Ever wonder why bonds aren't just called 'insurance'. It may seem like splitting hairs, but the reason why is that a bond is fundamentally different from insurance in several ways. Here's two:
Insurance is a contract between two parties - the insured and the insurance company. Bonds typically are contracts between three parties: the bond issuer (just to make things more confusing the issuer is usually an insurance company), a guarantor (bond purchaser), and obligee (whoever is requiring the bond).
Insurance generally is designed to 'make the policyholder whole' after a covered loss through financial payments. Bonds will pay the obligee when something goes other than according to plan (e.g., if construction deadlines are missed).
There are many, many types of bonds that are typically used in industries where there is a potential for financial loss in the course of business, such as construction or janitorial services.
Your business may need a bond when it is required by law or by a client as a condition of doing business. Bonds can provide financial protection for clients by guaranteeing that a business will perform its obligations, such as completing a construction project or complying with laws and regulations.
The bond issuer guarantees payment to the bondholder in the event that the bonded party fails to fulfill their obligations or causes financial loss as set forth in the bond contract. For example, a construction company may be required to obtain a performance bond, which guarantees completion of a project and protection for the owner in case the contractor fails to perform.
How does a bond work?
- The bondholder, typically a business, obtains an insurance bond to cover a specific risk or obligation.
- The bond issuer evaluates the risk and sets the premium, which is the cost of the bond. The premium is paid by the bondholder.
- If a covered loss occurs, the bondholder files a claim with the bond issuer. If the claim is approved, the bond issuer pays the bondholder the amount of the loss, up to the limit of the bond.
- The bond issuer may then attempt to recover the funds paid out on the bond from the bonded party, who is responsible for the covered loss.
What are the most common types of bonds?
- Bid Bond: A bid bond is a guarantee from the bond issuer that the bidder will enter into a contract and provide the necessary performance and payment bonds if awarded the contract.
- Performance Bond: A performance bond is a guarantee from the bond issuer that the contractor will complete the construction project in accordance with the terms of the contract.
- Payment Bond: A payment bond is a guarantee from the bond issuer that the contractor will pay all subcontractors, suppliers, and laborers for the work performed on the construction project.
- Maintenance Bond: A maintenance bond is a guarantee from the bond issuer that the contractor will maintain the completed construction project for a specified period of time after completion.
- Supply Bond: A supply bond is a guarantee from the bond issuer that the supplier will deliver the materials and supplies as specified in the contract.
For questions, call or contact Linville Insurance Agency today.