16.1 Surety and Fidelity Bonds

Surety Bonds vs. Insurance

A surety bond is a three-party agreement, not a two-party insurance contract. The three parties are the principal (the party required to perform), the obligee (the party protected and who requires the bond), and the surety (the company guaranteeing performance).

If the principal fails to perform, the surety pays the obligee but then seeks reimbursement (subrogation/indemnity) from the principal. This is the defining exam trap: unlike insurance, where the carrier absorbs the loss, in suretyship the principal ultimately repays the surety. Premiums are underwritten as a service fee for the guarantee, not as a fund expected to pay losses.

Because the surety expects full recovery, underwriting focuses on the principal's character, capacity, and capital (the "three Cs"). Surety loss ratios are intentionally low; rates assume near-zero net loss. The bond also states a penal sum - the maximum dollar amount the surety will pay - which on contract bonds usually equals the contract price. The principal signs a general indemnity agreement at bonding, and on construction bonds individual owners often sign personal indemnity, so the surety can pursue both business and personal assets after a default.

Major Surety Bond Categories

The national P&C exam tests four broad families of surety bonds:

Within contract bonds, three sub-bonds appear repeatedly on exams:

• Bid bond - guarantees the bidder will enter the contract at the bid price and furnish required performance/payment bonds if awarded; the obligee can collect the difference if the low bidder backs out.
• Performance bond - guarantees the contractor completes the job per specifications and contract terms.
• Payment bond (also called a labor-and-material bond) - guarantees subcontractors and suppliers are paid, protecting the owner from mechanics' liens.

Among the other families, license & permit bonds are the most common small-business bonds: a contractor, auto dealer, or mortgage broker posts a bond as a condition of licensure, guaranteeing it will follow the governing statute. Public official bonds guarantee the honest, faithful performance of treasurers, sheriffs, and notaries.

Judicial bonds divide into litigation bonds (appeal, attachment, injunction) and fiduciary bonds (administrator, executor, guardian) ensuring a court-appointed party performs its duties. A useful exam contrast: surety bonds cannot be cancelled by the surety the way insurance can - the surety remains on the risk until the bonded obligation is discharged or released by the obligee.

Fidelity Bonds and Commercial Crime

Fidelity bonds protect an employer against loss from dishonest acts of its own employees - theft, embezzlement, forgery. They are technically two-party (insured employer and surety) and behave more like insurance because the surety does not expect recovery from the dishonest employee. On modern exams, fidelity coverage is delivered through the ISO Commercial Crime program, most often the Commercial Crime Coverage Form CR 00 20 (loss-sustained form) or CR 00 21 (discovery form).

The two trigger forms are a classic exam distinction:

• Discovery form - covers loss discovered during the policy period, regardless of when the act occurred.
• Loss-sustained form - covers loss occurring during the policy period and discovered during the period or within a specified extended discovery window (often one year).

Key Commercial Crime Insuring Agreements

The Commercial Crime form is built from separately-scheduled insuring agreements. Memorize these for the exam:

1. Employee Theft - dishonesty by employees (the fidelity core).
2. Forgery or Alteration - of checks, drafts, promissory notes.
3. Inside the Premises - Theft of Money and Securities.
4. Inside the Premises - Robbery or Safe Burglary of other property.
5. Outside the Premises - money/securities in the care of a messenger.
6. Computer Fraud and 7. Funds Transfer Fraud.
7. Money Orders and Counterfeit Money.

Trap: A loss caused by an owner or partner's own dishonesty is excluded under Employee Theft - the policy protects the entity from employees, not principals from themselves. Also note crime forms typically pay actual cash value (ACV) or replacement of money/securities up to the scheduled limit, with no coinsurance.

Two more crime-form distinctions are tested. Robbery requires the taking of property by force or threat of force from a person, while burglary requires unlawful entry evidenced by visible signs of forced entry - simply finding property missing (mysterious disappearance) does not meet the burglary definition. Theft is the broadest term, covering any act of stealing.

Finally, separate financial institution bonds (such as the Financial Institution Bond, Standard Form No. 24) are used by banks instead of the commercial crime form, because banks have unique exposures like cash-letter and trading losses.

The Three-Party Surety Relationship

A surety bond involves three parties: the principal (who must perform), the obligee (who is protected), and the surety (who guarantees performance). Unlike insurance, the surety expects no losses and, after paying the obligee, has a right of reimbursement (indemnity) against the principal. So a surety loss is effectively an extension of credit, not a transferred risk — the defining surety-vs-insurance distinction.

Fidelity Bonds vs. Surety Bonds

Fidelity is two-party (employer + insurer) and behaves like insurance; surety is three-party with reimbursement. The exam frequently asks which protects an employer from a dishonest bookkeeper — the answer is a fidelity bond / employee-dishonesty crime coverage.