A surety bond is not an insurance policy although there is a basic similarity in the sense that there is a promise of indemnification for one of the parties concerned. An insurance policy is a two-party agreement where the insured pays a premium to the insurance company and receives the benefits of the policy in the event of loss. On the other hand, there are three parties involved in a surety bond – the Principal (the party bonded), the bonding company, and the Obligee (the party in whose favor the bond is issued). With regard to the premium, it is usually the Principal who shoulders it although there are occasions when the Obligee pays for it.
Under the laws of suretyship, the Principal is required to repay the bonding company for any loss the bonding company might incur by reason of having executed the bond. Thus, the Principal is required to sign an Indemnity Agreement or a counterbond in favor of the bonding company before the bond is released to the Obligee.
In underwriting a bond, the surety considers the character, personal circumstances and resources of the Principal, and depending on the nature of the bonding obligation, it would also require adequate security in the form of collaterals such as real estate, stocks, and other acceptable securities or the signature of solvent guarantors.
The primary purpose of the bonding company, at least theoretically, is not to pay losses but to perform a service to worthy individuals or corporations whose affairs require the guarantee of a bonding or surety company. This is the great difference between a surety bond and an insurance policy. Furthermore, in insurance, the insurer can cancel the policy upon proper notice to the insured plus a refund premium for the unexpired period of the policy while in suretyship, many bonds cannot be cancelled at all unless there is concrete evidence the obligation under the bond has been fulfilled. The term of a bond is therefore dependent upon fulfillment of its obligation or on its expiration date if there is any.
Contractors who bid and win large construction projects usually post performance bonds to guarantee their satisfactory completion. This is only one example of the important role of suretyship in business.
The author is a risk management consultant and Editor of Insurance Philippines magazine.
