Blog

Insurance policies and surety bonds are both vital risk management tools, and both may come into play when contractors take on major public or private development projects. But insurance and suretyship are distinct practices that serve distinct purposes, and this can cause some confusion for agents and clients alike. Here are five key differences to know:

1. Parties
   Insurance: An insurance policy is an agreement between two parties: the insured (the contractor doing the work) and the insurer (the insurance company issuing the policy). In some cases, a third party (like a government entity or property owner) may be named as an additional insured.
   Suretyship: A surety bond involves three parties: the principal (the contractor doing the work), the obligee (the government entity or property owner requiring the surety bond), and a surety (the surety company issuing the bond and serving as a guarantor).
2. Coverage
   Insurance: An insurance policy protects the insured in the event of a covered loss. A contractor’s policy might cover injuries, property damage, or legal claims arising from faulty work. Policies commonly cover a contractor’s entire operations for the year.
   Suretyship: A surety bond protects the obligee if the principal fails to complete the project or pay subcontractors or suppliers as agreed. This could happen because of financial distress, performance problems, or compliance issues. Bonds may be issued for individual projects or aggregate work programs. Gray Surety handles single bonds up to $25 million and work programs up to $75 million in all 50 states.
3. Premiums
   Insurance: Insurance premiums are paid by the policyholder. Premiums are calculated based on the overall scope and value of the contractor’s operations, the inherent risks involved, and the type and amount of coverage offered.
   Suretyship: Surety premiums are paid by the principal. Premiums are calculated based on the specifics of the project or work program as well as the credit profile and financial capacity of the principal.
4. Underwriting
   Insurance: While a contractor’s claims history may enter into the equation, insurance underwriters are primarily concerned with identifying and managing risks across an entire market. Because insurers can rely on actuarial data and spread losses over a large risk pool, minimal documentation is needed and most applications are approved.
   Suretyship: Underwriting a surety bond is often a more complex and rigorous process because principals must be individually evaluated for financial capacity and creditworthiness. Applicants must furnish more extensive documentation, and issuance is more selective.
5. Claims
   Insurance: The insurer will investigate whether a reported incident is a covered loss. If so, the insurer is responsible for paying the insured (although they may attempt to recover those costs from a third party via subrogation).
   Suretyship: The surety will work with the obligee and principal to determine if a claim is valid. If so, the surety will pay the obligee, but the principal is responsible for repaying the full claim amount to the surety. In this way, a surety bond is more like a credit line than an insurance product, with the premium compensating the surety for the time value of money and the risk of default.