While surety bonds are considered an insurance product, they’re actually very different. Insurance is a two-party contract, while a surety bond is a three-party contract. This post will explain the three parties of a surety bond.
With insurance, the two parties are the insured and the insurance company. If the insured suffers a covered loss, the insurance company pays the insured.
A surety bond, on the other hand, is a three-party obligation. The three parties are:
The 3 Parties of a Surety Bond
- Principal – This is the party required to provide the bond. In a construction project, it is the principal that must qualify for the performance and payment bonds. In other types of bonds, like license and permit bonds, the principal is the party applying for the license or permit.
- Obligee – This is the party requiring the bond. It would be the owner of the construction project that requires bonds. In the case of a license or permit bond, the obligee is almost always a state or a municipality. The bond is in place for the protection of the obligee, not the principal.
- Surety – The Surety is the insurance company. The surety bond is for the protection of the obligee. If the surety has to pay a claim, the surety will look to the principal for reimbursement. Unlike an insurance policy, if the surety has to pay out on a bond it will look to the principal to be made whole.
While an insurance product, a surety bond is underwritten similarly as a loan. To put it simply, the surety is a professional co-signor, guaranteeing the performance of the principal.