Common bond-types are:
- Fidelity bonds that provide insurance against loss from employee misconduct, such as theft or embezzlement, which is not otherwise covered by a compan’s regular insurance coverage. A bond can provide blanket coverage for the actions of all employees or can be tailored to cover one or more specific employees (as is the case with a pension fidelity bond discussed below).
- Surety bonds, which are contracts involving three parties: the party required to perform (called the’principa’), the party for whom the work is being done (called an’oblige’), and the party who insures the action of the principal (called the’suret’). If the principal fails to perform a job covered by the surety bond or otherwise causes damage or loss to the obligee, then the surety pays the bond amount to the obligee, who can then use the money to complete the job with another company.
When do you need bonds?
Depending on the type of work your business conducts or for certain other business-related activities, you may want or need to obtain a bond.
Contract surety bonds. If you are a contractor, manufacturer, or supplier, you may be contractually obligated to maintain a surety bond to guarantee your performance. For example, if you are a paving contractor and bid for the paving at your local town hall, typically you are required as part of the bid and contract process to obtain a surety bond that will pay the municipality if you fail to complete the contract. The municipality can then use the proceeds to pay another contractor to finish the job.
Business services (fidelity) bonds. If you have employees working on customer’ premises, this type of bond will provide coverage for employees’ fraudulent or dishonest acts. For example, if you have a cleaning service, this bond will reimburse you if your employee steals from a customer. You can then use the proceeds to reimburse your customer.
Fidelity bonds for pension plans. If your business has a defined benefit (pension) plan, you are required by tax law to have a fidelity bond equal to at least 10% of the assets. The maximum bond required is $500,000 ($1 million if the plan holds employer securities). No deductible is allowed in the bond and it must be in the name of the plan or trust (not the employer), or the bond must specifically state that the plan or plans (by name) are covered and that the general bond deductible doesn’t apply per ERISA requirements. The bond protects against dishonesty by those handling the company’s pension plan.
What do bonds cost?
There is no fixed rate for bonds. There are many factors that impact cost, such as the extent of coverage, whether there is a deductible (if allowed), and the surety company that issues the bond. As a rule of thumb, a fidelity bond can cost about ½% to 1% of the coverage obtained, so a $1 million bond would cost $10,000. The range for a performance bond generally is ½% to 2% of the contract amount, so a bond for a construction job of $1 million could be up to $20,000.
Because surety and fidelity bonds are a risk management tool, it is helpful to discuss your business needs with your insurance agent. He or she can then refer you to a surety company when traditional insurance won’t provide the protection you want or need.