A key focus of my blog is Financial Literacy/Money. One area many people don’t know about is Surety Bonds. As with most financial concepts, knowledge of Surety Bonds can be an important tool in your financial tool box. The following sponsored post is entitled, Surety Bonds Demystified – How They Work and Why You Need Them.
* * *
Surety bonds are an essential tool to help protect your construction business. But they can be complicated to understand.
A bond is a contract between a principal, such as a construction company, and an obligee, which could be a regulatory authority or a private client. The bond protects the obligee from financial losses incurred due to the principal’s actions.
Obtaining a Surety Bond
So, what is a surety bond? Surety bonds are financial guarantees that contractual obligations will be fulfilled. The bond binds the Principal, the Obligee, and the Surety Company.
The bond’s cost, known as a premium, is determined during underwriting when the bond provider assesses the applicant’s risk and approves or denies the application. The bond type, project scope, and principal’s financial wherewithal affect the premium amount.
Several techniques can help a Principal lower their premium, including providing collateral or having an experienced co-signer with a strong credit history.
These can also boost a Principal’s bonding capacity, the maximum amount a Surety Company will guarantee on any one or aggregate of projects.
A successful bond application requires a thorough understanding of the relevant state and federal regulations that apply. In addition, a Principal needs to know their obligee’s requirements. Knowing the specific stipulations for a project can help reduce delays in getting bonded and can also help ensure that all of the needs are met for a smooth construction process.
Underwriting a Surety Bond
Most bond applications require a detailed financial history to be reviewed by underwriters. This is done to determine if a principal can meet the bond obligations in the event of a claim. Underwriting involves assessing risk based on credit analysis, financial strength, and a record of honoring commitments.
The person or business requiring the bond (the obligee) files a claim with the surety company that issued the bond. Once the claim has been validated, the surety company will pay out the obligation outlined in the bond. The principal is then required to reimburse the surety company.
The best way to lower your bond costs is by partnering with a surety agency that specializes in your industry and has an extensive network of reputable A-rated surety companies to choose from. In addition, working with a broker who regularly analyzes your financial statements and focuses on building long-term relationships with underwriters can make a significant impact on your bond costs.
Claims Against a Surety Bond
When an obligee feels that a principal has not performed as agreed, they can file a claim against the bond seeking financial compensation. The claim is reviewed by the surety provider, who then pays out on the claim based on their evaluation of the circumstances. The obligee is then obligated to reimburse the surety provider.
Contract bonds are required by government agencies, private contracts, and certain other entities for companies that wish to perform work. Different types of surety bonds include court and probate, janitorial, notary, and license and permit bonds for individuals who perform home health care and janitorial services.
When choosing a surety broker, look for one that takes the time to understand your company’s history and future growth plans and present them in a way that best positions you to secure a bond. Evaluate your broker for more than good service; expect a business adviser who will help you navigate the sometimes complex world of surety bonds.
Payments Against a Surety Bond
A surety bond guarantees that contracts, business deals, and other obligations will be fulfilled according to mutually agreed-upon terms. If the obligee is harmed, they can claim the surety bond and receive financial compensation.
To be approved for a surety bond, your small business must be able to complete projects under the required conditions. This includes working capital, cash flow, and managerial experience. In addition, the underwriters must have a high degree of confidence in their technical skills and ability to manage the company’s finances.
Construction companies commonly need to obtain contract bonds to guarantee they will fulfill their work according to specific rules. Similarly, auto dealers must get cement to ensure they aren’t selling lemons. Many large-scale service providers, such as home health care agencies and janitorial companies, must also have surety bonds. Bonds are also used to protect individuals in court and probate matters.
