BOND INSURANCE: What Is It & Why Is It Needed?

Bond Insurance
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You may feel confident that your business is fully covered thanks to the presence of several types of insurance, such as general liability, professional liability, worker’s compensation, commercial auto, commercial umbrella, cyber insurance, and so on. But did you know that if you work in a particular industry, you might need more protection than what standard commercial insurance provides? This may seem bizarre, but hear me out. However, doing business with or delivering services to another party can be complicated, and additional risk mitigation methods may be required. Furthermore, this guide will teach you all you need to know about bond insurance and its types, what it covers, and bond insurance for your small business. 

Bond Insurance

An insurance bond is a legal agreement between a principal (the party purchasing the bond), an obligee (the party receiving the benefit of the bond), and a surety (the insurance company). Bonds are not insurance policies in the traditional sense; rather, they are legal contracts between three parties that guarantee compensation to the obligee if the principal defaults on contractual obligations.

Surety bonds and fidelity bonds are the two primary types of insurance bonds, each of which includes subtypes and protects against various situations.

Bond Insurance for Small Business

Bond insurance for small businesses implies the purchase of a surety bond. When it comes to bonds, three parties are involved:

  • Surety: The insurance firm that provides the bond.
  • Obligee: The party who needs the bond.
  • Principal: The person who bought the bond.

Bonds guarantee that the business will complete the task specified in a contract. Bonds protect against unfinished work. As a result, if a corporation fails to behave honestly or perform as specified in a contract or court document, the client may bring a claim with the surety.

A small business may qualify for bond insurance because it:

  • If something goes wrong with a client, your small business’s reputation will be safe.
  • Allows you to legally run a business or fulfill a specific position.
  • It demonstrates that your company is financially stable and able to fulfill its contractual obligations.

When a Small Business Needs Bond Insurance?

Small businesses may require bonds in a variety of situations. Examples include:

  • Fulfilling a customer or government contract: Clients, governments, or municipalities may need businesses to obtain bond insurance to guarantee the services the business provides.
  • Legally doing professional business: Bonds are required in certain sectors and occupations.
  • Assuring customers that your business can be relied on: Obtaining a bond from a surety company demonstrates to clients that your business will operate in accordance with the terms of the contract and in accordance with applicable laws and regulations.

Companies may require a business license and permit collateral for the following:

  • Contractor’s license
  • DOT permit, erosion, and sedimentation control
  • Professional services and retail

The following businesses may also require a bond:

  • Tax authorities
  • Notaries 
  • Treasurers

Read Also: Cheap Business Insurance Providers 2023

Types of Bond Insurance 

Surety bonds and fidelity bonds are the two main types of insurance bonds.

#1. Surety Bonds

A surety bond guarantees or offers security for the fulfillment of a contract. The bond does not safeguard the bond buyer (the principal), but rather a third party (the obligee) who is in danger of loss.

Surety bonds come in a variety of forms. Here are a couple of such examples:

  • Contract bonds: protect against losses resulting from noncompliance with the contract, such as bid bonds, performance bonds, payment bonds, and warranty bonds.
  • Commercial bonds: ensure compliance with the law, such as license and permit bonds, customs bonds, and court bonds.

#2. Fidelity Bond

In order to protect an employer or other entity from financial loss due to dishonesty and fraud as well as criminal activity, a fidelity bond promises a faithful, loyal connection.

Here are a few examples of fidelity bonds:

  • Commercial crime fidelity bond: safeguard against employee dishonesty and fraud
  • Financial institution: A financial institution bond protects against employee dishonesty and fraud.
  • ERISA fidelity bond: safeguard against plan fiduciaries’ dishonesty and fraud
  • Public official bond: protection against dishonesty and fraud on the part of a public official

Today, most types of fidelity bonds (but not all) work like insurance policies. They are contracts between an insurer and an insured person. A prime example is the commercial crime fidelity bond. The term ‘bond’ in this context is a historical remnant from the days when people bought ‘fidelity bonds’ from a third party to guarantee their trustworthiness to future employers. Employee dishonesty insurance (or fidelity coverage) is now included in most commercial crime insurance policies.

Read Also: Commercial Auto Insurance: How Does It Work?

What Does Bond Insurance Cover 

An insurance bond covers the obligee by guaranteeing that they will be paid back if the principal doesn’t keep its end of the deal or provide the services agreed upon or if an employee of the principal steals from the obligee

The principal purchases the bond from the surety and pays a premium to the surety in exchange for the surety’s assurance to pay for any losses that may occur. In the case of bonds, as opposed to an insurance policy, the principal is liable for repaying the insurance company.

An insurance bond helps all three parties involved since it guarantees payment to the principal.

There is no risk of financial loss to the obligor in the event that the principal is unable to fulfill its commitments. If the principal fails to meet its financial commitments, the bond ensures that the insurer will make good on its promise to do so. 

The surety makes money because it charges the principal a fee for the bond. The principle must be repaid in full, regardless of whether or not it was used to mitigate a loss. 

In the case of a breach of contract or other covered loss to the obligee, the principal will have access to a line of credit, allowing it to carry forward with the project or agreement with confidence. 

What Doesn’t an Insurance Bond Cover?

Insurance bonds do not cover any form of obligation, such as legal defense, settlements, or judgments. They will also not pay out if a project participant dies or becomes handicapped, or if the principal fulfills its duties but the obligee is dissatisfied with the service or finished product.

