Understanding the Basics of Surety Bonds and How They Work

Be honest. You’re most likely here because you need to obtain a surety bond, but you don’t really know what it is or how to get one. Whether you are a business owner, a contractor or simply curious, understanding the basics of surety bonds is important since they play an important role in many businesses and projects. We sat down with members of our bond department to get the inside scoop. Let’s discuss what surety bonds are, the common types and some practical examples to help turn your confusion into confidence.

So, what is a surety bond?

Unlike insurance, which is a two-party agreement, a surety bond is a three-party agreement/contract. It is a promise to be liable for the debt, default or failure of another. Think of it like a safety net for a project or agreement.

There are three parties in a surety bond:

1. Principal – the person or business who needs the bond

2. Obligee – the person or entity that requires the bond, usually a government agency or a project owner

3. Surety – the company or insurance company/surety that backs the bond and promises to pay if the principal fails to meet their obligations

   
   

To make it simpler, let’s look at an example.

Let’s say you are opening a new restaurant. In order to operate, the local government requires you to obtain a license bond to ensure that your restaurant pays taxes on alcohol sold. If the restaurant fails to comply, the insurance company/surety you chose to obtain the bond from has to compensate the local government and then seeks reimbursement from you, the restaurant owner. In other words, the surety company is protecting the obligee NOT the principal.

So, in this example, you (a hypothetical restaurant owner) are the principal, the local government requiring the bond is the obligee and the insurance company backing the bond is the surety.

Continue reading here at Auto-Owners Insurance.