This is always where the conversation starts. Why? Because if you think a bond is an insurance policy, you will have the wrong set of expectations. If you are seeking a bond, you’re likely to become very frustrated unless you have a correct understanding and the expectations to go with it.
Here are two basic differences between insurance and bonds:
1. Insurance transfers risk of a specific event from the insured (policy holder) to the insurer. (Example: The risk of financial loss due to fire is transferred from the insurance applicant to the fire insurance company.) With a bond, the bond applicant HOLDS the risk.
2. Insurers charge rates that expect a certain number of claims and losses. Sureties do not expect to have claims or losses and do not charge enough to pay for them.
There are other additional differences, but let’s focus on these two. With a bond, the surety is backing the bond applicant performance for the benefit of the party paying for the work. If a problem develops, it is still up to the applicant to solve it. In fact, contractors give their indemnity to the surety (promise to reimburse the surety if they fail to perform and the failure costs the surety money.) So when a bond is in place, it is even more important for the contractor to perform correctly. With insurance, you pay a premium to reduce your risk. With bonds you pay the premium, but have even more at stake than on an un-bonded project.
On the second point regarding rates, this helps explain why bonds are hard to obtain. If the surety has no tolerance for claim or loss, they can only provide bonds for the most qualified applicants. This means you must present yourself in the best manner possible if you hope to obtain a bond. Doing so requires good financial reporting, record keeping and complete disclosure. We’ll talk more about this later in this series.