Construction Insurance vs. Surety Bond: What’s the Difference?
Whether you are a construction contractor or run a construction company with many employees, you’re probably wondering what’s the difference between a contractor bond vs insurance and why you need to provide proof of both documents. Both documents prove that you run a responsible business and pose no financial risk to the people who hire you.
You may be wondering: contractor bond vs insurance—which do I need for my business? The answer is—both.
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A report by Arcadis indicates that the average cost of a construction dispute in North America in 2020 was a stunning $37.9 million, and the average dispute length was 14.2 months. Common lawsuits against construction companies claim negligence, breach of contract, or potential employee misclassification to avoid paying employee benefits.
All these lawsuits can end up being very costly when legal fees pile up. You would need all the support you can get to save your business from losing a substantial amount of money or even going bankrupt. Insurance can provide a financial safety net, so your company doesn’t have to defend a claim and pay for everything on its own.
What is Construction Insurance, and What Policies Do You Need?
Now that we know how vital it is to insure your construction business, let’s see what construction insurance actually is. Construction insurance is a term for all insurance policies you should consider purchasing to protect your business.
Your insurer should work with you to design coverage for your specific exposures. Knowing that your insurance would respond to lawsuits and similar events that could financially damage your company should give you some security and peace of mind.
It’s important to note that every policy is customizable to your particular needs and risk exposures, so you shouldn’t have too much trouble finding the right coverage for your business.
These are the policies every construction business owner should consider buying for their business:
General Liability Insurance
This policy provides coverage for third-party bodily injuries or property damage. A general liability insurance policy would respond if somebody (other than your employees) gets injured at one of your construction sites and consequently files a claim against you.
Also, it is possible that you accidentally damage the property you are renovating. This policy could cover the cost of repairing or replacing the broken third-party property.
Commercial Property Insurance
Your property also needs coverage in case of any damages. Commercial property insurance covers your tools, supplies, workrooms on-site, and your office space, if you use any.
If your policy covers the event that damages your property, your insurance provider will pay the insured value of damaged items. If you rent the equipment you use for work, you might want to consider extending your coverage to those items, too.
BOP
A business owners policy (BOP) binds general liability and property insurance into one bundled package. A BOP is a good solution for small business owners whose business doesn’t have some specific, prominent risks as it costs less than it would cost to buy separate policies.
A BOP typically also includes a business interruption policy that covers your business expenses if you have to abort your operations temporarily.
Inland Marine Insurance
This term could be a bit misleading, but don’t let it confuse you into thinking it has something to do with the sea. Inland marine insurance covers products, tools, equipment, and materials when transported overland or temporarily stored in a third-party’s warehouse. It also covers specialized high-value assets that property insurance couldn’t cover.
The most common threats this policy covers include collisions or equipment thefts. However, it doesn’t cover the damages inflicted by natural disasters, such as earthquakes or floods.
Builders Risk Insurance
Also referred to as “course of construction” insurance, builders risk insurance protects against damage or loss to buildings being built or renovated. If the property you are working on gets damaged by natural forces, such as wind, fire, or storm, this policy will cover the damage.
It would also cover the theft of construction materials or temporary structures from the site.
Workers Compensation
As the only state-mandated coverage, workers comp insurance is essential for every construction company. It covers medical bills, rehabilitation, and wage losses for employees that get injured or ill on the job.
In case of an unfortunate event with a fatal outcome, workers compensation would pay out the death benefits to the employee’s family.
How Does Construction Insurance Work?
Every insurance policy represents a contract between you, the insured, and the insurer. It defines the terms of your insurance coverage, your policy limits, and if your policy has a deductible. Your insurance policies provide a financial safeguard in case of a claim against your company for a monthly or annual premium you pay your insurer.
Your insurance policies respond to events stipulated in their coverage terms. If your company suffers a lawsuit over a matter covered by one of your policies, you need to file a claim with your insurer.
