If your business needs bonding and commercial insurance, you might not be sure about what each of these does—or why they’re both necessary. Aren’t they both a promise of payment in the event of a claim? And don’t you likely purchase both from the same insurance agent?
Although they have some similarities, insurance and surety bonds are two distinctly different types of financial products that have completely different uses. Below, we’ll discuss surety bonds vs. insurance and look into why you might need both.
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What is an insurance policy?
An insurance policy is a contract between you and an insurance company. This contract promises the insurance company will indemnify you (pay on your behalf) for certain damages you cause due to negligence and are thus legally liable for.
In simplified terms, insurance allows you to pay a predictable, negotiated monthly rate in exchange for the insurance company paying for unexpected large losses in your business. The contract can help minimize the negative impacts of an accident.
What is a surety bond?
A surety bond is a financial instrument. It financially guarantees that if the principle (you) cannot meet contractual obligations (such as completing a project, following through on a bid, paying your subcontractors and suppliers, etc.), the surety (the bonding company) will step in and fulfill those obligations for you.
Unlike insurance—which usually requires some sort of damage to occur—a bond claim happens when a company is unable to fulfill its obligations, usually due to insolvency.
Differences Between A Surety Bond And An Insurance Policy
Insurance pays on behalf of you; surety bonds are just a guarantee of payment to another party.
The primary difference between a surety bond and insurance is that insurance will pay for losses in a claim, whereas a bonding company will guarantee your obligations are fulfilled.
If you cannot fulfill a contractual obligation and the bonding company pays out, the bonding company will try to recover their money after the claim is paid. Often, the owners and their spouses of the business being bonded will be required to guarantee the bond personally and the bonding company will seek reimbursement from the owners if they are unable to collect from the business.
A bond has to be paid back if it pays a claim—it operates similarly to a loan. An insurance company will not seek reimbursement from the policyholder.
Insurance policies are more general in nature; surety bonds are for specific guarantees or projects.
When purchasing insurance, companies will seek a general liability policy that covers all their projects and operations. Most businesses will only need to purchase one general liability.
Bonds, on the other hand, are very specific in nature and cover particular areas; you might get a surety bond for a project or a license bond for the state/city government. A single business can have multiple bonds at any given time.
An insurance claim is usually triggered by damage of some kind; a surety bond is commonly triggered by insolvency or failure to pay.
Damages must occur for an insurance policy to pay out. Whether someone is injured on your premises or your property was damaged in a fire, there must be some harm that triggers the coverage on the policy.
A bond does not require damage to trigger payment. It just requires your inability to meet your financial obligations in a specific situation that will depend on the type of bond you purchased.
Bonds are usually written on standardized bond forms; insurance policies are more customized to the business.
Although not a hard and fast rule, bonds are frequently provided by the city or state governments or are standardized in certain industries, whereas insurance policies are usually tailored to cover the operations of a business (i.e., the underwriter can exclude certain activities).
While there are differences in how surety bonds and insurance work, they both play a critical part in certain industries. Do you still have questions? Are you ready for a quote? Please contact us—we can help you find the correct insurance/bond for your needs.