up to the penal amount of the bond;
  4. The surety may deny the obligee’s bond claim if the surety believes the obligee’s basis for claim is unfounded, incorrect, or unlawful.

There are four common types of contract surety bonds: bid bonds, performance bonds, payment bonds, and warranty bonds.

What are commercial surety bonds and the different types?

Commercial surety bonds guarantee performance by the principal of the obligation described in the bond and are meant to ensure a business complies with all state regulations. They are typically regulatory or compliant in nature. There are five types of commercial surety bonds: license and permit bonds, court bonds, fiduciary bonds, public official bonds, and other miscellaneous bonds.

Who pays for a surety bond?

While the surety bond is a three-party agreement, the obligee (the entity requiring the bond) requires the principal to purchase the bond and to honor its terms. Generally speaking, contractors pay for the cost of the bond and then pass this cost onto the obligee (project owner). The bond is typically paid by the obligee upfront during the project’s mobilization phase.

How much does a surety bond cost?

A surety bond’s cost will vary depending on the type of bond, the credit strength of the bond principal, the terms and conditions of the underlying contract and size of the bond needed. The premiums will generally range from 0.5% to 2% of the total contract bond amount. If your bond rate is 1.5%, then an $80,000 bond amount will cost $1,200. In selection situations, a surcharge may apply. This is common when the construction period is long (usually over two years), or a long-term warranty (usually over one year) is required by the underlying contract. Contractors generally incur no costs for bid bonds.

What is bonding capacity and what are the different types of capacity?

Bonding capacity is the amount of credit a surety company is willing to provide. There are two types of capacity limits: 

  1. Single job bonding capacity: The amount of surety credit the bonding company is willing to extend on any one project. 
  2. Aggregate bonding capacity: The total amount of work that the surety will support at one time. This number often includes both bonded and unbonded work.

Unlike insurance, bond capacity “limits” aren’t true limits. Rather, these two figures serve as general guidelines used to service the day-to-day bonding needs of the contractor. Sureties have the flexibility to extend credit support beyond these “limits” when underlying situations merit. 

How is my surety capacity decided?

Your surety capacity is based on a series of factors including accounting practices, the principal’s credit strength and capital structure, and the quality of the organization and C-Suite leadership. Surety companies are looking for well-managed, profitable organizations that have a strategic and thoughtful plan to maintain or grow their business.

How do I increase my surety capacity?

When you demonstrate financial stability, upward profitability trends, and a history of on-time projects, then surety underwriters can feel confident that you are a preferred risk. Thus, the surety may consider increasing the capacity limits of your surety program. A good surety advisor will not only provide recommendations on how to improve your surety relationship, but also secure these improvements on your behalf. Leveraging technology and insights (such as through the adoption and use of software like Procore) can help increase your surety capacity, reduce indemnity requirements and improve your bond pricing.

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Procore Risk Advisors (PRA) is a brand of Procore Insurance Services, Inc. Surety and insurance products provided by Procore Insurance Services, Inc., 221 W 6th Street, Suite 1800, Austin, TX 78701. Licensing Information