Tag Archives for Surety Education

Different Types of Bonds

A common misconception of bonds is that they are all considered surety bonds, but this is not the case. Bail bonds, treasury bonds, investment-grade corporate bonds, junk bonds, foreign bonds, mortgage-backed bonds, and municipal bonds are completely different than surety bonds. Bonds acting as a financial investment pay out agreed upon interest payments to the bond holder, often referred to as the “creditor”. Once the bond matures, the principal (borrowing entity) pays the face value of the bond. Bail bonds have two parties, the court and the defendant, and have the most similarities to surety bonds as they are guaranteeing that the defendant will show up in court. Investment bonds can be sold on secondary markets and publicly traded. However, surety bonds have a three-party structure with a principal, oblige, and surety. Surety bonds are used to guarantee the completion of construction projects, that a business will conduct themselves in accordance to local and federal laws, or fulfill requirements set forth by special courts such as a probate court.

A surety bond producer or agency typically will not issue bail bonds, investments bonds, or municipal bonds. Surety bonds are more similar to insurance products and are sold by surety brokers and agents who are typically affiliated with an insurance company or brokerage. Surety carriers are often the same as commercial insurance carriers. Despite the similarities, surety bonds are not the same as insurance products but are sold by insurance agents. Most insurance agents are unaware they only need a P&C license to earn commission off surety bonds. Most surety bond clients (referred to as the principal) are unaware their commercial insurance agent can sell them the surety bonds they are required to have. This often leads to the principals having to purchase their insurance from their insurance agent then searching for a surety bond broker or agent to purchase their bonds.

Who Can Sell Surety Bonds?

The principal of a surety bond (business owner or contractor) cannot purchase a surety bond directly from the surety carrier. Most principals are unaware they can purchase surety bonds from the same insurance agent who sells their commercial insurance. Making the process of purchasing a surety bond more complex, most insurance agents are unaware they can sell and earn commission on surety bonds. The principal must purchase the surety bond through a licensed insurance agency, agent, or brokerage. An agent, agency, broker, producer, or brokerage must have a Property and Casualty license in order to be paid commission on surety bond premiums.

Oftentimes, the underwriter who assesses the risk with surety bond applications for the carriers does not have a P&C license, as they are not earning commission on their bond sales. Insurance regulations are different in each state but all require that any insurance producer or agent earning commission on surety bond premiums have a P&C license. Earning a salary or bonus does not constitute earning commission. As long as a surety producer or surety broker works for a licensed brokerage or agency with at least one owner or employee being licensed in the state in which the bond is sold, commission can be earned from a surety bond. Oftentimes, the surety carrier will require the surety brokers with power of attorney to have a P&C license before they are granted power of attorney to issue bonds. Surety agents and producers without power of attorney will have to purchase bonds from the carrier or the brokerage on behalf of their clients.

Insurance agents who are unfamiliar with surety bonds should secure an appointment with a trusted surety bond broker. Surety brokers are often appointed with dozens of different surety carriers. Having multiple surety appointments allows the broker to secure the lowest premiums for the appointed agents and clients. An insurance agent can secure their own surety appointment without using a broker. However, if surety bonds are not a big piece of their business, most retail insurance agents will not be able to secure appointments with sureties that have the best premiums. This can cause the insured clients to shop surety bond rates and possibly move their entire commercials book of insurance business to the agent who can handle their insurance and bonding needs.

Different surety carriers have varying standards for their surety appointments. Some may require a minimum volume amount or they may only appoint brokers/agents who are experts in the surety bond industry. If an insurance agent who is unfamiliar with surety secures an appointment directly with the carrier, it can lead to some negative outcomes. Surety underwriters tend to frown on incomplete applications, applications with missing supplemental documents, and surety bond applications that do not match their appetites. This can lead to longer application process times, higher rates, and a decline in service. Surety carriers, who appoint all agents regardless of experience, tend to have a more automated system in place. Applications are sent to a general inbox or can be submitted online, usually without ever consulting with a surety underwriter. These applications can often take weeks to quote.

