What is a Surety Bond?

What is a Surety Bond? | Risk Strategies

    Key takeaways

    • What is a Surety Bond? A three-party financial guarantee ensuring the principal fulfills obligations to protect the obligee, backed by the surety.
    • Categories and Uses: Contract bonds secure project obligations (e.g., performance, payment), while commercial bonds guarantee compliance (e.g., licenses, court).
    • How to Get One: Identify the bond type, choose a provider, provide documents, and pay a fee (0.5%-15% of bond value). Bonds build trust and reduce costs.

    What is a Surety Bond?

    A surety bond is a financial guarantee that certain obligations will be fulfilled as per a contract or agreement. Essentially, a surety bond acts as a safeguard for one party, ensuring that the obligations or promises made by another party are carried out in good faith. The bond involves three key parties:

    • The principal: the party required to perform a specific task or fulfill an obligation
    • The obligee: the entity or individual that requires the bond for protection
    • The surety: the party that guarantees the principal will perform their duties according to the agreed terms

    In this guide, we will explore the various types of surety bonds, how they work, their uses, and how businesses and individuals can obtain them. We’ll take a closer look at the importance of surety bonds and why the global market for bonds is set to grow to $27 billion by 2030. We will also examine how bonds deliver lower costs of completion as well as payment protections for workers, subcontractors and suppliers.

    By understanding the specifics of surety bonds, we think it’s easy to see how projects and contracts can proceed smoothly, with minimized risks, and with all interests protected fairly. Let’s start with how surety bonds work.

    How Does a Surety Bond Work?

    Surety bonds are based on a legally binding agreement between three parties (as outlined above). The principal, which is typically a business or individual, purchases a surety bond to assure the obligee that they will meet the obligations as laid out in a contract or legal agreement. If the principal fails to meet these obligations, the obligee can file a claim against the bond.

    If the claim is valid, the surety company steps in to compensate the obligee up to the bond’s value. The principal is responsible for reimbursing the surety for any paid claims. So, while a surety bond protects the obligee, it is ultimately the principal’s responsibility to ensure they fulfill their legal requirements.

    What Does a Surety Bond Cover?

    Surety bonds can cover a wide range of obligations, depending on the type of bond involved. They safeguard government entities, businesses, and consumers from financial loss by ensuring that bonded parties uphold their legal or professional responsibilities. If the bondholder fails to meet their obligations, affected parties can seek compensation by filing a claim against the bond.

    For instance, surety bond requirements may include fulfilling a contractual project, adhering to industry licensing regulations, or responsibly managing estate assets.

    Who Needs a Surety Bond?

    Surety bonds are generally required when a contractual obligation must be guaranteed or when specific legal or regulatory compliance is essential. Some common scenarios include:

    • Business licensing: Industries like auto dealerships and mortgage brokers often require license bonds to protect consumers.
    • Government and legal contracts: Contractors and individuals may be required to post bonds for project or legal obligations.
    • Freight and transportation services: Freight brokers and motor carriers often need freight broker bonds to ensure compliance.

    Types of Surety Bonds

    Surety bonds fall into two categories: contract and commercial surety bonds.

    Contract Surety Bonds

    Used mainly in construction, contract bonds guarantee the fulfillment of contractual terms. Common types include:

    • Performance bonds: Ensure a project is completed per contract. Five times as many project owners report bonded projects finish on time.
    • Payment bonds: Guarantee payment to subcontractors, suppliers, and workers.
    • Bid bonds: Ensure a contractor will honor the terms of their bid.
    • Maintenance bonds: Cover defects in work during the maintenance period.

    Commercial Surety Bonds

    These bonds ensure businesses comply with regulations. Examples include:

    • License and permit bonds: Required for legal operation in regulated industries.
    • Fidelity bonds: Protect against employee dishonesty or theft.
    • Court bonds: Used in legal matters like appeals or probate.

    How to Obtain a Surety Bond

    1. Identify the type of bond: Determine what’s required for your situation.
    2. Find a provider: Choose a trusted surety provider, ideally recognized by the NASBP.
    3. Submit documentation: Provide financials, credit history, and project details.
    4. Pay the premium: Based on bond type, amount, and credit.
    5. Receive the bond: Once issued, the bond can be used to move forward.

    How Much Does a Surety Bond Cost?

