While most bonds are sold by insurance companies, bonds are not insurance. A bond guarantees the performance of a certain contract or obligation. A bond is a three party contract, in which one party guarantees or promises a second party the successful performance of a third party. The three parties are as follows:
- The Surety – This is the bonding company.
- The Principal – This is the company or individual or corporation
- The Obligee, sometimes called the Owner – This is the individual, partnership, corporation or government entity with is requiring the guarantee.
The purpose of a bond is to protect public and private interests against financial loss. With insurance, losses are expected, and planned for when a company sets its premium. A bond, on the other hand, is more of a service charge than an actual premium. The bond premium is based on the cost of investigating an applicant and handling the transaction. A bond resembles a loan, as the surety is lending its credit to the principal, therefore Sureties are selective and will weed out unqualified candidates. If a claim occurs and the Surety pays that claim, the Surety expects to recoup its losses.
There are six main categories of Surety Bonds.
- Contract Bonds – This category includes Bid Bonds and Payment and Performance Bonds.
- Bid Bonds – This is the first step in a bonded contract. When bidding a job, a bidder must guarantee the price bid by posting a certified check or indemnity bond. If the contractor fails to enter into an awarded contract the amount is forfeited.
- Payment and Performance Bonds – These are typically issued together and referred to collectively as ‘final’ bonds. The Performance bond guarantees the performance of the terms and conditions of a contract. A Payment bond covers the payment by the contractor of labor and materials used in the project
- License and Permit Bonds – Many businesses need a government permit or approval, and often these are only granted after a business posts a bond guaranteeing compliance with laws, ordinances or regulations.
- Fidelity Bonds – These are sometimes called ‘honesty insurance’. A fidelity bond covers losses due to a dishonest act of a bonded employee. A loss can be money, merchandise or any other type of property. This type of insurance is available to cover specific individuals or groups of individuals.
- Public Official Bonds – This type of bond guarantees taxpayers that the official will do what the law requires. A public official is expected to faithfully perform the duties of their office; if the official fails to perform the duty the bond would cover the costs up to a specified amount.
- Judicial Bonds – These are bonds written for parties to lawsuits or other court actions.
- Fiduciary Bonds – A fiduciary is a person who is appointed to handle the affairs of someone that is not able to do so themselves. A fiduciary is sometimes called a Guardian or Conservator or an Executor. Fiduciary bonds guarantee an honest accounting and faithful performance of their duties.