Depending on the specific type of bond, insurance bonds, in contrast to investment bonds, provide a relatively small area of protection.

Who Needs an Insurance Bond?

As previously stated, there are several sorts of surety bonds and fidelity bonds, each of which is created for specific individuals or businesses and protects against distinct defaults or actions.

Surety bonds, in general, protect a wide range of principals and are classified into two types: contract surety bonds and commercial surety bonds. Contractors, subcontractors, and suppliers who are working on or bidding on a project generally require contract surety bonds. Commercial surety bonds are typically required by the government or other regulatory organizations for a variety of individuals, including those seeking a professional license, filing a court case, or serving as public authorities.

Firms that offer in-home services, financial services, not-for-profit services, or health services frequently hold fidelity bonds to guard against employee dishonesty or other crimes like theft.

Read Also: Business Insurance for Consultants: What It Is & How Much It Costs

Fidelity Bond Insurance

A fidelity bond is a type of business insurance that protects an employer from damages caused by its workers’ fraudulent or dishonest activities. This type of insurance, also known as an honesty bond, can cover against monetary or physical losses.

A fidelity bond is known as employee dishonesty insurance in Australia and fidelity guarantee insurance in the United Kingdom.

Fidelity Bonds Explained

If an organization’s workers commit fraud, the company may face legal or financial consequences in addition to the individual employee or employees who committed the crime. As a result, businesses, particularly those with a high number of employees, are vulnerable to such penalties.

  • Fidelity bonds protect businesses from such losses. Although they are referred to as bonds, fidelity bonds are essentially insurance policies. They are commonly classified as either first-party or third-party:
  • First-party fidelity bonds are insurance policies that cover a company in the event that an employee commits fraud.
  • Third-party fidelity bonds safeguard businesses from comparable offenses committed by contract employees.

Typically, insurance companies, banks, and brokerage firms hold fidelity bonds because they are all required to carry protection equal to their net capital. A fidelity bond can cover a variety of losses, including fraudulent trade, theft, and forgeries.

Why Are Fidelity Bonds Used?

Fidelity bonds can be used as part of a company’s enterprise risk management strategy. These insurance policies serve as a kind of protection if the firm suffers damages as a result of fraudulent or criminal employee actions against the company or its clients.

This might include monetary thefts from the business as well as stealing from a firm customer. This type of coverage may also apply to employee forgery that has an impact on the company. Fidelity bonds also cover robbery and burglary of the company safe, damage to company property, and the illicit transfer of money.

Fidelity Bond Types

They are classified into multiple types, each of which covers a different topic. The following are the most common types of fidelity bonds:

  • Business services bonds, also known as business bonds or janitorial service bonds, are the most prevalent type of fidelity bond. It is their responsibility to protect clients when staff visit their workplace. For instance, if a corporation sends an employee to a customer’s home and that employee steals a computer, the bond would reimburse the client for the loss.
  • Employee dishonesty bonds: These bonds protect firms and their clients if an employee misuses Social Security numbers, credit card information, or other financial or personal data.
  • ERISA bonds: The Employee Retirement Income Security Act (ERISA) of 1974 requires pension plan trustees to hold fidelity bond coverage equivalent to at least 10% of total plan assets. This rule was enacted to safeguard plan beneficiaries from theft or other improper conduct perpetrated by individuals in charge of managing 401(k)s and other pension plans.

How Does a Fidelity Bond Work?

Fidelity bonds are insurance products that protect employers from damages caused by fraudulent or dishonest activities by their personnel. If a policy-covered event occurred, the company would submit a claim and receive payment in accordance with the terms set forth with the insurer.

Is Insurance a Type of Bond?

Insurance pays on your behalf; surety bonds only guarantee payment to another party. The key distinction between a surety bond and insurance is that insurance pays for losses in the event of a claim, whereas a bonding company guarantees that your obligations are met.

What Is Another Name for Bond Insurance?

Bond insurance is frequently referred to as financial guaranty insurance.

What Is the Difference Between Bond and Bank Guarantee?

A bank only offers a bank guarantee as a surety for specific people. The government, banks, and even sizable corporations issue bonds to fund their capital requirements. The payment for a bank guarantee will be transferred from the seller to the buyer through the bank.

Why Do Banks Use Bonds?

Bonds provide companies with a means to alleviate the constraints frequently associated with bank loans. As an illustration, financial institutions frequently impose contractual obligations on corporations, wherein the latter are prohibited from issuing additional debt or engaging in corporate acquisitions until the complete repayment of their loans. Imposing such limitations can impede a company’s capacity to engage in commercial activities and constrain its range of operational alternatives.

Are Bonds Protected by Insurance?

Bondholders will receive up to $250,000 in insurance coverage for all bonds issued by the same issuer, regardless of series. Identification of the account as a redemption account for bonds is sufficient for per-bondholder coverage, assuming that each bondholder’s interest can be ascertained.

Can You Use Bonds as Collateral for a Loan?

Bonds can be a form of collateral to get fast cash for big purchases. Lenders may accept corporate bonds, municipal bonds, and U.S. Treasury bonds as collateral for a loan, but some lenders may be wary of accepting corporate bonds as collateral.

How Do Bonds Gain Money?

A bond is just a debt that a firm takes out. Rather than going to a bank, the company obtains funds from investors who purchase its bonds. In return for the capital, the company gives an interest coupon. An interest coupon is the bond’s annual interest rate payment, shown as a percentage of the face value.



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