What is the Difference between Insured and Bonded?
About Difference between Insured and Bonded
There is a difference between being insured and being bonded. Most companies really want to be both as that provides a level of assurance to any potential client or business partner. Being bonded, especially a performance guaranteee bond, is typically used for a government contract pursuant to the Miller Act, or similar state or municipal statute (although more and more private companies are requiring a performance bond). The bond is typically based on a single underlying contract and has a defined period of time, such as completion of the contract plus a maintenance period (say, 1 year). Compare this to insurance. Insurance is a risk-shifting proposition that pools risk so that a single catastrophic event does not devastate a single member of the pool. Insurance is not based on an underlying contract, but instead an overall risk-sharing proposition. A bond, however, is not a risk-sharing proposition. Instead, it provides assurance against the risk of default of a single entity (such as a general contractor).
What’s the Difference between Bonded and Insured?
A bond is specific to a single entity and is underwritten based on that job and the risk of loss, which is assumed to be zero. Insurance on the other hand is a risk sharing tool where losses are assumed. If bonds were written like insurance they would be much, much more expensive.
The difference between bonded and insured can seem to be relatively small at the beginning. However, once you understand the difference between bonded versus being insured, it is quite a large gap. Most of us understand what it is to be insured. Being insured is entering into an agreement with an insurance company to share the risk pool among all parties. It is assumed that the underlying matter that is being insured will occur somewhere is the pool. So, the pricing reflects that certainty. For example, if there are 100,000 persons that have fire insurance, the underlying insurance model shows that approximately 20 will have a fire. Because it is impossible to know WHO will have the fire, all persons pay the same premium.
Being bonded is different. Bonds are not prices assuming that there will be losses. Instead, each bond is written with the assumption that there will not be a claim on the underlying contract that is being bonded. So the difference between bonded and insured is quite large. If bonds were priced according to an insurance based model, they would not cost a mere 3% of a contract job, but be closer to 15-20%. This would make it impossible for commerce to happen.
What does Bonded and Insured Mean?
Being insured is the ability to share risk with a pool of other people. Bonded is more like a guarantee, where the risk is not being shared, but instead falls on another party. If bonds were priced like insurance, they would be prohibitively expensive.