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Surety Bond Basics

What is a Surety Bond?

A surety bond is a written agreement providing for monetary compensation to be paid by the surety company should there be a failure by the person bonded to perform specified acts within a stated period.

What is Surety?

Surety is a specialized line of insurance where one party agrees to be responsible for the debt or obligation of another party.

There are three parties to this agreement:

  1. The principal is the party that undertakes the obligation and who is primarily bound on a bond.
  2. The surety company guarantees that the obligation will be performed.
  3. The obligee is the party who receives the benefit of the bond. The bond protects the obligee from loss.

What are the differences between surety and the common lines of insurance?

With traditional insurance products:

  • The risk is transferred to the insurance company.
  • The insurance company takes into consideration that a certain amount of the premium for the policy will be paid out in losses.
  • The goal is to spread the risk.

With surety:

  • The risk always remains with the principal. The obligee receives the benefit and protection of the bond.
  • The premiums paid are charged for the use of the surety company’s financial backing and guarantee.
  • Surety professionals view their underwriting as a form of credit so the emphasis is on prequalification and selection.

What is the basic information that a surety uses to underwrite?

The surety needs to determine if the applicant has the following:

  • Capacity: The applicant must have the skill and ability to perform the obligation.
  • Capital: The applicant’s financial condition must justify approval of the particular risk.
  • Character: The applicant’s record must show him or her to be of good character and likely to perform the obligation that he or she assumes.
Apply for your mortgage license bond online.

Common Surety Terms and Usage

Aggregate Liability Clause: A clause in a surety bond which limits the surety’s liability to the bond penalty regardless of the number of claims made against the bond.

Annual Bond: A bond which expires by its own terms in one year. If bond coverage is needed for a longer period, a new bond or a continuation certificate must be issued.

Application: A questionnaire which must be completed, when required, by an applicant for a fidelity or surety bond. It gives the company information about the applicant. On a surety bond, it also contains the applicant’s agreement to indemnify the surety in the event of loss, as well as the applicant’s promise to pay the premium.

Attorney-In-Fact: The holder of a Power of Attorney granted by a surety company empowering the execution of a surety bond on behalf of the company. An Attorney-In-Fact sometimes called “Agent,” “Attorney,” “Resident Vice=President,” or “Resident Assistant Secretary,” depending upon the usage of the surety company granting the Power of Attorney.

Bond: A written agreement whereby one party, called the surety, obligates itself to a second party, called the obligee to answer for the default of a third party, called the principal (or sometimes called the obligor).

Cancellation Clause: A clause in a bond which terminates the surety’s future liability.

Collateral: Anything of value pledged with the surety to protect the surety against loss by reason of default of the principal.

Commissioner of Insurance: The official charged with enforcement of the laws pertaining to insurance in his or her state. In some jurisdictions this official is called the Superintendent or Director of Insurance.

Continuous Bond: A bond which remains in force and effect until cancelled.

Corporate Surety: A corporation licensed under various insurance laws, which under its charter has legal power to act as surety for others.

Co-Surety: An arrangement where two or more surety companies directly participate on a bond.

Countersignature: A signature of licensed domiciled agent or representative required by the laws of some states in order to validate a bond.

Cumulative Liability: The aggregate amount recoverable under two or more bonds on behalf of the same principal filed in succession, where the succeeding bond(s) do(es) not extinguish the liability under the prior bond(s).

Earned Premium: The premium amount which would compensate the surety for the protection furnished for the expired portion of the bond term.

Effective Date: The date from which coverage is provided.

Expiration Date: The date upon which a bond or policy will cease to provide coverage.

Financial Statement: The financial presentation including the balance sheet, statement of earnings and other disclosures which the surety requires of an applicant for a bond, setting forth its financial position as of a given time or period.

Forfeiture Bond: A bond where the full penalty is payable upon breach of the condition regardless of the actual amount of loss or damage sustained by the obligee.

Home Office: The place where a surety company maintains its executive and general supervisory departments.

Indemnify: An agreement whereby the principal and/or others agree to make reimbursement to the surety for any loss the surety may incur under the bond.

Indemnitor: One who enters into an agreement with a surety company to hold the surety harmless from any loss or expense it may sustain or incur on a bond issued on behalf of the indemnitor or another.

