Surety Bonds

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Surety bonds operate as a guarantee and are not contracts of insurance. Unlike insurance, where a premium is paid to a company that is expected to pay for covered losses, surety bonds are a guarantee to a third party. Simply put, surety bonds are a guarantee that a second party will fulfill a contractual obligation to a third party if the first party defaults.
A surety bond is an agreement between three parties. Unlike an insurance policy which is only between two parties. You could also look at a surety bond as a line of credit issued by the company that issues the bond to the party that applied for the bond. A payment might not be necessary or called for by the first party. If a surety company has to make payment, they do have subrogation rights and can pursue the party that purchased the bond for what they paid out. They can also seek reimbursement of legal fees. The party that purchases the bond is required to sign a corporate, personal, and spousal indemnity.
Surety departments can be found in the largest property and casualty insurance companies. Some companies specialize in nothing but surety bonds. In order for any company to write a surety bond in the U.S., they have to be licensed by the insurance department of one or more states. Most of the time the surety company is required to be licensed by the state in which it is doing business or by the state where the business or obligation is being carried out.
The Surety & Fidelity Association of America (SFAA) represents surety companies. This is a District of Columbia non-profit corporation. This association is engaged in the business of suretyship. SFAA is licensed as a rating or advisory organization in all states, the District of Columbia, and Puerto Rico.

Sometimes, a second party, or the one that required the bond, might call on the bonding company to step in and do what they have to in order to complete a job. A common use of surety bonds would be for a contractor that bids on a job to build a new entryway to a restaurant. Before the work can begin, the owner of the restaurant requires the contractor to provide proof that he has been bonded. Once this is provided, the work begins. Three weeks into the construction project, the owner of the construction company pulls out of the project. The restaurant owner can make a claim with the bonding company asking the company to hire another reputable contractor to complete what the first contractor began.
The most common type of alternative to surety bonds is an irrevocable letter of credit.

Surety Bonds: Parties Involved
As stated earlier, one-way surety bonds are not like insurance policies is that three parties are involved and not just two. They are the principal, oblige, and surety.
The principal is the party seeking the surety bond. This could be almost any type of business and for almost any need.
The obligee is the party that requires the surety bond. Normally this is a governmental department. The Department of Motor Vehicles of most states will require the owner of an auto dealership to have a bond in case a state requirement or law is broken. The dealership would be required to pay fines.
The third party is the surety – also known as the bonding company or the carrier. This company provides the financial backing to the business in case something happens and there is a contractual problem that will require the surety company to step in and make a payment of some type.

Types of Surety Bonds:

Contract Surety Bonds
Contract surety bonds provide financial security and construction assurance on building and construction projects by assuring the project owner (obligee) that the contractor (principal) is qualified to perform the work and will pay certain subcontractors, laborers, and material suppliers.
Bid Bond
A bid bond is a guarantee that the bidder, a construction company, will actually carry out the contract at the winning bid price.
Insurance Bond
An insurance bond is a type of license and permits bond. It guarantees the insurance broker will account for premiums collected for insurance policies to their companies and the public. This type of bond protects individuals from any possible harm that might be caused by actions of licensed insurance brokers. These are required by the department of insurance in each state.
Payment Bond A payment bond is a bond that guarantees payment to employees, suppliers, subcontractors, and any other party during the life of a contract for an obligation in the event the contractor defaults. This is typically issued with a performance bond.
Maintenance Bond
A maintenance bond follows a performance bond where the work is completed. It guarantees against defects for a specified time period after the work is complete.
Subdivision Bonds (also called Performance Bonds)
Also referred to as site improvement or performance bonds. They are a guarantee that developers and individual landowners complete improvements made to a subdivision property. These are normally required by local government authorities. The underwriters for sureties that write this type of bond require information such as the scope of the improvements, a cost estimate and where the money is coming from.
Court Bonds
Many times court bonds are required by court proceedings to ensure against possible loss as a result of the outcome of the proceeding. The bonds are generally divided into the plaintiff and defendant bonds. There are also custodian bonds, estate bonds, executor bonds, fiduciary bonds, guardianship bonds, and probate bonds.
Bail Bonds
A bail bond is basically property, or money, deposited or pledged to a court to release a suspect from jail with the understanding that the suspect will return for trial or forfeit the bail. The bail money will normally be returned at the end of the trial no matter what the results are.
License Bonds
License bonds are typically required by a governmental department of a company to guarantee the company will abide by all regulations. License bonds can include auto dealer bonds, contractor license bonds, mortgage lender bonds, and mortgage broker bonds.