Surety Bonds versus Fidelity Bonds
Over the course of my 25 year commercial insurance career, I can say that without a doubt one of the most confused topics that I get questioned about has to do with “bonds”. With the onset of more and more school systems privatizing their janitorial services, I thought this may be a good time to clarify this issue and decipher the different types of bonds that are available.
Surety Bonds versus Fidelity Bonds
The best place to start with this clarification is by making a distinction between the two different types of bonds, as I believe much of the confusion can be resolved by making this differentiation.
Surety Bonds
A Surety Bond is a contract between at least three parties:
- The Obligee – the party who is the recipient of an obligation (building owner or property manager),
- The Principal – the primary party who will be performing the contractual obligation (BSC),
- The Surety – who assures the obligee that the principal can perform the task (Bond carrier)
So, bringing this all together, when a first party (obligee) calls upon a second party (principal) to perform duties in contract form, a surety bond is issued by a third party (surety), guaranteeing that the second party will fulfill an obligation or series of obligations to the first party. In the event that the obligations are not met, the first party will recover its losses via the bond. The major difference between insurance and surety bonds, is that 100% of the loss paid on behalf of a principal, will be contractually reimbursed to the surety by the principal.
Types of Surety bonds (that a BSC may come across)
Bid Bond - issued as part of a bidding process by the Surety to the Obligee (project owner), to guarantee that the winning bidder will undertake the contract under the terms at which they bid. Bid bonds are normally 5% of the total project amount and can also be posted as cash or letter of credit. The bid bond assures and guarantees that should the bidder be successful, the bidder will execute the contract and provide the required surety bonds.
*Noteworthy- A Surety will not issue a Bid Bond for a contractor that will not qualify for the required Performance Bonds. (see “Who is eligible” for qualifications)
Payment Bonds - protects certain laborers, material suppliers and subcontractors against nonpayment. Since mechanic's liens cannot be placed against public property, the payment bond may be the only protection these claimants have if they are not paid for the goods and services they provide to the project.
Performance Bonds – issued by an Insurance/Surety company or a bank to guarantee satisfactory completion of a project by a contractor (Principal)
Who is eligible to qualify for a Surety Bond?
Since “bond” losses are 100% reimbursable to a Surety, underwriters look at contractors financial statements to make sure that the “contract amount” for a project can be paid back to them in the case of loss. In other words, they will be looking for “liquid assets” on your corporate statements in the amount of the contract that you are bidding on. In addition to financial statements, they will also ask for projects that you have completed that are similar in size to your current bid as well as references from those projects. Lastly, there are few instances these days that a Surety would not ask for the owner's personal indemnification to protect themselves from a contractor moving assets of the company into their personal accounts.
Fidelity Bonds
While called “bonds”, these obligations to protect an employer are really insurance policies. In contrast to Surety Bonds, these types of bonds are a form of insurance protection that covers policyholders for losses they incur due to fraudulent acts by specified individuals.
There are two types of fidelity bonds as it relates to the BSC industry:
First party bonds – Employee Dishonesty coverage that is meant to protect employers (the First party) from employees that commit dishonest acts against their employer,
Third party bonds – Employee Dishonesty coverage that is meant to protect your customers (Third party) from your employees committing a fraudulent act against them.
There are two forms of Third Party Bonds available in today's marketplace and are in stark contrast of one another.
Janitorial Service Bonds – traditionally, these were the only types of third party bonds available to protect your customers. The problems with these bonds are:
1. In order for a theft from your customers property to be covered, there would have to be a legal conviction of your employee. The problem arises because your employees are usually working alone in areas where very few, if any, witnesses can corroborate their story,
2. For the sake of argument, let's say that your employee was caught on video tape stealing and the police were able to convict your employee. The second, and biggest problem with this bond, is that it requires the employer to reimburse the loss back to the Surety – much like the Surety Bond described previously.
Third Party Theft – the best way to cover this exposure of your business is to purchase third party theft coverage from an insurance carrier that provides the coverage as part of their Employee Dishonesty coverage. In contrast to the Janitorial Service Bond, there only needs to be a “preponderance” of evidence that your employee committed the theft. A preponderance of evidence is established by exonerating the customers employees leaving your employee as the only other alternative cause of the theft. Also, once your customer is reimbursed for their loss, you are not required to reimburse the carrier for their loss. There are only a few insurance carriers willing to provide this coverage for your industry so make sure that these conviction and reimbursement clauses are not present when purchasing this coverage.
For insurance programs designed specifically for cleaning businesses of all sizes, visit
http://vtcins.com/programs_janitorial.html (open in a new window)
Gary Beggs started his career with CNA Insurance Company underwriting the Building Service Contractors Association International (BSCAI) insurance program. After 10 years of acquiring this specific janitorial insurance experience, he became an insurance broker. Since then, Gary has deveolped several insurance programs for janitorial associations including the Affiliated Building Service Contractors in Michigan, as well as the Building Service Contractors Association International. Gary has held the Certified Insurance Counselor designation since 2002.
Website: http://www.vtcins.com
Phone: (248) 530-3279