Securing an appointment with a surety broker such as Allied American Underwriters, a division of USG Insurance Services can allow retail insurance agents to have the best of both worlds. When becoming appointed with USG, retail insurance agents can offer their insureds a fast application process, the most competitive quotes, and a surety broker to answer all questions and set realistic expectations. This allows the insurance agent to focus on assisting all of their clients’ insurance and surety needs, without all of the back-end work of remembering each specific caveat of the 13,000+ different types of surety bonds. Insurance agents appointed with USG earn commissions and have access to easy bond payment portals and additional educational resources from interacting with a surety broker directly.

Identifying Clients Who Need Surety Bonds

Commercial insurance agents have numerous existing clients who are required to purchase surety bonds. It can be challenging to figure out which insureds need to purchase bonds and when. There are three main types of surety bonds: commercial, contract, and court bonds. Understanding each of the three types will allow for easier identification of insureds that also need to purchase surety bonds.

Commercial Bonds

Commercial surety bonds, also referred to as “license and permit bonds”, are most often required when a business applies for a business license and must be renewed each year for the life of the business. Businesses that are required to have this subtype are:

  • Appraisal Management Companies
  • Auctioneers
  • Bars, Restaurants, and Any Business With Alcohol Sales
  • Cannabis Related Businesses
  • Car Wash Owners
  • Cleaning Services
  • Contractors
  • Convenience Stores Who Sell Lottery Tickets
  • Driver Training Schools
  • Health Clubs
  • Home Health Care Providers
  • Immigration Consultants
  • Mobile Home Manufacturers
  • Mortgage Brokers
  • Motor Vehicle Dealerships
  • Notaries
  • Pharmaceutical and Medical Equipment Businesses
  • Public Officials
  • Realtors
  • Retailers of Tobacco Products
  • Telemarketing or Fund Raisers
  • Travel Agents
  • Truckers and Other Transportation Related Businesses
  • Unaccredited Schools or Colleges

Contract Bonds

Contract bonds tend to have the highest premiums and are needed by contractors, though not all contractors need contract bonds. Contractors may need to purchase a commercial bond for their business license or a permit to operate in a specific city or county. They will also need to purchase bid bonds, performance and payment bonds, labor and materials bonds, warranty bonds, maintenance bonds and developer bonds.

Public and private construction projects are the two general project types for contractors. Public jobs, such as renovations to a school or a contract with the city to maintain roads or salt sidewalks, require a bid bond and performance and payment bond to be purchased for public over a certain amount. Each city, county, state, and federal government entity can require a bond for any size project if they choose too. The same applies with private work. If an owner of a retail store wants a new location to be constructed, they can choose to require any contractors who wish to bid on the project to be bonded.

Court Bonds

The last and least common type of bond is a court bond. Court bonds are required by a court. A court may require executors of wills and trusts to obtain a surety bond to ensure that the trust or will is executed as the benefactor intended it to be. Pennsylvania for example, has a requirement that any executors who reside in a different state than the benefactor must obtain a probate bond before being granted approval to execute a will. Court appointed guardians must obtain a probate bond in order to have control over a minor or incapable person’s well-being and their assets. Public officials such as a local treasurer must obtain a type of court bond in order to sign checks on behalf of the city. Different states, cities, and industries have varying types of bonding requirements. If an agency is in California, their clients may need numerous bonds of all types. If an agency is located in a less populated state such as Missouri, they may not need as many commercial bonds as they do contract bonds. States located in the northeast that are clustered together may require more probate bonds than larger states in the Midwest. Becoming appointed with a broker such as AAU will enable an agency to have access to surety insight that can be used to penetrate their existing book of commercial insurance with surety bonds.

The Three Parties of Surety Bonds

Working with surety bonds involves using unique terminology. Despite surety being lumped into the insurance sector, even insurance agents need a translator to navigate through the bonding process. The three parties to a surety bond are the Obligee, Principal, and Surety.

