16.1 Surety and Fidelity Bonds
Key Takeaways
- Surety is a three-party guarantee (principal, obligee, surety); fidelity is two-party insurance protecting the named insured against employee dishonesty.
- Surety expects zero losses and seeks indemnity from the principal; a paid surety claim becomes a debt the principal must repay, unlike a true insurance loss.
- Contract bonds (bid, performance, payment) and license/permit bonds are the most heavily tested surety types; penal sum caps the surety's total exposure.
- The ISO Commercial Crime program (CR 00 20 loss-sustained / CR 00 21 discovery) writes employee theft and other crime coverages on per-loss or per-employee limits.
- Fidelity (employee dishonesty) covers loss from employee theft; commercial crime adds forgery, computer fraud, funds transfer fraud, money/securities, and robbery/safe burglary.
Surety: A Three-Party Guarantee, Not Insurance
A surety bond is a written guarantee involving three parties, and the exam tests the roles relentlessly:
- Principal - the party who must perform an obligation (the contractor, the licensee).
- Obligee - the party protected by the bond and to whom performance is owed (the project owner, the state agency).
- Surety - the company that guarantees the principal will perform; if the principal defaults, the surety makes the obligee whole.
Quick Answer: In surety the party who BUYS the bond (the principal) is NOT the party protected (the obligee). That inversion is the single most common surety exam trap.
Unlike insurance, surety expects zero losses. The premium is a service/credit charge, not a pooled-risk premium. When a surety pays an obligee, it then pursues the principal for full indemnity under the general indemnity agreement signed at underwriting. A paid surety claim is therefore effectively a loan the principal must repay - the opposite of a true first-party insurance recovery.
Contract (Construction) Bonds
Contract bonds guarantee performance of a construction or supply contract. Three are tested as a set, often on a single public project:
| Bond | Guarantees | Typical Penal Sum |
|---|---|---|
| Bid bond | Winning bidder will enter the contract and post final bonds | 5-20% of bid (often 10%) |
| Performance bond | Contractor will complete the work per the contract | Up to 100% of contract price |
| Payment bond | Subcontractors/suppliers/labor will be paid (Miller Act on federal jobs) | Up to 100% of contract price |
The penal sum is the maximum the surety will pay; it caps total exposure regardless of actual damages.
Worked numeric. A contractor bids $2,000,000 on a state job with a 10% bid bond. He wins but refuses to sign. The re-bid awards the work to the next bidder at $2,150,000. The owner's damage is the $150,000 excess cost. The bid bond's penal sum is 10% x $2,000,000 = $200,000, so the full $150,000 is recoverable (it is below the cap). The surety pays the obligee $150,000, then seeks the entire $150,000 back from the principal.
License, Permit, and Other Surety Bonds
- License and permit bonds - required by a government before issuing a license (contractors, motor-vehicle dealers, mortgage brokers). They guarantee the licensee will comply with the statute or ordinance; the public/regulator is the obligee.
- Public official bonds - guarantee honest, faithful performance of an elected or appointed official.
- Judicial / court bonds - fiduciary bonds (administrators, guardians, executors) and litigation bonds (appeal, attachment, bail).
- Miller Act - on federal construction contracts over $100,000, both performance and payment bonds are mandatory; subcontractors look to the payment bond, not a mechanic's lien, because you cannot lien federal property.
Trap: A license/permit bond protects the public or regulator, never the licensee who buys it. Students who think the bond "protects the contractor's business" mark the wrong answer.
On a public construction project, which party is protected by a performance bond?
Fidelity Bonds and the ISO Commercial Crime Program
A fidelity bond is true insurance protecting an employer against loss from dishonest acts of its own employees (embezzlement, theft of money or property). It is two-party: the insurer and the named insured. There is no obligee, and there is no indemnity recovery from the wrongdoer expected as part of the premium model.
Modern fidelity coverage lives inside the ISO Commercial Crime program, written two ways:
- CR 00 20 - Loss Sustained form: covers loss discovered during the policy period that occurred during the policy period (or prior, if continuous coverage existed). Includes a one-year extended discovery period after expiration.
- CR 00 21 - Discovery form: covers loss discovered during the policy period (or within 60 days after), regardless of when it occurred - the broader trigger.
Trigger trap: "Discovery" pays on when the loss is found; "loss sustained" pays on when the loss happened. Match the trigger word to the form.
Crime Insuring Agreements You Must Know
The Commercial Crime form is a menu of insuring agreements; the insured schedules limits per agreement:
| Insuring Agreement | What It Covers |
|---|---|
| Employee Theft | Loss of money, securities, or property by employee dishonesty |
| Forgery or Alteration | Forged checks, drafts, promissory notes |
| Inside the Premises - Money & Securities | Theft, disappearance, destruction on premises |
| Inside the Premises - Robbery/Safe Burglary | Robbery of a custodian; safe burglary of other property |
| Outside the Premises | Money/securities in a messenger's care off-site |
| Computer Fraud | Fraudulent transfer of property via computer |
| Funds Transfer Fraud | Fraudulent electronic/telephonic transfer instructions |
| Money Orders & Counterfeit Money | Loss from accepting bad money orders/counterfeit currency |
Employee theft can be written per loss (one limit per occurrence regardless of how many employees) or per employee (a separate limit applies to each identified dishonest employee), a frequent distractor on the exam.
Worked numeric. A firm carries a $50,000 per-loss Employee Theft limit. Two employees colluded to steal $80,000 in one scheme. On a per-loss basis the recovery is capped at $50,000 (one loss, one limit). Had the policy been written per employee at $50,000 each, the limit available would be $100,000 and the full $80,000 would be paid.
What is the fundamental difference between surety and fidelity coverage?