Underwriting: How do surety bonds differ from insurance?
For those who are new to surety or who don’t handle bonds often here is a quick refresher on the subject. A surety obligation involves three parties; the principal, who is the primary obligor, the surety, who is the secondary obligor, and the obligee. The insurance obligation will only have two parties, the insured and the insurer.
The surety provides a bond that guarantees the performance of an obligation by the principal to the benefit of the obligee. Should the principal not fulfill the terms of their obligation or default on their obligation, the surety bond guarantees that the surety will step in to remedy the default. However, unlike insurance, the principal on the surety bond now becomes indebted to the surety for the amount the surety expended in making the obligee whole.
The surety bond guarantees an underlying contract, statute, and/or other written agreement between two parties. Normally the surety obligation is not extinguished until the obligation is fulfilled and the obligee releases the bond. Some surety bonds, court bonds for example, are not cancelable, and the surety can only be released by an action of the court. However, most License and Permit bonds are cancelable with notice to the obligee. Normally, there will be a period for claims, after a period of time, the surety’s liability will cease as a matter of law.
Insurance is a device whereby a group of people contribute to a common fund for the express purpose of utilizing this fund to pay for losses sustained by individual participants. Surety, on the other hand, is basically a credit function. While insurance presupposes loss, surety does not. While the charge for insurance and surety is called a premium, the terminology represents the only real similarity between the two.
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