Written by Richard Zehr
VP of Operations, Zehr Insurance
Many contractors or construction companies in Ontario will be required to purchase surety bonds when tendering for a private or government project. These bonds range from bid bonds, performance bonds, or labour & materials bonds. A surety bond is purchased in addition to your commercial insurance policy.
What are Bonds and Suretyship?
There are three parties to a surety bond: the principal, the obligee, and the surety.
When discussing contract bonds, the principal will typically be the contractor hired to complete a project. The principal owes their obligation or performance to the obligee. The surety guarantees this obligation.
An obligee to a bond is the project owner. The obligee receives the surety’s guarantee that the principal will fulfill their duties as described in the contract.
The surety is usually an insurance company. The surety underwrites the principal based on a multitude of factors and charges a premium for bonds issued which guarantee duties or obligations to the obligee.
These three parties all sign and are bound by the terms and conditions of the bond. It is important to understand that the surety does not sign the initial project contract between the project owner and the contractor. Upon contract default, the surety’s obligations are laid out in the bond wording and the surety will step into the contractor’s role to either remedy the default, complete the project, or pay the bond penalty to the owner.
Typical insurance policies like home or farm insurance will be between two parties – the insured and the insurance company. In a typical insurance policy, the benefactor of indemnification is the policy holder who is the insured. However, the benefactor of indemnification under a surety bond is the obligee (or project owner) who does not purchase the policy.
Claims Example: The general contractor on a project has stopped paying the subcontractors responsible for installing the heating and cooling system in an apartment building. As a result, the HVAC sub has stopped working on the building which not only delays this portion of the project but all related construction such as final drywalling and painting. The project required the general contractor to purchase a labour & material bond for the project and with the help of the Surety, the situation is remedied and the project continues.
Who is Involved in a Surety Bond?
The role of a producer is important in placing and writing bonds. The relationship between a contractor and their bond producer, typically an insurance broker, must be built on mutual trust. Most insurance policies are underwritten based on physical attributes of a business. Whereas surety bonds are underwritten based on financial and performance history of your business. The role of the producer is to act as a facilitator of information between the client and the surety. The producer must be able to present all relevant data accurately and correctly to the surety on behalf of the contractor. It is therefore vital the contractor trusts the producer with their business and personal financial information.
Defaulting on a bonded project is uncommon but can happen. It is the responsibility of the claims representative to filter through often conflicting information provided by the contractor and the project owner. The financial stability of the project and the contracted businesses is closely tied to the decision of the claims adjuster.
Utilizing the information provided by the client, the underwriter has a duty to the surety and the producer to make decisions related to the approval and issuance of surety bond policies to the client. The underwriter will examine the client’s personal and business financial health, current backlog of projects, success on similar projects, and necessary collateral for the client to support the risk. Again, the relationship between the underwriter, the producer, and the client must be built on mutual trust and respect.
Navigating the underwriting and application process to obtain surety bonds is complex and requires specialized support from trusted relationships at every stage. If your contracting business requires a bid bond, performance bond, or labour & materials bond Zehr Insurance can offer you that support.
To find a commercial insurance broker who can help you as a construction company securing bonds or a project owner requiring insurance, please call us at 800-617-4666.
Call Zehr Insurance brokers and see if we can help you with your insurance needs.