In business, when it comes to protecting against financial loss or liability, there are two options available: surety bonds and insurance. While both provide a form of financial protection, there are significant differences between the two. Understanding these differences is crucial when considering which option to choose. Below we review the difference between surety bonds and insurance so you can make the best decision for financial protection.

What is a Surety Bond?

A surety bond is a three-party agreement between the obligee (the party requiring the bond), the principal (the party obtaining the bond), and the surety (the party guaranteeing the bond). The surety bond guarantees that the principal will fulfill its obligations to the obligee. If the principal fails to meet its obligations, the surety will step in and pay the obligee up to the bond amount.

Industries with high financial risk commonly require surety bonds, such as construction projects and government contracts. They are typically used to ensure that the principal will complete a project on time and within budget, pay suppliers and subcontractors, and comply with all applicable laws and regulations.

What is Insurance?

Commercial insurance contracts are between a business (the policyholder) and an insurance company. The insurance company agrees to provide financial protection against specific risks in exchange for premiums payments. If the policyholder suffers a covered loss, the insurance company will pay out a predetermined amount to cover the loss.

Insurance policies are available for various risks, including property damage, personal injury, professional liability, and more. Insurance policies do not require a third party to guarantee payment, unlike surety bonds.

Key Differences Between Surety Bonds and Insurance

1. Purpose: The purpose of a surety bond is to ensure that a principal fulfills its obligations to an obligee. The purpose of insurance is to protect against financial loss from unexpected events.
2. Parties Involved: A surety bond involves three parties – the obligee, the principal, and the surety. Insurance involves two parties: the policyholder and the insurance company.
3. Risk Assessment: Before issuing a surety bond, the surety assesses the financial risk of the principal. Insurance companies also assess risk but focus more on the probability of a loss occurring.
4. Premiums: Premiums for surety bonds are typically lower than insurance premiums because surety bonds are considered a lower-risk product.
5. Claims Process: In the event of a claim, the obligee must provide evidence of the principal’s failure to fulfill its obligations for payment of the surety bond claim. For an insurance claim, the policyholder must provide proof of the loss.
6. Recovery: With a surety bond, the surety will seek to recover any payments made to the obligee from the principal. With insurance, there is no expectation of recovery from the policyholder.

Which is Right for You?

Choosing between a surety bond and insurance depends on the situation. If you need financial protection for a specific obligation, such as completing a construction project, then a surety bond is likely the right choice. Business insurance is likely the better option if you need protection against unexpected events that could cause financial loss.

In some cases, both a surety bond and insurance may be necessary. For example, a construction company may need both a surety bond to guarantee the completion of the project and liability insurance to protect against property damage or injury claims.

In conclusion, while surety bonds and insurance provide financial protection, they serve distinct purposes and involve different parties. Understanding the differences between the two is essential when deciding which option to choose.

Related Article: Does Your Company Need a Surety Bond?

At Magnolia Insurance Agency, we can advise whether your business needs a surety bond in addition to commercial insurance. There are no guarantees in business, but we can ensure that if you need one in the form of a surety bond, we can help. Call us at 770-213-5171 or email us at info@magnoliainsuranceagency.com.

Commercial Insurance / By Magnolia Insurance Agency