By Evan Tarver
Surety bonds are purchased by principals to protect third-parties from a failure to meet contractual obligations. There are 4 main types of surety bonds. Contract surety bonds and commercial surety bonds protect private and public interests and are the most common. Fidelity surety bonds and court surety bonds protect against theft and litigation and are less common.
Some surety bonds are required by law – such as the case with larger commercial projects and government projects – while other types of surety bonds are required by private project owners. We discuss the different surety bond coverages and their use in the table below, including what they protect against, why they’re important, and how much they cost
The surety bonds mentioned above typically have many characteristics in common. For example, most sureties cap the total bonded amount between 10x – 15x of the value of a business’s equity. Further, almost all surety bond types require at least 10% of the total bonded amount in working capital. This means that while there is no hard cap on a surety bond, a business will often have a maximum bonding capacity.
All surety bond types also charge a bond premium between 1% – 15%, based on the business owner’s personal credit score and the performance of the business itself. The length of a surety bond is usually between 1 – 4 years, after which the principal can renew the bond. Some surety bonds can “continue until canceled,” meaning there is no expiration.
While there are many similarities with the different types of surety bonds, there are also many differences between them. These differences include the contractual items that are bonded, the requirement of the bond, the length, as well as the cost. It’s important to understand all types of surety bonds to ensure proper coverage.
There are 4 primary types of surety bonds:
Contract Surety Bonds
A contract surety bond is used to guarantee that a contractor will perform the duties outlined in a construction contract. With a contract surety bond, the contractor is the principal who purchases the bond to protect the obligee from any harmful business practices. In this scenario, the obligee is a project owner or investor.
A contract surety bond ensures that a contractor will meet the specifications of a contract, including completing the work properly as well as paying contractors and other types of laborers. Contract surety bonds are typically used by the following people and organizations:
Large construction companies with multiple projects
General contractors with one or more projects
Individual contractors with a single project
Trade contractors such as electricians, carpenters, plumbers, etc.
Subcontractors of the federal government with projects of $100k+
Contract Surety Bond Costs, Terms, & Qualifications
A contract surety bond typically costs the principal a surety bond premium between 1% – 15% of the bonded amount. Surety bond premiums are often dependent on a business owner’s personal credit score. Scores above 700 typically have bond premiums between 1% – 3% while scores below 700 have premiums between 4% – 15%.
However, business performance can also be taken into account. For example, when calculating a surety bond premium, sureties can also look at such business information as the following:
Company financial performance – Past 3 years financial statements, including the amount of business’s liquid assets and working capital.
Existing business lines of credit – Higher credit limits are seen as a benefit since it decreases the likelihood of financial distress during a project.
Industry experience – The past experience of both the business owner as well as the company is assessed, including the number of similar past projects completed.
All surety bond premiums are paid annually by the principal. Contract surety bonds can either have terms between 1 – 4 years or be “continued until canceled,” which means there is no expiration. Regardless, bond premiums are assessed as a percentage of the bonded amount of each individual contract bond.
Sureties that offer contract bonds typically have caps on individual bonds as well as a company’s total bonding capacity. For example, a surety has a cap on individual bonded amounts equal to $5 million.
They will then also have a cap on the aggregate bonding amount, typically between 10x – 15x of a company’s equity and require 10% of the total bonded amount in working capital. This, of course, constrains the types of contracts and construction projects you can bond, making it more difficult to win bids.
Finally, some contract surety bonds can be guaranteed by the SBA. The SBA guarantee fee is currently 0.729% of the bonded amount, paid annually. While this increases the cost of a contract bond, it reduces the risk of a surety and makes it easier to qualify for a contract surety bond, helping you win more business.
Types of Contract Surety Bonds
There are 4 different types of contract surety bonds. Each of these surety bond types are used by contractors to reduce the risk of a project owner or real estate investor. The contractor will always act as the principal and the owner or investor will always act as the obligee. Let’s take a closer look at each of the contract surety bonds.
A bid bond is a contract surety bond that guarantees a contractor will comply with a bid contract. A bid bond assures a project owner that the contractor has the ability to complete a project to the specifications outlined in the submitted bid. This stops contractors from backing out from a bid after the work has been won.
Bid bonds typically only cost $100 per bid. However, the bonded amount is usually equal to 100% of the bid cost. If a contractor wins a bid and then backs out, a project owner can claim financial damages up to 100% of the agreed contract. This ensures that contractors have “skin in the game” and protects project owners against bids that fall through after awarded.
Bid bonds are typically required on any federal and/or commercial projects. Further, private residential projects might also require a bid bond at the discretion of the project owner. A bid bond reduces a project owner’s risk and makes him or her more likely to accept the bid of a new contractor.
