Comparing Surety Bonds & Insurance
|Parties Involved||What gets Covered?||Who is Protected?||Who’s ultimately responsible?|
|Insurance||The Insurance Company and you||Losses covered by the policy||The person buying the insurance||The insurance company takes the risk of loss|
|Surety Bonds||The entity requiring the bond (the obligee); the company needing the bond (the principal); and the supplying the bond (the surety)||The contract||The Obligee gets the contract performed per its terms||The surety pays the claim and then asks the principal to reimburse for those losses|
What’s the Difference between Insurance and Surety Bonds?
Surety bonds are an important risk mitigation tool, but it’s essential to know that insurance and surety bonds are two different types of tools. The terms “surety bond,” “surety bond insurance,” and “surety insurance” are often used interchangeably, causing some confusion for consumers. It’s important to note that surety bonds are not insurance.
Is a surety bond an insurance policy?
The quick answer to this is, no, a surety bond is not an insurance policy. Although it seems very similar to insurance a surety bond is really more like a form of credit (and it’s issued by surety bond companies, which are essentially a bunch of very conservative bankers). One of the key features is where the risk falls. On a surety bond, the risk is still on the principal and not the surety company.
What does the premium cover?
In a typical insurance policy, the risk of loss is pooled and spread among all the clients that are similarly situated (such as homeowners), and the loss is assumed based on historical experience and built into the cost of the policy. In a surety bond situation, the loss is not assumed (as that would make the price astronomical). The premium covers the fee for borrowing the surety bond credit, covering overhead, as well as paying for extreme outlier losses. However, a loss is not assumed.
What do surety bonds cover?
Surety bonds typically cover contracts. In Federal Government work, the governmental agency require a surety bond (pursuant to the Miller Act). There are two parts to these bonds: 1) a performance bond, which ensures that the contractor performs according to the terms in the contract (i.e., they actually build the building); and 2) labor and material bond, which ensures that they pay their subcontractors and material vendors. The second type of surety bond is one issued that ensures that the company pays its taxes or otherwise doesn’t harm the public. These are called License and Permit bonds.
How does Bond insurance work?
A surety bond protects the owner of the project (called the Obligee). If the project is not done according to the terms of the contract, then the owner can make a claim against the bond and get the project finished (usually by another contractor). The Surety will then look to be reimbursed for any loss by the original contractor.
There are many surety bonds that exist. Some of these bonds are in some serious niche industries. However, a good surety bond can really reduce the amount of risk to your company. These risk mitigators, along with specific types of insurance, can be really beneficial to your overall financial well being.
See the article below for some good advice on the difference between a surety bond and E&O Insurance.
How Protected Is Your Business? Learn How to Safeguard It With Bonds and E&O Insurance
When I first started my freelance career, I thought it was going to be a piece of cake (didn’t we all?). Once I got into the thick of things I noticed that every question I received an answer to only caused me to ask 10 more questions. Sound familiar?
This is commonplace for anyone going into business for the first time. One of the most confusing things for me in the beginning was understanding what it meant to be “bonded and insured”–or at least the difference between being “bonded” and being “insured.” I knew of both, thanks to my business career, but did not fully understand each until later on in my freelance career.
I have to admit, I had both a surety bond and insurance (errors and omissions insurance, or EOI for short) before I fully understood the purpose of each one. Thankfully, I have never had to use either, but will continue to have them in order to protect myself and my business. Hopefully I will be able to help you out here by providing my understanding of each.
Surety Bond Insurance
Surety bond insurance is not really a thing. Instead, the two terms are many times juxtaposed. Surety bonds are done instead of having insurance. The reason for that is that it is a guarantee that the job will be done timely.
A good example: in our neighborhood, there was a huge development going on. The general contractor had some problems and lawsuits ensued, which delayed the project by around five years. There was plenty of insurance on the project, but that didn’t stop the lawsuits from delaying the project.
Risk of Insurance
A surety bond would not prevent the litigation. However, the project would not have been delayed for five years as the bond would have prevented the stoppage of work. That’s why everyone wants them – it means that the entire project will move forward.
