Thinking about building a book of surety business? As an insurance agent, you’ll want to understand how the surety claims process differs from the insurance claims process. You’ll also want to share this post with your small business owner clients who may find bonding to be as intimidating as they find insurance. With your help, they can understand what protections they need and how any claims will proceed.
The claims process for surety bonds is considerably different from the process for an insurance claim. One significant distinction is which party is ultimately responsible for payment of a claim.
First, let’s review the difference between insurance and surety bonds. Businesses often require both traditional insurance as well as surety bonds, depending on their industry and details of their operations.
- Insurance is a two-party agreement between the insurance company and the policyholder. The insurance company compensates the insured for a covered loss.
- Surety bonds are a three-party agreement between the principal, the surety (bonding) company and the obligee. The obligee is the party requiring the bond. This party is often a public entity (for example, a state, city, county or local municipality).
Surety bonds can either guarantee compliance or provide financial guarantees. Bonds that guarantee compliance are often written more freely than financial guarantee bonds, which undergo a more conservative process.
There are also variations in the underwriting process for insurance compared with surety bonds. For insurance, underwriting factors depend on the type of insurance policy being written and may include (but are not limited to) items such as age, geographical location, claim history, credit history, as well as coverage and deductible.
Meanwhile, surety underwriting also varies depending on the type of bond that is requested as well as the amount of the bond. The surety underwriter may consider factors including, but again, not limited to, claim history, credit history, financial statements, industry experience, the nature of the risk and language in the bond form.
Surety Claims Process
A key difference between insurance coverage and a surety bond is who is responsible for paying a claim. When an insurance claim is filed and found to be valid, the insurance company is responsible for paying it. But the principal of a surety bond has the primary obligation to the obligee. The principal also has the obligation to reimburse the surety for a claim payment, whether there is a signed indemnity agreement or not.
When a bond is written, the surety may also require a signed indemnity agreement. The indemnity agreement is a legal document setting out the indemnitors’ (usually the principal and the owners and spouses of the principal) obligations to the surety should there be a loss under the bond, as well as any expenses. The indemnity agreement is intended to allow the surety to recover any losses and or expenses paid out on behalf of a principal if the principal does not fulfill its obligations under the bond agreement.
Related: The ABCs of Surety Bonds
If an indemnity agreement is signed, the surety has another theory to seek recovery. That theory is based on contractual obligations arising out of the indemnity agreement. The indemnity agreement usually gives the surety the right to seek reimbursement against the signatories to the indemnity agreement for costs and expenses resulting from the issuance of the bond — such as attorney fees and or consultant expenses. The indemnity agreement gives the surety other contractual rights as well.
When a surety claim is made, there is an investigation into the merits of the claim. If, based on the documentation submitted by both the claimant and the principal, the surety finds that the claim is not valid or legitimate, payment will not be made to the claimant; however, the surety may still incur expenses. If the claim is found to be valid and is paid out, the surety company expects the principal to reimburse the surety for the paid claim and possibly other expenses incurred.
Why The Claims Process Differs for Fidelity Bonds
Surety companies also write fidelity bonds, which are technically insurance products as they are two-party agreements between a principal and the bonding company.
Employee fidelity bonds provide protection to an employer from employee theft, either internal or external, depending on the specifics of the fidelity bond issued.
The fidelity bond underwriter often asks questions intended to verify that a business has certain or specific controls in place. Underwriters may inquire about items or practices such as the following:
- Separation of duties
- Regular audits
- Countersigning checks
- Hiring practices such as background and reference checks
Some fidelity bonds contain a conviction clause, meaning that the employee named or deemed at fault must first be convicted (loss payment limited to the amount of restitution ordered) before a claim will be paid.
Any company that has employees can consider fidelity bonds. Some common businesses that request business services bonds include janitorial service companies, contractors, pet sitters, and home health services.
Another common type of fidelity bond is an ERISA (Employee Retirement Income Security Act) bond. This type of bond protects retirement and pension plan assets from fraud or dishonesty by persons who handle plan funds.
Old Republic Surety offers various types of bonds, including contract bonds, commercial bonds, and fidelity bonds for different businesses, organizations, and industries. If you have any questions about anything related to surety or fidelity bonds, please contact your nearest local Old Republic Surety branch.
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