Construction Insurance and Surety Bonds

Surety bonds have always been a part of public construction projects to prevent the government from losing money if a project is not completed. Increasingly, private project owners have seen surety bonds as way to guarantee they are safe from financial loss if a project is not completed. The reason the surety bond, sometimes called the construction bond, has become a popular way to insure a project is that if the contractor does not complete the job, the project owner can recover money spent on the project.

While a type of insurance, the surety bond differs from construction insurance in a few ways. There are a number of surety bonds, but the two primary ones are the performance bond, which insures that the work gets done even in the event that the contractor cannot complete the job, and the payment bond. Payment bonds guarantee that suppliers, subcontractors, and vendors receive payment from the contractor.

Both provide protections, but the main difference relates to the parties involved and the protections. With the construction bond, three parties are involved in the agreement. The investor/project owner, the building contractor, and the surety company backing the bond come into agreement to make sure the project is insured. The surety company underwrites the bond, which guarantees that the contractor, or the principal, meets the contractual conditions of the obligee, the investor/project owner.

Conversely, construction insurance agreements involve only the business owner and the insurance company underwriting the policy. Construction insurance comes in various types, including general liability and commercial property insurance. Policies can cover employee injuries, stolen or lost equipment, and work that causes bodily harm.

Another difference deals with the way the policy is underwritten. To be bonded, the party executing the project has to pay a monthly premium, which is typically between 1 and 5 percent of the full value of the bond. A person with a poor credit rating might have to pay anywhere between 5 and 20 percent of the bond value.

If a claim is filed related to an event, the insurance company investigates and then the insurance issues a payout. In essence, the insurance company's obligation is to the policyholder whereas the surety bond company and the contractor are liable for claims made by the investor/project owner.

With a surety bond, the affected party files a claim, and the surety company completes an investigation. If the claim is valid, the surety company will honor the initial claim costs. The surety company then gets the money back from the contractor, or the principal, to cover the claim costs.

Insuring a project this way has other guarantees. The surety bond requires that the contractor meets financial requirements, has good credit, and has a good reputation.

Ultimately, when a company says it is bonded and insured, it comes with a certain amount of good faith. Depending on the bond type, contractors and project owners/investors are protected against subcontractors, vendors, or suppliers placing liens on the property. Moreover, the surety bond insures that the project owner will not be liable for a contractor’s default.