Most insurance policies have a “duty to defend” clause, meaning that your insurer provides legal representation for you during the whole lawsuit process. Your insurer also covers any potential settlements or court-awarded damages.
Note that if your policy has a deductible, you are responsible for paying the amount you agreed on when signing a contract with your insurer.
What Is a Surety Bond?
A surety bond protects the third party who hires your company to perform a job or a service for them. Some businesses require a construction company to be bonded (purchase a surety bond) in order to do business with them. Having a surety bond proves that you are compliant with the laws and regulations and that your company is a safe and responsible business partner.
All states require that you purchase mandated surety bonds to obtain your licenses and permits. A surety bond doesn’t protect your business but the parties you work with from your potential dishonesty or poor service or performance.
Suppose that, for some reason, you abandon a project halfway through, and your client doesn’t get what they hired and paid you to do. That’s when a surety bond kicks in to pay out the amount your clients need to hire someone else to finish what you started.
How Does a Surety Bond Work?
A surety bond is a unique type of insurance contract. It is agreed on and signed among three parties:
Principal: The principal is the party that purchases the surety bond under the obligation to deliver its services as agreed in the contract. In this case, the principal is you and your construction business.
Surety provider: This is the insurance or surety underwriter who guarantees that you will meet your end of the deal and fulfill all your contractual obligations. If you fail to perform the promised services, the surety provider covers the losses the other party suffers.
Obligee: An obligee is a person, business, or organization that hires your company. They are the beneficiary of the surety bond you obtain with the surety provider.
The principal and the surety provider agree on the amount a surety bond covers, and the principal then pays the insurer a certain percentage of the bond’s value. The principal’s bond premium is usually 1-3% of the total cost, depending on the risk you pose to the insurer.
You can expect that the insurer will look closely into your business and yourself before providing a surety bond. If your credit score is bad, you can expect to pay a higher premium to obtain your bond.
Contractor Bond vs Insurance: How Are They Different?
We already mentioned some of the differences when explaining the coverages, but let’s repeat them to sum everything up.
Construction insurance is a contract between the insurer and the insured, whereas a surety bond is an agreement between three parties: principal, obligee, and surety provider. Also, insurance protects the insured, and a bond protects the obligee.
Another substantial difference is that you file an insurance claim if an event happens that your insurance policy will cover. If a surety bond needs to be triggered, it’s the obligee that files the claim with the surety provider. The surety then investigates the claim, and if they deem it viable, they pay out the cost of the claim.
If construction insurance covered the claim, that’s where the case would end for you. The insurer takes the financial burden of the claim off your back, and if you don’t have that small deductible that you would need to pay, you probably won’t have to pay much of the claim costs. However, you can expect your insurance premium to be higher at the next policy renewal.
When a surety covers the claim, that works like a credit you take out from a bank. The surety will pay out the total amount of the claim, but you will need to reimburse them. You will need to pay back the full amount the surety covered for you.
Just like with every other line of insurance, many factors influence the cost of your construction insurance and surety bonds. Both insurance and surety providers start by evaluating the amount of risk your business faces.
The insurer will look into the industry you are in, the size of your company, the location where your business operates, your claims history, and policy limits.
The surety provider will calculate your premium based on the type and size of your bond. Some types of bonds carry more risk than others, and they are more likely to be claimed against, making them more expensive to purchase.
The same way a company with no claims history is a smaller risk for the insurer, a business owner with a better credit rating is considered a lower risk for the surety provider. Vice versa, if the principal has a poor credit score, they can expect to pay more in premium, which can sometimes be even up to 20% of the bond.
Clients prefer working with companies or contractors that carry insurance and surety bonds, which prove they run a financially responsible business.
If you still don’t have your construction insurance policies in place, or you think you might be underinsured, you can always talk to one of our experienced brokers. If you are ready to get your online quotes, you can start by signing up on Embroker’s digital platform.