Along Comes Errors and Omissions Insurance
Who cares about errors and omissions insurance? Actually, that is the type of attitude that would require someone to have EOI. It was a coworker of mine that turned me onto it, and I am glad that he did. He and I were doing countless background checks on potential employees: 4,000+ of them.
He explained to me that having EOI would protect individual investigators in the event they failed to do something correctly on a background check (e.g., making an “error” or “omitting” something in the course of their work).
And that is exactly what EOI is. It is insurance coverage that pays out in the event of professional negligence. It is used by countless professionals from freelance writers to doctors and lawyers. I did not get back to having EOI until a few years ago when I became involved in online marketing.
After obtaining my own legal advice, I decided it was best to have it. So here I am, years removed from doing government work, but sitting on a policy that protects me professionally.
Surety Bonds Vs. Errors and Omissions Insurance
It kind of sounds like bonds and insurance are the same. However, that is not the case. So now that I bored you with my personal stories, let’s get down to the nitty gritty. What is the difference between a surety bond and EOI?
Let’s start with surety bonds
There are typically three parties in each transaction. The first party is you (the principal), the second party is the person you contract with (the obligee), and the third party is who pays out (the surety) in the event there is a claim.
There are many types of surety bonds depending on the profession, but basically the “surety” is going to pay the “obligee” in the event you breach your agreement. Here are some examples:
A surety pays for damages caused by an electrician who failed to follow code and caused damage to a house.
A mining company fails to implement reclamation procedures after mining a claim; the surety will end up paying the cost to clean up the area.
A surety posts bond for someone in jail; if that person fails to show up for their court date, the surety will lose the bond money to the court.
There are numerous types of surety bonds, and I could list many more examples, but I am sure you now get the idea of how they work.
Now let’s take a look at E&O Insurance
EOI is a professional liability insurance. What EOI does is protect you from liability for negligence. It works in a similar manner as a surety bond, except EOI protects the policy holder while the surety bond protects the person receiving the service.
Here’s a simple way to remember it–keep in mind this is just an example and each situation should be evaluated individually:
Let’s say you are a notary and fail to properly notarize a document. As a result, the person who hired you loses a piece of real estate they wanted to purchase. A surety bond would pay the signee for any damages resulting from your mishap. Now, in the event that person sues you for negligence, EOI will help cover any damages awarded in court.
Here are some examples of EOI claims:
An architect gets sued for failing to make a correct calculation, causing a company to stop construction once they notice the error.
Accountant makes a mistake while calculating someone’s business income. The person is later audited by the IRS and sues the accountant for the error.
An attorney gives legal advice to a client which turns out to be false and the client sues for damages caused from acting upon that advice.
If you’re still confused, here is the easiest way to remember the difference. Bonds are meant to protect the obligee, while EOI is meant to protect the principal. If something bad happens, a bond pays the victim while insurance will pay you if the victim sues you.
Cost of Surety Bonds and EOI
Calculating the cost of bonds versus EOI is very different. For errors and omissions insurance, the cost has pretty much become standard over the years. You can base the cost on the amount of coverage you are looking for within the industry you work.
Unlike insurance, bonds are determined individually based on risk and there can be a wide range of prices depending on your profession. The cost of a bond is determined by your personal conduct. Expect a credit check when you apply for a bond as how you handle your financial obligations is a big factor in calculating the rate.
For bonds, someone is taking a risk that you are going to do what you are supposed to do. If you have a history of not following the rules (such as the people in the examples I used previously), then expect to pay a higher rate.
Basically, you need to know that EOI cost is roughly the same no matter who you are, while bonds can vary depending on your personal conduct.
Summing it Up
Surety bonds and EOI may seem similar, but there are some major differences that set them apart. The basic concepts to remember are that EOI pays if you have to pay for your negligence, while a bond pays someone you harm as a result of your conduct. Calculating the cost of each is also different.
Do you need them? No comment from me. But at least you can now understand each one better which will help you make that decision.