3 Major Differences Between a Bond and an Insurance Policy
June 20, 2016 | By Kelly Mansfield |
Bonds are often required for a contractor to obtain licensing or to meet the obligations of a contract. I find that there is often confusion on how bonds differ from insurance policies. While bonds are technically a form of insurance, there are significant differences between bonds and insurance policies and bonds should not be purchased in place of liability insurance. Here are 3 major differences between a bond and an insurance policy;
1. Parties involved in the contract. There are three parties involved in the bond contract. The first party is the company requesting the bond, referred to as the principal. The second party is the customer, referred to as the obligee. And the third party is the surety company. The obligee transfers the risk to the surety company that the principal will not fulfill their contractual duties.
In contrast, there are only two parties involved with an insurance policy; the insurance company and the business purchasing the coverage, the insured. When the insured causes bodily injury or property damage to a third party, the insurance company pays the damages.
2. Financial restoration after a loss. Losses are not expected to occur when a surety bond is issued. However, if a loss occurs, the principal is expected to fully restore the surety company for any financial loss incurred. Before a bond is issued, the underwriter requires proof that the principal has the financial means to reimburse the surety company should a loss occur. Thus, a bond acts like a line of credit for the principal.
On the other hand, an insurance policy does not require that the insured restore the insurance company after a loss occurs. The insured pays premiums in exchange for the coverage provided. The insured may be responsible for a deductible in the event of a loss, but does not have to reimburse the insurance company for the full loss incurred. The risk of financial loss is transferred from the insured to the insurance company.
3. Premiums and/or fees paid for the coverage. When a surety bond is issued, a premium or service fee is paid by the principal to the surety company. The service fee allows the principal to use the financial backing of the surety company. If there is a loss, the surety company pays for the loss, but requires the principal to reimburse all funds that have been paid out.
In contrast, a premium is paid by the insured to the insurance company for an insurance policy. In return, the insurance company promises to protect the insured from financial loss. The insurance company determines the premium charged for losses that are expected to occur based on the insured’s operations, characteristics, and history.
In summary, while bonds are useful for providing protection for a customer and may be required for some contracts, it is important to understand the key differences between a bond and an insurance policy.
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