Insurance Commissioner: See: Commissioner of Insurance.

Joint Control: A written agreement between a fiduciary and a surety, acknowledged by the bank in which funds are deposited or securities lodged so that the funds or securities are controlled by both parties. Usually all checks are required to be signed by the fiduciary and countersigned by an authorized representative of the surety. Access to the securities is possible only in the presence of an authorized representative of the surety.

Liability: This is a broad term denoting any legally enforceable obligation.

Limit of Liability: The maximum amount which a surety company will pay in case of loss. Sometimes called the bond penalty or penal sum.

Minimum Premium: The least amount a surety company will charge for a particular bond for a designated period.

Obligee: The party to whom a bond is given. The party protected by the bond against loss. An obligee may be a person, form, corporation, government or a government agency.

Obligor: Usually called the principal, or one bound by the obligation.

Penal Sum: See: Limit of Liability.

Personal Surety: An individual who acts as surety for another, who may or may not charge a fee for his or her guarantee. Unlike corporate sureties, which are closely regulated and licensed, personal sureties are generally not subject to any government regulation or licensing requirements.

Power of Attorney: The authority given to a person or corporation to act for and obligate another, to the extent set forth in the instrument creating the power. See Attorney-In-Fact.

Premium: The fee to be paid for the bond. The cost of the bond.

Principal: The one who is primarily bound on a bond furnished by a surety company. For example, in a contract bond, the principal is the contractor, n a public official bond, the principal is the public official; in a fiduciary bond, the principal is thee administrator, executor, or guardian; in a license bond, the principal is the one to whom the license is issued. Sometimes the principal is called the obligor.

Pro Rata Cancellation: Cancellation of a fidelity bond or policy before the end of the bond or policy term, where the return premium is the full unearned premium. Distinguished from short rate cancellation.

Rate: The cost of a unit of bond coverage.

Recovery: Reimbursement received by a surety following a loss from a reinsurer, or by subrogation, or from salvage.

Reinsurance: An agreement whereby the original insurer arranges to pads on all or part of the risk to another insurer, known as the reinsurer, in consideration of a premium paid to the reinsurer. The original insurer may be referred to as the primary insurer, the reinsured, or the ceding company. The amount of liability retained by the original insurer is commonly called the retention or net line.

Rider: A printed or manuscripted form attached to a bond to add to, alter or vary the bond’s provisions.

Salvage: That which is recovered from the principal or an indemnitor to offset in whole or in part the loss and expense incurred by a surety in satisfying obligations it has sustained under a bond.

Short Rate Cancellation: Cancellation of a fidelity bond or policy by the insured, before the end of the bond or policy term, where the return premium is the unearned premium less and expense charge.

Subrogation: The legal or equitable process by which a surety company obtains from a third party recovery of an amount paid out by the surety to the obligee or a claimant under the bond.

Surety Association of America: An unincorporated, non-profit association supported by insurance companies which are engaged in the business of writing Fidelity, Forgery and Surety bonds. It establishes classification of risks, develops advisory rates, creates standard bond forms and riders, collects and analyzes statistical data, makes filings with regulatory authorities on behalf of those members which authorize it to do so and performs other functions for the benefit of its member and the surety industry.

Surety Bond: A written agreement providing for monetary compensation to be paid by the surety should there be a failure by the person bonded to perform specified acts within a stated period.

Suretyship: Refers to obligations to pay the debts of, or answer for, the default or miscarriage of another. It is a legal relationship based upon a written contract in which one person or corporation (the surety) undertakes to answer to another (the obligee) for the debt, default or miscarriage of a third person (the principal) resulting from the third person’s failure to pay or perform as required by an underlying contract, permit, ordinance, law, rule or regulation.

Term: The period of time for which a bond is issued.

Treasury List: To be an acceptable surety on bonds in favor of the United States, the surety must qualify financially under regulations of the Treasury Department. The department annually issues a list of companies so qualified, the underwriting limit of each, the states in which each is licensed and other data. The underwriting limit is frequently referred to as the qualifying power, which is equal to 10% of the capital and surplus of the surety.

Underwriter: An officer or employee of a surety company who has the responsibility for accepting or rejecting risks.

Unearned Premium: That part of the premium which has not yet been earned by the surety for the unexpired portion of the term of the bond.

Apply for your mortgage license bond online.