I recently had the opportunity to write an article in the Austin Construction News August 2020 newspaper. Check is out below or online.
The Differences between Bonding and Insurance
Eric Schmalz, Principal, Schmalz & Associates Surety Bonding
Liberty Hill, Texas
As a surety bond agent, I find that many people confuse surety bonds with insurance. I thought it would be good to discuss the important distinctions between the two products.
- As a risk product business that responds to “claims”, the surety bond industry needs a pool of capital to operate and pay losses. This model lent itself to sureties becoming divisions of insurance companies.In many ways, that is where the similarities of bonding and insurance end. Surety is better described as a “credit” financial product with underwriting more akin to banking.
- The insurance industry compiles actuarial data on the frequency and severity of losses that occur in an insurance product. Armed with this data they set the premium rates on a product to cover those anticipated losses. With surety bonding there is an underwriting goal of zero losses. The premium charged is best described as an underwriting fee. Using the example of a construction project, the surety is pre-qualifying the contractor to ensure the project will be delivered as specified by the contract with no performance issues and all labor and material suppliers getting paid. The surety company is not underwriting or pricing the bond expecting a loss.
- An insurance contract is a two-party agreement between the insured and the insurer, often with the insured as the beneficiary of the policy. Whereas a surety bond is a three-party agreement including the Surety, Principal (contractor), and Obligee (owner). The Obligee is the primary beneficiary of the bond rather than the contractor.
- Sticking with the construction industry as our example, a contractor buys insurance primarily to protect themselves against financial loss – the goal is to transfer risk from themselves to an insurance company. With a bond, it is the owner or entity the for which the contractor is performing work who requires and benefits from the bond protecting their project.
- As insurers expect losses on their policies and recoup much of that loss through the proper premium pricing, they also ‘subrogate’ or turn to the person or entity found at fault for the loss for financial responsibility. With a bond, based on the premise of underwriting to a zero loss, the surety and principal sign an “indemnity agreement” or promise from the principal to the surety to make them “whole” financially if they sustain a loss.
- Insurance policies, such as general liability, are typically renewed annually and offer coverage across a contractor’s scope of operations. A Performance & Payment bond is also referred to as a “contract bond” as it directly guarantees the obligations of a specific underlying contract. The bond is put in place when the contract is signed and is closed when the obligations under that contract have been met. So, a bond follows the life of the contract and construction project and does not renew annually like an insurance policy.
- With insurance, even if you are deemed a high-risk account or in a high-risk class of business, there are usually options in the marketplace to obtain a policy. But you may have to pay more premium for the policy. This is where the phrase “there are no bad risks, just bad pricing” comes from. With surety bonding, we have options in the market to establish bonding for a contractor with higher risk attributes. Such as lack of financial resources, credit problems, or recent track record of losing money. That said, there is a limit to what is available and there is time when you just might not be bondable. In these instances, I would recommend working with your surety bond agent. A professional surety bond agent can help establish a plan and goals around what a surety underwriter wants to see and take those steps to becoming an acceptable risk and bonded.
Schmalz & Associates is an agency exclusively supporting contractor’s bonding needs. Eric Schmalz was an underwriter and manager for over 15 years working for Top 10 surety companies and now helps his contractor clients establish and maximize their bonding. Please call 512-640-6444, email firstname.lastname@example.org or visit the website at www.schmalzsurety.com
Check out the article here.