There are fundamental differences between insurance and surety bonds and knowing the difference will help you avoid making mistakes, should claims arise. This blog will discuss the differences between insurance and surety bonds.
An insurance policy is a two party contract between an insurer and the insured. The policy is intended to protect the insured. The cost of insurance is calculated by the insurer based on how many claims and how large those claims may be that the insurer anticipates will be made under the policies it has issued.
A surety bond is a three party contract, usually between a contractor (the bond principal), the project owner (the obligee) and a surety. There are rights flowing between all three parties, such as the owner’s obligation to make a claim within a certain time frame, the surety’s obligation to extend credit should a claim be approved, and the contractor’s obligation to pay the surety the premium. The surety does not calculate premiums based on anticipated losses. Sureties do not expect losses. This is one reason sureties learn so much more about your business than insurers.
When an insured makes a claim on its insurer, the two parties assess the situation and the insurer determines whether to pay the claim. But, in a surety bond claim, the claimant, bond principal and surety have rights and obligations flowing among them. Once the claim is made, the surety must investigate the situation from the standpoint of both the claimant and the bond principal. This investigation and claim determination is more involved than the investigation undertaken by an insurer.
One of the biggest differences between surety and insurance is the expectation that a claim will be paid by the insurer, less a deductible. When one buys insurance, there is an expectation of coverage. Sureties do not expect a loss. Moreover, the bond principal (contractor) is ultimately responsible to fully indemnify the surety for any costs incurred in a claim. In essence, insurance is purchased to protect the insured from a loss while a bond is obtained to protect the project from a loss.
Insurance and surety are distinctly unique. But, knowing the difference can help contractors better understand their obligations in each situation and adjust their expectations accordingly. If you have any questions about bonds versus insurance, we recommend you contact an experienced construction attorney.