Surety Bonds vs Fidelity Bonds
Purchasing commercial insurance for your business? Consider buying bonds. Bonds are a form of insurance that can be used to protect your company against damages and losses. There are two major kinds of bonds available for people purchasing business insurance. These are surety bonds and fidelity bonds. One or both could be right for your business. Let’s take a look.
Surety and fidelity bonds are forms of insurance issued by licensed insurance companies and they are used to manage risk and protect against losses and damages in commercial business transactions.Let’s start with taking a closer look with surety bonds.
With surety bonds, a surety, the insurance company, promises to pay one party a certain amount of money should a separate party fail to complete an obligation. Having a surety bond prevents the first party from taking a loss.
Here’s how it works:
A surety bond brings together three parties in a legally binding contract.
The principal is the individual or business that buys the bond as a guarantee of future work performance.
The obligee is the entity requiring the principal to purchase the surety bond.
The surety is the insurance company that backs the bond. A surety will provide a line of credit in case the principal fails to perform a task.
Let’s say the principal fails to complete a job. An obligee can make a claim for losses. If the claim is valid, the insurance company who is acting as the surety will pay reparations but not above the bond limit. Insurance underwriters will then expect the principal to reimburse them for claims paid.
If as principal you fulfill the work task as agreed, no claim will be made on the bond. And you can continue with your professional and work duties. You will however not get a refund for the money you paid for a bond. That money was non-refundable.
Types of Surety Bond Claims
What constitutes a surety bond claim? There are a number of things including not finishing the job on-time, going over a job’s budget and performing faulty or shoddy work.
Not paying subcontractors or suppliers is another cause for a surety bond claim.
How to Make a Surety Bond Claim
Here are the steps you need to make a surety bond claim.
Find out the bond company that bonded the principal. Check for this information in your contract. You also can check with the state licensing board.
Reach out to the bonding company’s claim department.
File your surety bond claim. A letter or supporting documentation may be required.
Maintain contact with the surety, the insurance company.
The surety company will conduct an investigation. If the claim is valid, the surety will give the principal the opportunity to pay the claim. If the principal fails to pay the claim the surety will step in and pay the claim.
The surety will then go to the principal for repayment for satisfying and paying the claim.
Who Uses Surety Bonds?
One example would be a company requiring a surety bond before an independent contractor can begin work on a project. But there are specific industries that use surety bonds.
Construction and environmental industries use these kinds of bonds as do supply and maintenance companies.
Surety bonds help principals, typically small contractors, compete for contracts by reassuring customers that they will complete services or products as promised. Government agencies use surety bonds as well.
How Long Does a Surety Bond Last?
A surety bond usually has a term of one to four years. And some surety bonds are perpetual with no expiration date.
Where Can I Buy a Surety Bond?
Surety bonds are insurance policies and are sold by insurance companies. Most national insurance companies have bond departments that specialize in surety bonds.
So reach out to your insurance company when shopping for surety bonds. You might find a surety bond at the same insurance company where you have your home and auto policies.
Surety bonds are also available from surety bond brokers. These brokers sell surety bonds from multiple insurance companies.
When choosing a provider for a surety bond be sure to look for the bonding license. All surety bond providers are required to have one.
Work with a surety bond provider in choosing the surety bond that is right for your business.
You also will want to consider cost. Shopping around is the best strategy for getting a lower price on a surety bond.
Bond issuers have varying rates and terms for surety bonds that are based on your business’ financial health and your personal credit score.
Many surety providers offer set prices and terms for small business owners and independent contractors.
If the surety provider doesn’t have a set price, the bond’s premium is the percentage of the total bond amount, typically between 1 percent and 15 percent. The percentage you are charged on a surety bond premium is usually based on your personal credit score.
For example, someone with a credit score of 700 or higher would pay 1 percent to 3 percent of the annual bond premium.
Now that we’ve learned quite a bit about surety bonds it is time to take a closer look at fidelity bonds.
