What is a Surety Bond？
A surety bond is a promise to be liable for the debt, default, or failure of another. It is often referred to as a three-party contract by which the surety being the first party, guarantees the performance or obligations of a principal (second party) to an Obligee (the third party). The three-party explanation is often used to show the contrast between surety and insurance. Insurance is a two-party agreement between the insured and the insurer.
While Surety bonds are typically issued by an insurance company, they are not insurance. It is the financial assurance given by a Surety to an Obligee (typically a government entity) ensuring that money damages will be paid in the event that the Principal either defaults, fails to uphold its promises, or becomes insolvent.
Surety bonds are required for many government jobs, construction jobs, or by the court. Additionally, certain industries are also required by federal, state, or local governments to have bonds before a business license will be issued in order to protect its citizens.
The principal pays a premium in exchange for the surety’s commitment to guarantee a bond(s) to an Obligee. If the principal defaults and the surety turns out to be insolvent, the bond worthless. Which is the reason why insurance companies, whose financial strength and solvency is verified by private audit and/ or governmental regulation, are typically granted licensing and authority to underwrite Surety Bonds.
In the event of a claim, the surety will investigate, pay, and typically seek reimbursement from the principal for the claim amount paid plus legal fees incurred.In some circumstances, when the principal is unable to fulfill its obligations, the surety has chosen to “Subrogate” which includes substituting for the principal in order to fulfill the terms of an obligation and/ or recovering damages.