6.4 Surety & Fidelity Bonds

6.4 Surety & Fidelity Bonds

Surety and fidelity bonds are three-party guarantee instruments that differ fundamentally from insurance. They appear in both personal and commercial lines and are tested on the adjuster exam.

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Surety Bonds: Three-Party Indemnity

A surety bond is a three-party agreement guaranteeing that one party will perform an obligation:

• Principal: The party who must perform (the contractor, licensee, or bonded party).
• Obligee: The party protected by the bond (the project owner or government).
• Surety: The company guaranteeing the principal’s performance.

Bond vs. Insurance

Surety Bond Types

• Contract Bonds: Bid bonds, performance bonds, and payment bonds guarantee a contractor’s obligations on a construction project.
• License and Permit Bonds: Required by government to secure a license (electricians, contractors, motor-vehicle dealers).
• Public Official Bonds: Guarantee the faithful performance of elected or appointed officials.
• Judicial (Court) Bonds: Bail, appeal, and fiduciary bonds guarantee appearance or faithful handling of funds.
• Fiduciary Bonds: Guarantee faithful handling of estate/trust funds by executors, guardians, and trustees.

Fidelity Bonds: Employee Dishonesty

A fidelity bond protects an employer against financial loss from dishonest or fraudulent acts of employees.

• Employee Theft (Commercial Crime): Covers money, securities, and property stolen by employees.
• Financial Institution Blanket Bond: Specialized fidelity bond for banks covering employee dishonesty, robbery, burglary, forgery, and computer fraud.
• Public Employee Bonds: Cover dishonest acts of government employees.

Adjuster Notes

• A surety bond is a guarantee, not insurance: when the surety pays the obligee, the surety has the right to indemnification from the principal.
• A claim under a surety bond arises when the principal fails to perform; the adjuster verifies the obligation and the obligee’s loss.
• Fidelity bonds are often written on a discovery basis — the loss must be discovered during the bond period.

Additional Surety Bond Categories

• Subdivision Bonds: A developer posts bonds guaranteeing completion of public improvements (streets, utilities) in a subdivision before lots can be sold; the municipality is the obligee.
• Miscellaneous Bonds: A catch-all category for bonds not elsewhere classified (lost instrument bonds, indemnity bonds, permit bonds).
• Court Bonds include plaintiff attachment bonds (securing damages if attachment was wrongful) and defendant replevin bonds (securing return of seized property).
• License and Permit Bonds protect consumers against licensee misconduct (motor-vehicle dealer bonds, contractor license bonds, electrician bonds).

The Surety Claim Process

1. The obligee declares the principal in default and tenders a claim to the surety.
2. The surety investigates to confirm the principal's default and the obligee's loss, and gives the principal an opportunity to cure.
3. The surety may arrange completion (bring in a replacement contractor), pay the obligee the bond penalty, or finance the principal to finish the work.
4. The surety then seeks indemnification from the principal (and any indemnitors who signed a General Agreement of Indemnity) for all amounts paid plus expenses.

Fidelity Underwriting and Claims

• Fidelity coverage is written on either a blanket basis (all employees) or scheduled basis (named positions).
• A commercial blanket bond covers all employees for a single limit per loss; a position schedule bond covers named positions (teller, loan officer) for a per-position limit.
• The financial institution blanket bond is mandatory for federally insured depository institutions under Regulation 5000.
• Fidelity claims require proof of employee dishonesty, financial loss to the employer, and discovery within the bond period.

Underwriting Surety: The Three Cs

Surety underwriting evaluates the principal using the Three Cs: Character (willingness to perform), Capacity (technical and financial ability to complete the obligation), and Capital (financial strength and liquidity). The surety also reviews the principal's work program, prior projects, and financial statements, and typically secures an indemnity agreement from the principal and its owners. Unlike insurance underwriting, the surety does not expect to pay losses; the premium compensates the guarantee and the screening service.

Fidelity and Surety Claim Traps for the Adjuster

The adjuster must avoid the most common errors on bond claims. For a surety bond, never treat the surety as an insurer: confirm the principal is in default (not merely a dispute over workmanship quality), give the principal an opportunity to cure, and remember the surety's payment creates an indemnity right against the principal and any indemnitors who signed the General Agreement of Indemnity — the surety is not a deep pocket absorbing the loss. Distinguish a performance bond (complete the contract) from a payment bond (pay subcontractors and materialmen), because the obligee and the claimant differ. For a fidelity bond, the adjuster must prove three elements: (1) employee dishonesty — a dishonest or fraudulent act, not mere negligence or mistake; (2) financial loss to the employer — the employer must have suffered a covered loss, not merely a third party; and (3) discovery within the bond period — coverage is triggered by discovery, not occurrence, so a theft discovered after the bond expires is not covered unless a discovery period endorsement applies. Confirm whether the bond is blanket (all employees, single limit per loss) or position schedule (named positions, per-position limit), because the limit application differs. For South Carolina, license and permit bonds (contractor, motor-vehicle dealer, and electrician) are common: the obligee is the state or municipality, and a claim arises from licensee misconduct. The financial institution blanket bond is mandatory for federally insured depositories and covers employee dishonesty, robbery, burglary, forgery, and computer fraud as a package.