What’s the difference between surety and insurance?

Have you ever heard a company say they are bonded and insured? Those are stated separately because surety is not insurance. However, if you have ever been confused about how they are different, you are far from alone. There are even some insurance agents that don’t fully understand surety bonds.

Surety is often looked at as a small piece of the greater insurance world. The same carriers are typically writing both items. Even the same state licensing is required of agents whether they write insurance, surety, or both. So let’s look at how surety bonds and insurance policies are similar yet different.

Insurance policies and surety bonds are both tools used to transfer someone else’s risk to the carrier for some given situation.
Here’s a very simple, common example of risk transfer. There’s a risk your house may burn down, and you’d have to rebuild it and replace the items you lost. You, the principal, probably don’t want to take this risk on your own, so you buy an insurance policy to cover it. If your house burns down, the carrier pays you money to get it rebuilt. The insurance policy transfers the principal’s risk to the carrier. In exchange for taking on this risk the carrier charges a premium. The transfer of risk and charging of premium to do so is about the extent of the similarities between insurance and surety.

The most fundamental difference between surety bonds and insurance policies is the type of risk that is transferred to the carrier.
Insurance takes on the risk of unpredictable events that may or may not occur, such as your house burning down. While surety bonds take on the risk of defined performance that actually should occur. 

EXAMPLE: Money transmitters (the principal) — companies that electronically move money from one party to another —  are required to post a surety bond to obtain a license by most states (the obligee) to be able to operate in their area. These state laws and regulations are in place to ensure that when a state resident uses a money transmitter to pay a bill or give someone cash, that service performs accordingly. The required surety bond financially guarantees that the money transmitter will perform according to that state’s laws. Essentially, It’s a defined performance that should occur and the surety bond provides assurance that it will happen.

Another fundamental difference between insurance and surety is what happens if the risk being covered actually takes place.
Despite our best efforts, unpredictable calamities happen. You have a car wreck, someone steals your jewelry, a dog bites the mailman. These are unexpected events covered by insurance policies. You don’t plan for them to happen, but we all know they do occasionally and are mostly outside of your control. Therefore, insurance claims are expected. The insurance carrier understands this and charges appropriate premiums to cover it. While they do occur, surety bond claims are not expected. The majority of the time, principals do what they say they will do, since the fulfilling the established performance criteria is usually completely within the principals control. The surety bond is there just in case it doesn’t.

If you make a claim on an insurance policy, the insurance carrier doesn’t make you pay it back for covering that claim. The covered event is outside of your control and that was the risk for which they took responsibility and charged a premium. However, if a surety carrier pays a claim on a surety bond, the company expects you to indemnify it. Your performance is within your control, and you’ll have ever opportunity to make it right should a claim arise (unlike being able to turn back time and prevent a fire). If you don’t make it right, the surety must pay a claim and then seek reimbursement from you.

The last major difference is the reason you get an insurance policy vs the reason you get a surety bond.
For the most part, insurance is optional. Yes, there are exceptions such as states requiring car insurance or banks requiring homeowners insurance. But in general, you have the option of whether or not you want to transfer the risk of unforeseen, unpredictable bad things happening to someone else. If you decide to get an insurance policy you also have the option of the amount of risk to transfer. This affects the premium charged so you also have some control over what you pay for insurance policies.

No one gets a surety bond because they want to. You get a surety bond because someone is making you get it in order to do business with them. Otherwise, if they will take your word that you’ll do what you say you’d do, then there is no reason to pay a premium to transfer that risk to someone else. The risk transfer with surety bonds is all or nothing. So the premium charged is set by the surety carrier based on the underwriting.