What is a Surety Bond?

A surety bond is a mutually binding contract between three parties known as the Obligee, the Principal, and the Surety. The Obligee is the entity that requires the guarantee of a surety bond from the Principal. The Obligee may be a government agency, a company, or an individual. The Principal is the person or entity applying for and purchasing the bond from the Surety. The Surety is the insurance carrier.

The process of a surety bond is simple. The Obligee requires the Principal to provide a surety bond. The Principal applies for a surety bond from the Surety. Through underwriting the Surety evaluates the Principal’s wherewithal to fulfill the contract or obligation. After the assessment, the Surety will extend a surety credit to the Principal. By extending this credit to the Principal, the Surety is telling the Obligee that the obligation or project is going to work out. If the Principal does not fulfill the contract, the Obligee can make a claim on the surety bond to recover losses.

In general, a surety bond guarantees that the Principal understands the requirements and regulations outlined in a license or contract. A surety bond’s specific guarantee depends on the bond type and the actual language of the bond.

Surety bonds are a means to protect governments, companies, and consumers from nonperformance or violations by the Principal. A surety bond may also guarantee that the Principal is operating within the laws and regulations. When considering a surety bond, keep in mind that alternatives can be costly. Escrowing your own assets can lead to decreased operating capital and weakened a balance sheet. Excessive costs can be avoided because surety bonds are available at a reasonable premium.