A performance bond is a surety bond that protects a project owner against a contractor’s failure to complete a project as agreed. Performance bonds effectively “bond” specific agreements outlined in a construction contract. If the bonded obligations aren’t met, an obligee can claim financial damages. Performance bonds are typically required as part of a bid bond.
Performance bonds typically guarantee 100% of a contract’s total cost. If a contractor fails to meet bonded agreements within the construction contract, a project owner can claim financial damages up to 100% of the contract price. Damages are covered by the surety and repaid by the principal. Performance bonds typically cost between 1% – 15%, based on creditworthiness.
A payment bond used to guarantee that a contractor will pay the necessary subcontractors, material suppliers, and labor as outlined in the contract. This means that payment bonds actually protect the subcontractors and other laborers rather than the project owner or investor. If a contractor doesn’t pay for the labor once completed, obligees (the subcontractors) can file a claim for damages.
The amount of a payment bond is typically equal to the estimated labor costs outlined in a construction contract. Most commercial and federal construction projects will also require a payment bond as part of the project. Other private project owners might also require a payment bond, but not always. The bond premium is usually between 1% – 15% of the bonded amount.
Regardless of the requirement, payment bonds are good for contractors who work with a lot of outsourced labor. A payment bond reduces the risk to a subcontractor and gives them confidence when working with a new general contractor. It also has the ancillary benefit of protecting project owners against any potential liens or damages if the general contractor doesn’t pay the subcontractors.
A maintenance bond protects a project owner against financial losses due to defective workmanship or faulty materials used during a construction project. The typical length of a maintenance bond is between 12 – 24 months. A maintenance bond is only required at the discretion of the project owner. The typical cost is between 1% – 15% of the bonded amount.
If a project owner experiences problems with the workmanship within the 12 – 24 month period, they can either request that the contractor fixes the problem or they can file a claim for damages. This type of bond puts a project owner’s mind at rest regarding the use of cheap materials or inexperienced contractors.
Commercial Surety Bond
A commercial surety bond is a bond required by federal, state, or local government agencies to protect public interests. Typically, a government entity requires a commercial surety bond for licensed professionals such as with a contractor. Commercial surety bonds ensure that businesses that operate with a license adhere to all the required codes, regulations, and conduct.
Commercial surety bonds protect the portion of the general public that interacts with a bonded principal. This means that the public’s well-being can be thought of as the obligee, with the licensed professional the principal. Anyone who is part of the public can file a claim against a bonded person or organization for damages.
Commercial surety bonds are therefore used by the following types of people and organizations:
Sellers and distributors of liquor
Businesses that sell lottery tickets
Other professions that require a government license
If you’re a licensed professional who might need a surety bond, look at this list of required professions that require a bond. Within each of these commercial surety bond types, you can choose your state to see a list of requirements. This will help you ensure that you’re properly bonded for your work.
Commercial Surety Bond Costs, Terms, & Qualifications
Commercial surety bonds are often required by the government. Typically, professionals who are applying for an industry-specific business license will need a commercial surety bond before a license is issued. For this reason, the annual bond premium will often vary, depending on the industry and the type of license being bonded.
A commercial surety bond typically has a term of 1 year. Each year, the principal is required to renew the surety bond as part of its license. Sometimes, however, a commercial surety bond will have a term longer than a year, such as with sales tax bonds, which have 2-year terms before the principal has to renew.
Commercial surety bonds cover any financial damages caused by the principal as well as government fees for any license violations. For this reason, the government will typically require a set bonded amount for each company or licensed professional. The size of the bonded amount is largely dependent on the following factors:
Number of physical locations or projects
Total number of employees
Annual sales transactions
The specific license being bonded
Types of Commercial Surety Bonds
There are many different types of commercial surety bonds. In fact, there are over 15 different commercial surety bond types, each protecting the public against the harmful business practices of a different licensed professional. Let’s take a look at the 2 most common types of commercial surety bonds, as well as a list of other types of commercial bonds.
License and Permit Bond
A license and permit bond is required by a government organization when a professional applies for a license like a contractor’s license. These surety bonds protect public interests against failures to follow the codes and regulations of a professional license. The most common professions that require a license and permit bond include contractors, electricians, plumbers, and non-resident professionals.
For example, in the state of California, the cost of a license and permit bond for contractors is currently $15,000 annually. This is on the high end of what you’ll typically see for license and permit bonds. Annual bond premiums – as well as the penalties and fines for breaching your license – are set by government agencies and specific to individual professions.
Mortgage Broker Bond
A mortgage broker bond is a bond required by the state that protects borrowers from the harmful business practices of mortgage brokers. This bond ensures that all mortgage brokers will comply with state-specific laws and regulations outlined in the mortgage broker license code. Mortgage broker bonds, like a mortgage broker’s license, don’t cover multiple states.
