A surety bond is not an insurance policy although there is a substantive similarity in that there is a promise of indemnity for one of the parties involved. An insurance policy is a bipartite arrangement where the insured pays a premium to the insurance company and receives the benefits of the policy in the event of a loss. On the other hand, there are three parties involved in a bond – the principal (the bonded party), the bond company, and the creditor (the party in whose favor the bond is issued). As far as the premium is concerned, it is generally the principal who assumes it, although there are occasions when the creditor pays it.
Under the surety laws, the principal is required to reimburse the surety company for any loss that the surety company may suffer as a result of the performance of the bond. Thus, the Principal is required to sign an Indemnification Agreement or a counter-guarantee in favor of the surety company before the surety is released in favor of the Bondholder.
When taking out a surety bond, the guarantor takes into account the personality, personal situation and resources of the principal and, depending on the nature of the bond obligation, he would also require an adequate guarantee in the form of guarantees such as only real estate, stocks and other securities or the signing of creditworthy guarantors.
The primary purpose of the surety company, at least theoretically, is not to pay losses but to render a service to worthy natural or legal persons whose business requires the guarantee of a surety or surety company. This is the big difference between a bond and an insurance policy. In addition, in insurance, the insurer can terminate the policy with due notice to the insured plus a reimbursement premium for the unexpired period of the policy while in bonds, many bonds cannot be canceled at all unless there is concrete evidence that the bond obligation has been fulfilled. The duration of a surety bond therefore depends on the performance of its obligation or its expiry date, if there is one.
Contractors who bid on and win large construction projects typically post performance bonds to ensure their satisfactory completion. This is just one example of the important role of bonding in business.
The author is a risk management consultant and editor of Insurance Philippines magazine.