A bond guarantees the performance of a contract or other obligation. Bonds are three party instruments by which one party guarantees or promises a second party the successful performance of a third party.
1. The Surety:
Is usually a corporation which determines if an applicant (principal) is qualified to be bonded for the performance of some act or service. If so, the surety issues the bond. If the bonded individual does not perform as promised, the surety performs the obligation or pays for any damages.
2. The Principal:
Is an individual, partnership, or corporation who offers an action or service and Is required to post a bond. Once bonded, the surety guarantees that he will perform as promised.
3. The Obligee:
Is an individual, partnership, corporation, or a government entity which requires the guarantee that an action or service will be performed. If not properly performed, the surety pays the obligee for any damages or fulfills the obligation.
The example below illustrates how a surety bond works:
Joe, the principal, has promised someone (the obligee) that he will do something. If Joe fails to perform as he has promised, financial loss could result to that person. Consequently, the obligee says to Joe, “If you can be bonded, I’ll accept your performance promise”. Joe goes to a surety and asks to be bonded. After the surety is satisfied that Joe is qualified and will live up to his promise, it issues the bond and charges Joe a “premium” for putting its name behind Joe’s promise.
Joe is still responsible to perform as promised. The surety is responsible only in the event that Joe does not fulfill his promises.
Protection – The Surety’s job:
The purpose of a surety is to protect public and private interests against financial loss. Therefore, the surety bonding company must be profitable and must have a strong balance sheet. No one is likely to accept the guarantee of a party with a bad name or a weak balance sheet. The surety bonding company guarantees performance. Its good name and its balance sheet back up that guarantee.
Probate bonds, notary public bonds, court bonds, license and permit bonds and public official bonds all guarantee protection of public Interests from financial loss.
Why has corporate surety become such a vital part of doing business in today’s economic society? Be- cause there is no practical alternative for protecting public and private Interests from financial loss.
The Surety Bonding Agent
The surety bonding business is hazardous—and’ always has been. Francis Bacon once said that “Going surety for a neighbor is like putting on iron to swim.” Still, the need for bonding grows daily. Therefore, the number of agents required to service this great need also Increases. Agents are the link between the surety company and those who need bonds. The primary source for bonding agents is established independent insurance agents. And today, most licensed independent casualty agents write at least some surety bonds.
Only licensed insurance agents can sell surety bonds.
Licensing individual agents helps keep un-scrupulous and incompetent people from doing
business on behalf of a surety. Agents must also sign a contract with the company they represent. The contract and the license are necessary because each agent is granted certain authority agreed upon by the company and agent.
Agents are often granted a Power of Attorney which gives them the authority to execute bonds. Each agent is limited in the amount and type of bonds that can be executed. Powers of Attorney and pre-executed bond forms literally put a surety company In the agent’s office. The agent can execute a bond on the spot. This requires the use of considerable discretion and is an important part of this highly service-oriented industry.
How is a Surety Bond Sold?
The typical sales problem of creating a need is not a factor in the surety business. A need for the bond has already been created either by law or by the nature of a particular business.
The surety agent earns a commission providing the customer’s bond. Until that bond is properly executed and filed, it does not begin to function. Therefore, availability is critical.
Since an agent cannot “create a need” for most surety bonds, service and availability are key to becoming the source when bonding needs arise.
Some Differences between Surety and Insurance
Although surety companies are often regulated by state insurance departments, surety bonding is different from insurance in some ways.
Several Differences
Insurance is a risk sharing device. It assumes that there will be losses. The expected losses are calculated by actuaries. These losses, coupled with anticipated overhead and other expenses, form the basis for the premium.
Surety is not actuarially rated as is insurance. Both insurance and surety call their fee a “premium.” The surety’s premium is as much a service charge as a conventional premium, which is determined on the basis of actual or anticipated losses. It is based largely on the cost of investigating the applicant and handling the transaction.
Surety: A Form of Credit
Surety is as much like banking as insurance. Bankers extend credit in the form of dollars loaned or as a commitment to loan. Every banker granting a loan fully expects to have the loan repaid. He investigates the borrower in sufficient detail to assure that such will be the case. Surety underwriters proceed in the same way.
SURETYSHIP verses INSURANCE
SURETYSHIP
Three party agreement. The surety guarantees’ the faithful performance of the
principal to the obligee.
INSURANCE
Two party agreement. Insurance is basically a two party agreement whereby the insurance company agrees to pay the insured directly for losses incurred.
SURETYSHIP
Losses not expected. Though some losses do occur, surety premiums do not contain large provision for loss payment. The surety takes only those risks which its underwriting experience indicates are safe. This service is for qualified individuals or businesses whose affairs require a guarantor.
INSURANCE
Losses expected. Losses are expected. Insurance rates are adjusted to cover losses and expenses as the law of averages fluctuates.
SURETYSHIP
Premiums cover expenses. A large portion of the surety bond premium is really a service charge for weeding out unqualified candidates and for issuing the bond.
INSURANCE
Premiums cover losses and expenses. Insurance premiums are collected to pay for expected losses. If an insurance company can get enough average risks of one class, it will always have enough money to pay losses and the expenses of doing business.
When the surety company is called in, the principal has usually paid as much of the loss as he is able. At this point, the surety company must pay the difference. The surety then tries to reclaim its loss from any resources left to the principal. In some cases the surety recoups all of the money it had to pay the obligee. In most cases, however, the principal either cannot be located or proves to be insolvent.
In reality, no obligee wants a claim against the surety bonding company. The obligee wants the principal to carryout his obligation. A surety bond is written because the obligee expects the surety company to weed out any applicant who cannot fulfill his commitments.