What Is a Surety Bond?

A surety bond is an attractive alternative to letters of credit because it's an off-balance-sheet item. Premium rates are also stable or declining.
By: | August 30, 2018

Landscaping and commercial real estate companies are among the industry sectors that use a surety bond to manage contractual risk.

Mention surety to some insurance people and they might think its boring.  But they’d be wrong.  Surety is a vital financial tool, without which most of our major construction projects and a host of other economic ventures would never get off the ground. Okay, so what is surety?

A surety bond, according to the brokerage Marsh, is a contract involving three parties.

A principal, the party that needs the financial support of the bond.

An obligee, the party requiring that there be a bond.

And a surety; An insurance company guaranteeing that the principal will be able to meet its obligations to the obligee.

Here is another explanation, in the word of Robert Duke, the general counsel for the Surety and Fidelity Association of America.

“A surety bond is an instrument by which an obligation owed by one party (the bond principal) to another is secured by a third party, the surety.”

David Hewitt
Head of Surety for Marsh

Although, according to Rich Ciullo, chief operating officer of the Hartford Bond, although 80 percent of surety bonds are used in construction, there is a growing use of surety bonds outside of construction. Growing uses include as a sales contract guarantee in the energy business and increasingly, for large corporations that are waiting the results of an appeal in court litigation.

Say your company suffered an adverse legal decision. A surety bond can cover the settlement while you litigate for a reversal. These days, it’s a cheaper option than taking out a letter of credit.

One of the chief advantages of a surety bond, according to insurance experts, is that unlike a letter of credit from a bank, it is an off-balance-sheet arrangement. It doesn’t count as a debt and frees up capital and credit for other uses.  As interest rates rise on letters of credit, surety bonds become that much more attractive an option.

“Rates in surety are relatively stable and slightly down,” said David Hewitt, the surety practice leader for Marsh.

Another advantage to using a surety is that it frees you from being dependent on just one or two financial institutions.  Surety underwriters go through their own vetting process and don’t depend on the opinions of bank loan officers to make their decisions. Losses for sureties remain low, which indicates that generally speaking, surety underwriters know what they’re doing.

For insurers, the surety business is growing and creating revenue.  According to data from the Surety and Fidelity Association of America, direct written premiums from commercial surety bonds grew 65 percent between 2005 and 2016.

Surety growth, in premiums written, as provided by the Surety and Fidelity Association of America

2012: $2,963,077,802

2013: $3,154,259,692

2014: $3,315,369,862

2015: $3,444,900, 908

2016: $3,554, 026, 690

Here is a brief list of uses of surety bonds outside of construction, according to sources with Marsh and The Hartford.

  1. Lease bonds for renters in commercial real estate.
  2. Performance bonds for landscaping contractors.
  3. As mentioned above, bonds used to cover litigation costs. Intellectual property court disputes are a growing use.
  4. As a guarantee in energy purchasing contracts.
  5. A performance bond for mine reclamation work.
  6. Gas and oil well plugging and reclamation projects.
  7. As a guarantee for product delivery in manufacturing.

Dan Reynolds is editor-in-chief of Risk & Insurance. He can be reached at [email protected].

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