Fidelity bonds cover losses caused by dishonest employees, mainly negligence and fraud. A fidelity bond can apply to a specific person or place or it can be applied to the company overall. Fidelity bonds typically deal with commercial or financial issues but they also serve as a means of dealing with dishonest employees.
How Much Do Fidelity Bonds Cost?
The cost of a fidelity bond is determined by your policy limits on the bond, the amount of sensitive information that your company manages and how many employees have access to it affect the cost as well. Policy limits on fidelity bonds vary widely. There are policy limits beginning at $5,000 going all the way up to $10 million. The cost of a fidelity bond increases along with the policy limit. So the higher the policy limit the more you’ll pay for a fidelity bond.
Should I Choose a High or Low Deductible with a Fidelity Bond?
A deductible is the amount the policyholder must pay out of pocket before an insurance company will cover a claim. Choose a low deductible and you’ll pay more for a fidelity bond. Choose a high deductible and you’ll save money in the short term with a lower priced fidelity bond. But you will need to pay more, the higher deductible amount, when filing a claim. So weigh your choices carefully. Choose the deductible that will work for you and your business.
Why a Company Needs a Fidelity Bond
If a company has an employee that commits fraud, the company itself may be exposed to legal or financial penalties. Fidelity bonds are insurance policies that cover the company from these kinds of damages. Insurance companies, banks and brokerages all use fidelity bonds to protect their businesses from fraudulent employees. Fraudulent trading, theft and forgery are all covered by a fidelity bond.
First-party and Third-party Fidelity Bonds
As with surety bonds, fidelity bonds are a form of insurance. You can purchase a first-party or a third-party fidelity bond. With first-party fidelity bonds, businesses are protected from wrongful acts committed by their employees. With third-party fidelity bonds, companies are protected from wrongful acts committed by individuals who are employed on a contract basis.
Companies Use Fidelity Bonds for Risk Management
Fidelity bonds are part of a company’s risk management strategy. With fidelity bonds, companies are protected from fraudulent acts from their employees or independent contractors.
Types of Fidelity Bonds
There are three major types of fidelity bonds. They are business service bonds, standard employee dishonesty bonds, and fidelity bonds for pension plans and 401(k) plans. Let’s look at each.
Business Services Fidelity Bonds
This type of fidelity bond protects against the loss of a customer’s money, equipment, supplies and even their personal belongings. This loss occurs when one of the company’s employees steals and performs other dishonest acts on the customer’s premises. Types of businesses that would benefit from a business services fidelity bond include janitorial services, contractors and dog sitters and house sitters.
Standard Employee Dishonesty Fidelity Bonds
This type of fidelity bond protects your business from financial loss due to fraudulent activities by an employee or even a group of employees. In these cases, an employee may steal money, securities or other property. This type of fidelity bond makes sense for non-profit organizations and professional offices such as accountants, dentists and physicians.
ERISA Fidelity Bonds
The Employee Retirement Income Security Act of 1974 requires trustees of pension plans to have a fidelity bond coverage equal to at least 10 percent of the total plan’s assets. The Pension Protection Act of 2006 increases the maximum bond amount for these bonds to $1 million for retirement plans that hold employer stock or other employee securities. This type of fidelity bond protects the pension plan participants and beneficiaries from dishonest acts of the fiduciaries who handle the employment benefit plans or pension plans, including 401(k) plans.
Surety Bonds vs. Fidelity Bonds
Both surety bonds and fidelity bonds protect your business in different ways. Both make sense as part of a company’s risk management plan. Examine your business. Would a surety bond work best for you? Do you use a lot of contract work in your business and need an added layer of protection that the job gets done right? Or are you more concerned about fraud by an employee? To protect against employee fraud, a fidelity bond makes sense.
Choose your bonds wisely. And reassess your needs each year. Choose the type of bond you want, with the coverage you want and a price you can afford. Don’t forget to take the time to shop around for the best bond deal. Comparison shopping works. Take these steps and you will have the bonds you need for your business.
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