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Surety companies, or sureties, issue surety bonds to guarantee that contractors will perform according to the terms of a contract. The surety bond itself is an insurance contract, and the companies that issue surety bonds are either specialized or general insurance companies. The Small Business Administration and other governmental agencies interact with surety companies to facilitate and supervise the surety bonding process.
What is The Role of a Surety Company?
A surety company insures the obligee against loss caused by a non-performing principal. This arrangement is routinely used when contractors bid and are awarded contracts from governmental agencies at the federal, state and local levels. There are various types of surety bonds that cover situations involving contractors, licensed businesses, professional service providers, court litigants and other principals.
There are three parties that participate in a surety bond transaction:
- Principal: The principal is the party who must perform a contractual obligation.
- Obligee: The party to whom the principal is obligated is the obligee.
- Surety: The surety bond issuer that guarantees the principal will perform is the surety.
What is The Surety Bonding Procedure?
The typical procedure used by a surety company to issue a bond is:
- 1. A principal applies for a bond from a surety company licensed in the principal’s state. The principal can also apply to the SBA’s Surety Bond Guarantee Program, which co-insures surety bonds.
- 2. The surety underwrites the principal’s application—that is, it decides whether to grant the bond request, the bond terms, and how much it will charge for the bond. Underwriters examine the principal’s credit history, criminal background, past experience with surety bonds and other factors. If the principal has received approval from the SBA, the surety faces much less risk and will usually approve the bond.
- 3. The principal will sign an indemnity agreement pledging certain business and personal assets if it fails to perform its contractual obligations.
- 4. The principal submits the surety bond to the obligee, often at the time of bidding for a contract.
- 5. If the principal defaults on its contractual obligations, the surety (and the SBA co-insurer, if appropriate) will pay the obligee for some or all of the damages caused by the principal’s failure to perform.
- 6. The surety will attempt to collect reimbursement from the principal, including seizing the assets listed in the indemnity agreement.
Note that steps 5 and 6 are contingent in the event the principal fails to perform.
Who Issues Surety Bonds?
Surety companies must be licensed by the state they operate in. If you perform an internet search on surety companies, you’ll find a mix, including:
- Bond producers: These are licensed business professionals and companies, also known as agents and brokers, who work with a network of surety insurers. Many surety insurers work with public-facing bond producers. At its best, working with a surety bond producer provides principals with competing quotes that can lower the cost of the bond. However, some producers work with a single insurer and may not be as competitive. Bond producers can offer services that help principals improve their chances of meeting surety insurance underwriting requirements. Some examples of surety bond producers include JW Surety Bonds, Platinum Bonds Insurance Agency, and Alpha Surety and Insurance Brokerage.
- General insurance companies: Many well-known property and casualty insurance companies, such as State Farm and Travelers, issue certain types of surety bonds. You can deal directly with the insurer without going through an independent agent.
- Specialty surety companies: These are companies that make most or all of their revenues by issuing surety bonds. Some of the larger ones are American Surety Co., Colonial Surety Co., and Universal Surety of America.
Where to Find Information About Surety Companies
You can often find information about surety companies in records maintained by your local municipality or legislature. Websites maintained by states, counties and even townships will often be a helpful source of surety bonding information:
- U.S. Treasury: The United States Treasury maintains a list of certified surety companies that qualify for federal contracts. The list is updated annually.
- State Insurance Departments: The Bureau of The Fiscal Service also maintains a separate list of state insurance departments that license surety companies.
- National Association of Surety Bonding: This is a trade agency for surety producers.
- The Surety & Fidelity Association of America: Another trade agency with links to its members
- AM Best: A private ratings agency that rates surety companies.