Businesses and individuals incur risks when carrying out projects or providing services. Two tools for managing risk are bonds and insurance. However, the two are not interchangeable. When you buy an insurance policy, risk is shifted to the insurer. When you purchase a surety bond, another party, such as a client, is protected against loss.
Insurance and Surety
When a business or individual takes out an insurance policy, the insurance company assumes some risk as specified in the contract. For example, if a customer is injured on the premises of your business and you have a liability policy that covers such events, the insurance company pays damages, thereby protecting the business from loss. Typically, insurers pay a percentage of losses after the insured pays a deductible amount.
A surety bond is a three-party contract. The principal is the business or individual purchasing the bond from the second party, called the surety. In the event of a claim, the surety pays a specified amount to the party requiring the bond, called the obligee. Thus, a bond protects the obligee from loss. Bonds are used in situations where an obligee wants assurance a service or contract will be satisfactorily carried out. Examples include construction projects, janitorial services, notary services and government contracts that mandate bonds. In the event the surety must pay a claim, it can recover the money from the principal. That is, the principal is not protected against loss, only the obligee.