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Surety Basics


A surety bond is a three party agreement between a principal (bond holder), a surety (underwriter), and an obligee (entity requiring the bond). In exchange for an agreement of indemnity and a premium from the principal, the surety agrees to guarantee the successful performance of the principal to the satisfaction of the obligee, subject to the terms, conditions, and language of the bond. A surety agent communicates with all three parties and coordinates the bond.

(Note: Unlike insurance policies, should a principal fail to perform under the bond, the principal is required, via the indemnity agreement, to hold the surety harmless from any loss or expense it may sustain as a result of the principal's failure to perform.)

How are surety bonds underwritten?

Surety underwriters analyze the principal's three "C's": character, capacity, and capital. Underwriters seek the following attributes in their principals:

  • They are trustworthy, reputable, and of good character.
  • They have the capacity to complete the work guaranteed by the surety bond.
  • They have adequate capital to make the surety whole again should a loss occur.

The differences between surety bonds and insurance:

Surety

Insurance

Three party agreement

Two party agreement

No transfer of risk

True risk transfer exists

No losses expected

Losses are expected

Law of large numbers does not apply

Law of large numbers applies

Losses are recoverable

Losses are generally not recoverable

Premium = service charge

Premium = charge to cover losses

Selective Underwriting

Most risks written (at an adequate premium)

Terminology: “Principal”

Terminology: “Insured”

Terminology: “Bond”

Terminology: “Policy”

 

For more information, please contact the AHT surety team.