Other Commercial Surety Bond Types
There are many other types of commercial surety bonds. Each of them is purchased by a specific professional before receiving a professional license. Other types of commercial surety bonds include the following:
Required for companies that sell, manufacture, and/or warehouse liquor.
Ensures that a business or person will pay for all utilities.
Makes sure that items stored in a warehouse will be delivered as planned.
Required for auctioneers and auction houses in an attempt to protect auctioned items, bids, and purchases.
Any business that sells lottery tickets is required to have a lottery bond.
Fuel tax bond
Required by businesses that sell fuel to ensure that the proper taxes are paid.
Travel agent bonds that ensure payments collected by travel agents are sent to the appropriate airline or travel company.
Auto dealer bond
Ensures that any auto dealers comply with the law as it relates to car sales.
AG dealer bond
Required by the Department of Agriculture for people or businesses that buy and sell agricultural products.
Fidelity Surety Bond
A fidelity surety bond is a bond that protects a company against employee theft and/or dishonesty. Fidelity surety bonds are designed to be used by businesses that have employees who handle cash or similar valuable assets. With this bond, the principal is the company and the obligee can be either the company itself or the company’s customers.
A fidelity surety bond is considered to be a “blanket bond.” This means that when a principal purchases a fidelity bond, it protects either the company and/or its customers from the malpractice of all employees within the business. Of course, there are situations when a fidelity surety bond can only cover certain employees.
The best way to think about this bond is more like normal insurance. Companies can take out a “policy” as low as $10k and pay as little as a 1% premium, $100 a year in this case. However, annual premiums can reach as high as 15%. Further, it’s not uncommon for businesses to take out a fidelity surety bond in excess of $5 million.
Fidelity surety bonds can be used by any company that wants to protect itself or its customers against theft and/or employee dishonesty. A fidelity surety bond typically isn’t required. However, the following types of companies can benefit from a fidelity bond:
Businesses with employees who handle cash
Businesses with employees who make home visits
Businesses that hire seasonal employees or that mass hire
This means that the companies that stand to benefit most include brokerages, cash carriers, delivery services, restaurants, brick-and-mortar shops that accept cash, as well as in-home service providers. Let’s now take a look at the costs, terms, and qualifications of a typical fidelity bond.
Fidelity Surety Bond Costs, Terms, & Qualifications
Fidelity surety bonds charge a bond premium between 1% – 15%, based largely on the personal credit score of the business owner. However, business information such as working capital, financial performance, and the D&B business credit report can also be included, depending on the principal. A fidelity surety bond has costs that are similar to contract surety bonds.
Personal credit scores above 700 typically receive a bond premium between 1% – 3%. Personal credit scores below 700 typically have bond premiums between 4% – 15%. The maximum bonding capacity of a company is usually capped at 10x – 15x a business’s equity. Further, companies are typically required to have at least 10% of the bonded amount in working capital.
The usual term of a fidelity surety bond is between 1 – 4 years. However, some fidelity surety bonds can be continued until canceled, meaning that there is no expiration. Generally, a fidelity surety bond can cover the following types of people and organizations:
Current and former employees
Partners, directors, members, or trustees
Seasonal and temporary employees
The business itself
Let’s now take a look at the 3 types of fidelity surety bonds.
Types of Fidelity Surety Bonds
There are generally 3 types of fidelity surety bonds. These bonds can protect a company against the loss of customer cash or assets, dishonest employees that harm the business itself, or can protect employees from the malpractice of a fiduciary managing their retirement account. Below is more information on each fidelity surety bond type.
Business Services Bond
A business service bond protects against the loss of a customer or client’s money, supplies, and/or personal belongings as it relates to dishonest acts by employees. The obligee is the customer and the principal is the company itself. A business service bond is the most common type of fidelity surety bond.
While this isn’t required, like a contract surety bond, it can set a business apart when trying to win new business or reduce the risk to existing customers. If any valuable items are lost or stolen, the customer can file a claim and the financial damages are covered by the business service bond.
Employee Dishonesty Bond
An employee dishonesty bond is a unique surety bond in that it’s purchased by a company to protect the business itself. Employee dishonesty bonds protect a business against financial losses due to an employee or group of employees. Financial losses include such things as money, financial securities, or even property. Employee dishonesty bonds are commonly used by non-profits.
ERISA fidelity bonds were created as part of the Employee Retirement Income Security Act of 1974. ERISA surety bonds require that trustees of large funds such as pension plans have a bond equal to 10% of the fund’s total assets. An ERISA bond protects participants and beneficiaries from the malpractice of the fiduciary managing their retirement plans.
Bottom Line: Types of Surety Bonds
There are many different types of surety bonds. Each of these surety bond types is used by a principal to protect an obligee from any harmful business practices on behalf of the principal. Some of these types of surety bonds are required while other surety bond types are simply a good idea when trying to win new business.
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