    Costs range from 0.5% to 15% of the bond amount depending on factors like bond type, amount, and your credit.

    Applicants with strong credit receive lower premiums. Poor credit may increase the cost. Industry and regulatory conditions can also affect pricing.

    In the U.S., performance and payment bonds for small businesses may incur a Small Business Administration (SBA) fee of 0.6%. If unused, the fee is refundable.

    Surety bonds can also provide economic benefits—building trust and even generating savings. For example, on a $35M project, bonds can save $141,000 in taxpayer money.

    Examples of Surety Bonds

    Auto Dealer Bond

    • Purpose: Ensures compliance with ethical and regulatory standards.
    • Who Needs It: Car dealers (varies by state).
    • Bond Amount: $10,000 to $100,000+.
    • Cost: 0.5%–5% of the bond amount.
    • Example: A California dealer needs a $50,000 bond.

    Contractor License Bond

    • Purpose: Protects clients from fraud or negligence.
    • Who Needs It: Contractors in licensed trades.
    • Bond Amount: $5,000 to $100,000.
    • Cost: 1%–3% annually.
    • Example: Arizona contractors must post bonds from $9,000 to $50,000.

    Freight Broker Bond (BMC-84)

    • Purpose: Ensures payment to carriers and shippers.
    • Who Needs It: Freight brokers and forwarders.
    • Bond Amount: $75,000 (required by FMCSA).
    • Cost: $750–$7,500 annually.
    • Example: A Texas freight broker must secure this bond.

    Mortgage Broker Bond

    • Purpose: Ensures compliance with lending laws.
    • Who Needs It: Brokers, lenders, loan originators.
    • Bond Amount: $10,000 to $150,000.
    • Cost: 0.5%–5% annually.
    • Example: Florida brokers need $10,000–$100,000 depending on loan volume.

    Surety Bond vs. Insurance: Key Differences

    We know you are probably thinking that surety bonds sound a lot like insurance. And although both surety bonds and insurance provide financial protection, there are some key differences between them.

    Surety bonds guarantee one party will fulfill its obligations to another party, while insurance protects the insured party from loss or damage. In a bond, the principal is ultimately responsible for reimbursing the surety if a claim is made. In contrast, insurance companies pay out claims directly without requiring reimbursement from the policyholder.

    FAQs

    Sources

    Independent Agent Magazine. (n.d.). Key trends facing the future of the surety bond market. Retrieved February 17, 2025, from https://www.iamagazine.com/markets/key-trends-facing-the-future-of-the-surety-bond-market

    Construction Business Owner. (n.d.). How surety bonds can better your business. Retrieved February 17, 2025, from https://www.constructionbusinessowner.com/accounting/how-surety-bonds-can-better-your-business

    Surety & Fidelity Association of America (SFAA). (n.d.). EY report: Surety bonding provides strong economic value and strengthens performance for public and private construction projects. Retrieved February 17, 2025, from https://surety.org/news/ey-report-surety-bonding-provides-strong-economic-value-and-strengthens-performance-for-public-and-private-construction-projects/

    PR Newswire. (2023, January 5). EY report: Surety bonding provides strong economic value and strengthens performance for public and private construction projects. Retrieved February 17, 2025, from https://www.prnewswire.com/news-releases/ey-report-surety-bonding-provides-strong-economic-value-and-strengthens-performance-for-public-and-private-construction-projects-301681918.html

    Surety & Fidelity Association of America (SFAA). (n.d.). Fact sheet on surety bonds. Retrieved February 17, 2025, from https://surety.org/wp-content/uploads/2023/03/SFAA-Fact-Sheet_p2.pdf

    U.S. Small Business Administration (SBA). (n.d.). Surety bonds: Bond guarantee fee. Retrieved February 17, 2025, from https://www.sba.gov/funding-programs/surety-bonds#bond-guarantee-fee

    National Association of Surety Bond Producers (NASBP). (n.d.). Inside NASBP. Retrieved February 17, 2025, from https://www.nasbp.org/inside-nasbp

    Surety & Fidelity Association of America (SFAA). (n.d.). Surety protects. Retrieved February 17, 2025, from https://surety.org/suretyprotects/

    Risk Strategies. (2024). State of the insurance market report Q4 2024: Surety. Retrieved February 17, 2025, from https://www.risk-strategies.com/state-of-the-insurance-market-report-2024-q4-surety