Obligee

This is the entity that is requiring the principal to be bonded. Often times this is a government entity, such a Department of Motor Vehicles for commercial bonds or a general contractor for contract bonds.

Example: A cosmetology school must be bonded. Halfway through the semester the cosmetology school goes bankrupt and must close. The bond protects the students and their pre-paid tuition. Students can make a claim on the bond to be reimbursed. The surety will pay the claim and then look to the individuals who own the business to be made whole on the full amount of the bond claim.

Principal

The person or business required to be bonded by the obligee. The Principal must purchase a bond from a licensed insurance agent or surety bond broker and abide by the obligations stated on the bond form. The Principal is in a position where their decisions may cause harm to consumers of their business or to entities required to maintain oversight and regulation – such as a state or local government. Therefore they are required to be bonded.

Example: Cosmetology schools, car dealers, contractors, mortgage brokers, freight brokers, health studios and even an executor of a will are examples of bond principals.

Surety

The Surety is an entity providing a line of credit guaranteeing the compliance or performance of a specific obligation, contract, or law. The surety underwrites the principal during the application process to ensure zero losses. Unlike insurance, surety bonds are written with the expectation of zero losses. Also unlike insurance, if a claim is made the surety will pay the claim if proven valid. The surety will then look to the principal to reimburse the surety for the full claim amount. This is why indemnities require a signature from the business and a signature from the business owners.

Surety Bonds vs. Insurance

The distinction between insurance and surety bonds isn’t always clear, so we’ve created a visual showing the differences and similarities between the two.

Insurance-vs-Bonds_Venn-Diagram_01

The surety and insurance industries use the same concepts when placing business, but use different terms to describe each concept. Here are some of the most common surety terms translated for the insurance industry.

Surety Term Insurance Term
Principal Insured
Surety Insurer
Rider Endorsement
Execution Binder
Bond Certificate of Insurance
Penalty Coverage Amount

The Three Types of Surety Bonds

There are three main types of surety bonds; commercial, contract, and court bonds. Within each of the three types, there are numerous subcategories. The following will provide a general overview of the three main types. All surety bonds are three-party agreements between a principal, obligee, and surety company. However, the purpose as to why these bonds are required varies between bond types.

Commercial Bonds

Local, state, and federal government agencies require commercial bonds for businesses in certain industries. Commercial bonds are required to be purchased before the business can legally be licensed. These bonds are also referred to as “license and permit bonds”. The bonds require that business owners abide by laws and regulations enforced to ensure consumers are not harmed by the business owner’s unlawful acts. These bonds also ensure that the bills and fees will be paid on time, such as utility bills, taxes, employee wages, etc.

Examples of commercial bonds are motor vehicle dealership bonds, freight broker bonds (BMC 84), DMEPOS (Durable Medical Equipment, Prosthetics, Orthotics, and Supplies), notary bonds, contractor license bonds, and marijuana bonds

Court Bonds

There are two subcategories of court bonds- judicial/civil and probate/fiduciary. Judicial/Civil court bonds are required when a court proceeding informs certain parties they must get a specific bond in order to verify their financial and personal integrity. A judicial court bond denies all uncertainties within court proceedings which would lead to losses resulted from a ruling. Fiduciary or probate bonds are required for an individual that is appointed to care for someone else that is either a minor or incompetent to care for themselves. These individuals are appointed by the court to handle assets and the care of a person who cannot do so themselves.

Examples of judicial court bonds are appeal bonds and the plaintiff’s attachment bonds. Examples of fiduciary or probate bonds include guardianship bonds, custodian bonds, executor bonds, and VA bonds.

Contract Bonds

Contract bonds guarantee that only qualified contractors or sub-contractors are able to bid and perform work on construction projects. The Obligee is typically a construction project owner that can be a government entity for public projects or a private property owner.

Examples of contract bonds are bid bonds, payment bonds, performance bonds, and supply bonds.