The term bonded and insured is common in the world of real estate business and many other industries. However, the two types of coverage – bonds and insurance – are not one of the same. Instead, being bonded is part of the licensing requirements for certain professionals, including mortgage brokers, as it offers a way to protect customers. Insurance, on the other hand, is often an optional strategy for protecting the business or the professional.
Here’s a breakdown of how a surety bond differs from insurance in terms of who’s involved, how one obtains coverage, the pricing, and the specific way claims are handled.
The Parties Involved
The first way a surety bond differs from insurance involves the parties to which each type of protection benefits. With a surety bond, a contract includes three parties: the surety agency, the person or business holding the bond (the principal), and the person or organization requiring the bond (the obligee). This contract guarantees that you as the bondholder will fulfill your obligations to the obligee, and the surety agency will pay claims on your behalf if you fail to do so.
Insurance, on the other hand, involves just two parties. An insurance contract includes you or your business as the insured party, and the insurance company as the provider. This agreement creates a transfer of risk away from you or your company to the insurance company who pays insurance claims if something goes wrong.
Providers of Bonds and Insurance
Surety bonds are offered by surety agencies, and bondholders have many options for selecting their surety provider. Strong surety agencies will have experience in your industry, such as real estate, and a knowledge of the specific types of bonds you may need. An insurance company offers insurance coverage, and again, there are many different providers available. It is also important to work with an insurance company that has expertise in the specific type of business insurance you need, such as general liability coverage.
Surety bonds and insurance also differ in pricing, although both are based on a form of risk assessment. Surety agencies review a new bond application under a lens of how likely the bondholder is to have a claim made against him or his business. This risk assessment involves taking a close look at the business experience in the industry, your claims history with other surety bonds, and your personal and business finances.
One of the most important driving factors of surety bond pricing is your credit, as this represents how much of a risk you may be in when it comes to paying claims. If you have bad credit or no credit, your surety bond pricing will be higher. Those with good credit will pay less for their surety bond cost. Another factor of pricing is the amount of the bond needed. A mortgage broker may need a bond of $50,000, but the cost of the bond is not that full amount. Instead, based on your credit and your bond amount, the total price you pay is between 1 and 10% of your bond amount.
Insurance is priced based on your risk of claiming in the future. This risk assessment may depend on the location of your professional activities, the revenue or value of your business, and your claims history with other insurance policies. High-risk applicants will pay more than low-risk applicants for a new insurance policy, as will those with minimal industry experience. The premiums paid for insurance is also dependent on the amount of coverage purchased.
Claims and Coverage
Additionally, surety bonds and insurance are different in who and what they protect, as well as how claims are managed. With surety bonds, the protection extends to the obligee or the customer of the business or profession. When a claim is made against a bond because of bad business practices or non-compliance with state or federal regulations, the surety bond agency pays the claim amount up to the total bond in place. However, the bondholder repays the claim amount back to the surety provider over time.
This differs from insurance significantly. Insurance policies pay successful claims to the insured should damage or financial loss occurs. These benefits paid to the policyholder do not need to be repaid, but the cost of insurance may increase if many claims are made over the life of the policy. Because of this structure, insurance is meant to protect you and your business – not necessarily your customers or clients.
As you can see, being bonded and insured are two different strategies for protecting you and your business. Surety bonds are often required as part of the licensing process, while insurance may be an optional addition to add more protection. It is important to know the differences between surety bonds and insurance, including who’s involved, how they work, and the cost, so you can make an informed decision about what’s best for you and your business.
Eric Weisbrot is the Chief Marketing Officer of JW Surety Bonds. With years of experience in the surety industry under several different roles within the company, he is also a contributing author to the surety bond blog.