Surety bond basics - Commercial surety versus contract surety
By Erle Benton, AVP, Surety Contract Underwriting, UFG Surety
If you're new to the world of surety bonds, you've probably come across a lot of unfamiliar terms and concepts. Don't worry. We're taking it back to the basics by explaining the two main types of surety bonds and the key differences that determine their use in today’s market.
To start off, every surety bond serves an important purpose but not all surety bonds are the same. There are two primary categories of surety bonds: commercial surety and contract surety. Understanding these two categories is an important first step in the bonding process.
What are commercial surety bonds?
- License and permit bonds: ensure the principal complies and/or fulfills the statutory obligations with state or local authorities (i.e. obligee).
- Court bonds: address faithful performance or payment of court costs.
- Fiduciary bonds: protect parties when someone is appointed by the court to manage an estate, trust or financial responsibility.
- Public official and notary bonds: required by the law and designed to protect the government entity and the public against any wrongdoing.
What are contract surety bonds?
- Bid bonds: ensure the contractor will enter into the proposed contract and provide the required performance, payment and maintenance bonds should they be awarded the contract. If not, the obligee may be compensated for the difference between the contractor's bid and the next qualified bidder's bid, up to the amount covered by the bid bond. The bid bond amount is typically stated as a percentage of the contractor's bid amount.
- Performance bonds: guarantee the principal will fulfill the obligations contained in the contract as well as all the plans and specifications used in the bidding process.
- Payment bonds: ensure subcontractors, suppliers and laborers are paid for their work and materials on a construction project.
- Maintenance/warranty bonds: guarantee workmanship for a defined period of time.
Related reading: The difference between bid bonds and payment bonds | UFG Insurance
Key differences between commercial surety and contract surety
While commercial surety and contract surety products both provide a financial safety net, they differ in terms, underwriting, rates and more.
| Commercial | Contract | |
|---|---|---|
| Term | Annually or until fulfilled | Duration of the contract |
| Underwriting | Credit and/or financials | Performance and financials |
| Cancellation | Typically, allowed; unless release is required by the obligee | Cannot be cancelled |
| Rates | Typically, a flat rate per $1,000 | Normally a graded scale |
| Governance | Statutory law | Common (court) law |
How do surety bond companies use these products in the market today?
Commercial surety bonds are primarily used to satisfy legal, contractual and regulatory requirements while contract surety bonds are associated with traditional “sticks-and-bricks” construction projects.
However, as industries have evolved, some surety companies are expanding the use of commercial surety bonds to nontraditional construction projects, such as solar farms, computer programming and waste incineration. The benefit is allowing a flat percentage rate for these projects, but it does blur the distinction between commercial surety and contract surety bonds.
A relatively new application of commercial surety bonds involves using them as a financial instrument. Instead of providing collateral to the bank, businesses can provide some lending institutions a commercial surety bond guaranteeing the bank will be repaid if the principal defaults. This approach allows principals to leverage their creditworthiness and leave business assets unencumbered.
Whether a bond is classified as commercial or contract surety, its purpose remains the same: providing confidence that obligations will be met. Understanding the differences between these two categories can help identify the best solution for your specific needs. It is important to have a conversation with your surety underwriter about risk appetite to determine if their commercial surety or contract surety operation would handle your bond request.
At UFG Surety, we’re proud to support the commercial and contract surety bond needs of agents, contractors and businesses across the country, helping customers navigate the bonding process with confidence. From single bonds to large bonded programs, turn to our surety team for responsive, trusted and knowledgeable expertise and collaborative solutions to get the job done.