Insurance Bonds Guarantee
nsurance bonds are often misunderstood and improperly defined. This is understandable, considering the general nature of the term, and the fact that it may refer to different things in different industries, or even in different areas. In the United States, however “insurance bonds” are also referred to as surety bonds.
What Do Insurance Bonds Do?
Insurance bonds are defined as a type of assurance that protects parties entering into a contract from financial loss. Specifically, an insurance bond gives a person buying goods or services (called the obligee) the guarantee that the service or goods he or she has paid to receive will be delivered to the specifications of the contract. If they are not, the insurance bond steps in to investigate the situation and, if deemed valid and necessary, make financial restitution to the payee.
It's easiest to understand insurance bonds in the context of contract work, such as when a homeowner hires a laborer to perform work on a house or building. Most people have heard of “bonded” contractors, and most people also have been advised that hiring a bonded contractor is an essential part of making a wise hiring decision. This type of “bonding” of contractors is an example of an insurance bond.
A contractor who is bonded has an agreement in place with a third party bonding company, who has provided him or her with financial backing in exchange for an annual premium (similar to a typical insurance policy). Should the contractor fail to perform the job properly or otherwise default on the contract, the insurance bond is in place to provide the person who hired the worker with compensation. The bonding company is essentially guaranteeing the work of the contractor.
Through this agreement, the surety agrees to uphold - for the benefit of the obligee - the contractual promises (obligations) made by the principal if the principal fails to uphold its promises to the obligee. The contract is formed so as to induce the obligee to contract with the principal, i.e., to demonstrate the credibility of the principal. After a surety company pays out money to an obligee, the surety or insurance bond company then attempts to collect the funds from the company who defaulted on the work. This is one way in which insurance bonds differ insurance; when a standard insurance company pays out, the insured doesn't have to pay back the money.
Benefits Of Insurance Bonds
Insurance bonds have been functioning in the service industry for hundreds of years, providing security to both customers and contractors. Customers are given peace of mind and a guarantee on their money, since the bond ensures that they will get what they paid for (or get the money back for it). The contractors are given the security of bond backing that helps them market themselves to customers. In some cases, a contractor or other business, like an auto dealer, may actually be required to purchase an insurance bond or surety bond before a license permit will be used. Bonds, therefore, are an important part of doing business.
It's even possible for contractors to reverse the system a bit and use payment bonds, which are yet another form of insurance bond that are designed to ensure payment is received for any third-party contractors who work on the job. For example, if a building foreman brings an independent plumber onto the site, he should make sure his agreement with the customer (and with the bonding company) includes payment bond backing, so that the plumber gets paid and the contractor himself cannot be held personally liable for doing so.
Types of Insurance Bonds
All bonds and bonding companies are regulated and licensed by various state departments. While many states have similar ordinances in place, each state has its own requirements in terms of what type of bonding a professional may need in order to be licensed, or even to perform work, in the area. There are two basic types of insurance bonds that are regulated by the insurance industry.
1. Contract insurance bonds: A contract insurance bond is, more or less, exactly what is described above. It's an agreement between the payee/ customer, contractor (also known as the obligee), and a third party who provides the surety of the bond. The bond is a legal agreement on the part of the third party to provide financial assurance that the obligee will complete the terms of the contract.
2. Commercial insurance bonds:? Commercial insurance bonds are a bit different than contract insurance bonds; they cater more to the specific rules and regulations according to local laws. A commercial insurance bond typically guarantees to the payee that the obligee will perform duties that are in compliance with any local state, county, city, or federal regulations that may apply to the job. ??
Commercial insurance bonds break down into various types based on the type of work being performed and the type of agreement in place. A building contractor, for example, may need a license and permit bond in order to assure the customer that the work performed will meet all local building ordinances (and that, if it does not, the bond will pay for any fees or repairs required). License and permit bonds also cover everything from mortgage brokers (ensuring they perform financial commitments properly and according to state statutes and contract agreements), to motor vehicle dealers, who must meet ordinances regarding honesty, financial transactions, warrantees, and more. ??
License and permit bonds are just one type of commercial insurance bond: there are multiple others. A public official bond, for example, is required by many local ordinances to guarantee the behavior of a person in a public office. Fiduciary bonds guarantee the honest and accurate behavior and work of administrators of trusts, wills, estates, and the like. In general, commercial insurance bonds are any that are specifically applied to particular duties that may require regulation and guarantees because they would otherwise involve financial risk to the customer and/ or the public.