Contractors: What is a Surety Bond and How Does it Differ from Insurance?

The construction industry has been on a growth streak for the last decade, offering several opportunities for those with skills and experience in the industry. Becoming a licensed construction contractor offers unlimited potential to work on residential and commercial projects, all which can be lucrative when done right.

However, there are several aspects of business as a construction contractor that require some consideration, particularly in the realm of protecting the business and its customers. Both surety bonds and insurance can play important roles in providing this protection but in different ways. As a construction contractor, it is beneficial to know where insurance and surety bonds fit into the mix of business management, and when each is required.

The Ins and Outs of Surety Bonds

Many people use the terms bonded and insured interchangeably, but surety bonds stand out from insurance in several ways. A surety bond for a construction contractor is a safeguard against poor performance is less than honest behavior on behalf of the contractor, for the benefit of the project owner.

A contractor purchases a surety bond from a surety agency which acts as a form of credit. When a claim is made against the bond, the surety agency pays out the claim to the project owner. The contractor then repays the bond claim back to the surety.

Because of this unique relationship between the surety agency, the contractor, and the project owner, surety bonds are priced differently than insurance policies. A contractor pays a percentage of the total bond amount which is determined by his or her financial track record. If there are credit issues plaguing a contractor’s financial history, such as bankruptcies, court judgments, or tax liens, the price paid for a surety bond is higher. Those in good financial standing, both from a business and personal perspective, pay less for surety bonds over time.

How Insurance Differs

Unlike a surety bond, insurance for a construction contractor’s business is an agreement between only two parties—the contractor and the insurance company offering coverage. Insurance is meant to protect the contractor, not necessarily the customer, from financial loss due to death, disability, theft, fire, or other damage to the business. Insurance comes in many different forms, including:

• General liability insurance – this covers property damage and bodily injuries related to the contractor’s business activities.
• Commercial property insurance – this covers damages or stolen business property, such as tools or equipment.
• Builder’s risk insurance – this helps pay for damage to a building, tools, or equipment after a natural disaster or theft.
• Workers’ compensation insurance – this coverage pays for the costs associated with work injuries or illnesses experienced by employees of a construction contractor.

Each type of insurance policy is priced based on the amount of risk the insurance company takes on in providing coverage. While there is generally no check of personal credit when determining the price of an insurance policy, other risk factors are evaluated.

Contractors with many claims against other insurance coverage, a lackluster work history, or high-risk job sites will likely pay more for insurance premiums. However, unlike surety bonds, when an insurance claim is paid out, there is no requirement to repay the coverage amount.

Requirements for Construction Contractors

Construction contractors are often required to put a surety bond in place, especially if the projects they work on exceed a certain dollar amount. States, counties, and municipalities dictate the amount of the surety bond requirement for licensed contractors.

Insurance is typically an optional part of operating a business, but it can be incredibly helpful to offset financial losses over time. Some projects may require additional insurance coverage, such as workers’ compensation or general liability coverage, but these requirements vary from project to project and from state to state.

For licensed contractors working in the construction industry, having a clear understanding of insurance coverage and surety bonds is crucial to developing and maintaining a successful career. Both offer vital protections, but in different ways, meant to keep the customer, the contractor, and the business safe during the course of a project.