What is an indemnity agreement for surety bonds? As we’ve discussed previously, a surety bond is a three-party agreement between the Obligee, Principal, and Surety Company. The bond guarantees the principal will fulfill its obligations. We have also mentioned that unlike insurance underwriting, surety bond underwriting assumes a zero loss. How is that possible? Well that’s where the indemnity agreement comes in to play. Let’s take a look at what an indemnity agreement is for surety bonds:
What is an Indemnity Agreement?
What is an indemnity agreement? The indemnity agreement is a separate contract which transfers risk from the surety to the principal. If the Obligee or other party to the bond suffers loss or damage, they can make a claim on the bond. If the claim is validated, the surety company will pay out. In the insurance arena, many times this is where the story would end as they factor losses into the pricing of their products. However, with surety, an indemnity agreement would be signed by the Principal guaranteeing to make the surety whole for any losses they suffer in conjunction with a bond written on their behalf.
Recovering Costs
A surety company would not look to make a financial gain through indemnity. But they want to recoup any money’s paid out to claimants as well as other ancillary costs, such as legal defense, incurred in the process. Learn more in our article discussing surety bond cost.
Underwriting Process
The underwriting process involves the “Three C’s”:
- Character
- Capacity
- Capital
Capital is the key underwriting factor when considering indemnity, making sure there are sufficient business and personal financial resources in place to pay back the surety company if a loss is incurred.
Indemnification
Typically, parties signing the indemnity agreement would be the principal company (principal on the bond), the owner(s) personally, as well as the owner’s spouse. Many times, spousal indemnity is a point of contention, but it is very important for the surety company to secure this which prevents assets from being transferred between owner and spouse to protect both parties. A general rule of thumb in the industry is owner’s holding 10% or greater in the principal entity will be asked to indemnify.
The Importance of Indemnity in Surety
Indemnity is a very serious matter for any party needing a bond — especially for contractors needing a performance bond. While the language in the agreement is typically not open to modification, it’s important to be very familiar with the clauses in the agreement, what the Principals’ duties are, and what recourse the surety company holds. In the end, the surety company is prequalifying you to engage in the activities that will be guaranteed by the bond and anticipating that there will be no loss.
Surety bond premiums are essentially an underwriting fee and therefore relatively low losses can be incurred; a surety company could never survive without an indemnity agreement!
Discover More About Indemnity Agreements and Surety Bonds
We hope that we’ve helped answer your question, “what is an indemnity agreement in surety?”, and that this information helps you better understand indemnity for a surety bond. Please feel free to reach out to us should you have questions. You may contact Eric Schmalz via email or by calling 512.640.6444. Be sure to stay tuned for additional information regarding surety bonds. To learn more about surety bonds, check out these related articles:
