To say that Surety Bonds are confusing is putting it mildly. There are so many misconceptions and misunderstandings when it comes to Surety Bonds. Below are the Top Ten Misconceptions about Surety Bonds. We hope that this article clears some of them up.
Misconception #1:
Surety Bonds and Insurance are the same.
While Surety Bonds are regulated by the Department of Insurance, Surety Bonds are not Insurance. Surety Bonds involve 3 separate parties – The Obligee (person or entity protected by the bond), The Principal (person or entity required to post the bond), and the Surety Company (Insurance Carrier backing the Bond).
Insurance policies involve 2 separate parties – The Insured (person or entity protected by the insurance) and the Insurer (the carrier that backs the insurance policy).
One of the main differences is that an Insurance Claim does not need to be repaid while a surety claim must be repaid to make the Surety Company whole again.
Misconception #2:
Surety Bonds are insurance/protection for the purchaser.
Surety Bonds do not protect the bond purchaser or the bond holder. They are in place to protect the consumers that the bond holder is servicing. It guarantees the bond holder will act ethically and follow the rules and regulations set forth by the Obligee. Surety Bonds are required because the Obligee wants a guarantee the Principal will be ethically if they are provided a business license.
Misconception #3:
Surety Bonds can be very costly due to having to pay the full face value of the Bond.
Nothing could be further from the truth. The principal is required to pay a portion of the bond amount for the face value coverage of the Bond.
Example: A new Mortgage Broker in the state of Maryland is required to post a minimum of a $50,000 Surety Bond to the state in order to complete their licensing requirement. The premium they pay will range anywhere from $375 – $5,000 annually based primarily off the personal credit of the principal.
Misconception #4:
Surety Bond premiums are the same for all applicants.
This is a very common misconception which mainly comes from a marketing standpoint. Surety Bond rates today are very personalized. The rates a Principal may pay vary based on many factors such as: Years in Business, Experience, Personal Credit History, Claim History, & Previous Business Practices. The typical range can be quite wide ranging from 1% – 10% of the face value of the bond on an annual basis.
Misconception #5:
Annual Surety Bond premiums can be paid in installments like insurance policies.
Unfortunately, this is rarely the case. Most surety companies do not allow or have payment places set up for bond premium financing. The main reason for this is that all premiums for a bond in the first year are Fully Earned as soon as the bond is in place. Should a finance company providing premium finance for a bond they must agree that they will not receive a refund of premium in the first year even if the Principal defaults and misses a payment. This is different in subsequent renewal years where the Surety Carrier will provide a pro-rated refund depending on the circumstances.
Misconception #6:
Surety Bond Carriers Handle the majority of the business licensing legwork for a Principal.
The only service that a Surety Carrier will provide to the Principal is the actual Surety Bond delivery. They do not get involved in any transactions of other business pertaining to a client’s license. The Surety Carrier does not guarantee the client will get licensed. The only guarantee from the Surety Carrier is that the bond will be accepted and it will provide the adequate coverage that the Obligee requires.
Misconception #7:
Only Fortune 500 Companies require Surety Bonds
Surety Bonds are required by all different size companies. The basis for a Surety Bond requirement is not decided on the size of a company but rather for the type of license a company is applying for to transact business. Each business segment will have different requirements.
Misconception #8:
A client can purchase a “blanket” bond that will cover their business in all 50 states.
Surety Bonds are very specialized when they are required. Each state has their own bond forms, bond language, and requirements so there really is no “blanket” bond that would cover what each state requires. If a Principal is going to be licensed in multiple states they will have to secure multiple bonds posted to the individual state Obligee.
Misconception #9:
I will not qualify for a surety bond if my personal credit score and history is considered “less than perfect”.
Years ago, this may have been the truth but in today’s surety market it is very rare that someone would not qualify for a surety bond. However, the surety carriers will not give credit challenged Principals standard rates that someone with great credit would get. If your personal credit is challenged it is a safe assumption that you will pay 3 – 15X a standard market rate. Ultimately though, you will be able to secure the bond. The only factors that could eliminate your possibility of getting a bond would be past due child support obligation and not being a citizen of the United States.
Misconception #10:
It does not matter what Surety Bond Company backs my Bond – they are all the same.
In some case this could be true but most of the time it is not. Many state licensing departments will require that the Surety Carrier has an A.M Best rating of “A–” or higher in order to sufficiently handle the bond exposure and pay out claims. Companies with lower rating may be able to sufficiently handle the bond but the preferred companies will have the highest ratings and standing in the eyes of the Department of Insurance.
These are just a few of the common misconceptions that have come in the forms of emails, questions, and phone inquiries over the past 13 years. There are so many other misconceptions and confusions about Surety Bonds that we have not discussed. If you are confused, we strongly suggest doing your research and reaching out to an experienced and licensed surety professional prior to simply buying a bond because the price is right.