What are Surety Bonds?
The principal is the person who is trying to purchase the bond. The obligee is the person or entity that requires the principal to purchase a surety bond. Lastly, the surety is the carrier that financially backs the guarantee.
While the principal is required pay a bond premium to purchase the surety bond, they do NOT receive financial support from the surety in the event that claim arises. The surety bond itself covers the obligee, or in other words the client of the principal. To further understand this concept, I’ll use a real world example. Let’s say a construction company (the principal) is hired to build a structure for someone (the obligee). If for whatever reason the construction company wasn’t able to finish the job, a claim would arise on their surety bond. In this case, the person/entity that hired the construction company to do the work would receive money to pay someone else (another construction company) to complete the work. The surety would then require the principal to provide the requisite payment for the claim in addition to any legal costs that may arise.
Not everyone that applies for a surety bond will be qualified for one, because underwriters do not want to write bonds in cases where the possibility of a claim arising is highly likely. This is something that differentiates surety bonds from insurance. When dealing with customers, insurance companies come up with premiums/rates assuming that claims will take place in the future, and therefore their rates are adjusted based on the likelihood of such losses actually occurring.