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What does a Surety Company do?

By C. Mitchell
Updated May 16, 2024
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In many long-term contracts, particularly those for construction projects and corporate financing, parties often want assurance that the bargain will be lived up to before they are willing to commit their time and resources. A surety company is a company that acts as a sort of insurance agent for these kinds of contracts. In most instances, the party who is bearing the brunt of the contract’s obligations — the construction company, for instance, or the financier — will secure what is known as a surety bond before finalizing a contract. Surety bonds are financial instruments that guarantee performance of contracted goods and services. A company that issues a surety bond assumes responsibility for the contract if the bond holder defaults.

Surety bonds are a very common way of insuring contracts. Most of the time, entities like cities and municipalities will not enter into contracts with contractors like construction companies unless the contractors have retained the services of a surety company. It is usually too risky for a city to sink resources into starting road work, for instance, or beginning construction on a bridge or building, only to have the construction company default or go bankrupt before completion. When a company has a surety bond, the city knows it can recoup its losses if a worst-case scenario were to happen.

The services of a surety company are not always easy to procure. When a surety company issues a surety bond, it accepts liability for any default, which usually comes at quite a cost. A surety bond agency will typically begin by assessing the risk of contract default, and the potential costs of that default over time. Then, it will set a premium rate that the contracting party must pay, usually on an annual or monthly basis. A surety premium works a lot like an insurance premium in that the bondholder pays the premium in order to secure the bond company’s indemnity and surety bond performance.

Working with contractors, surety companies set premiums that will be fair and achievable. Premiums vary based on contractor size, project duration, and available financing, among other things. Sometimes a surety company will also offer other sorts of indemnity services to contractors, including fidelity bonding and general project insurance. The primary goal, however, is to insure the obligation, and to guarantee completion of the contracted project.

A surety company plays a crucial role in many contracts of civic importance. As such, they usually must be licensed by the government in order to operate. Most of the time, it is a state or local government insurance regulators handle surety company oversight and licensing.

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