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How Much Does a Performance Bond Cost

09 December 2020

 

In the world of Suretyship, the most common question we are asked is how much does insurance cost for a Performance Bond?

There are already so many things wrong with this question and it is an easy mistake for a client to make as confusingly Performance Bonds are commonly issued by Insurance Companies, but they are not in fact Insurance.

So what is a performance bond? let's take a more detailed look.

Risk Transfer

An Insurance policy works on the key principal of risk transfer, a fixed premium is paid in exchange for a known risk between a customer and insurer. This risk can be estimated by actuaries using mountains of available data and the likelihood of a fortuitous event occurring, the customer pays a premium and the insurer accepts the risk.

The Parties Involved in a Bond

Firstly, lets look at the different parties involved and their roles.

1. The Employer, the person requesting the bond referred to as the Obligee,
2. The contractor the person tendering for the works known as the Principal
3. And finally the guarantor or otherwise known as the Surety, in this case an insurance company.

So instantly this changes the tone of the agreement as there are three parties involved with the person buying the bond, the Principal, not being the beneficiary of the bond but rather the Obligee being the beneficiary to whom the Surety assumes the obligation of the Principal should they default on the agreement.

Why is Surety not Insurance?

• With a performance bond the mechanism is very different, most importantly there are three parties involved as described above, whereas with Insurance you only have two parties.
• The second distinguishing point is losses, with insurance you know you will have them, however with surety bonds they seek security and collateral from the Principal and underwrite for no losses, we will look at this point next in the article.
• This leads on to the next factor being if we do not underwrite for losses a fixed premium cannot be established like it can with Insurance therefore a ‘fee’ is charged instead.
• Our final difference to highlight is that of Indemnity, as the Principal is required to indemnify the Surety for any losses this does not make for a contract of insurance, so simply put this is surety and not insurance.

What Security is a Principal likely to be asked to provide

As discussed above the Surety has the right to indemnity themselves for any claim made against them from the Principal. There are various different levels of Security a company may be asked to give depending on the bond amount, experience of the company making the application and their financial soundness.

The following are the most common requests of security asked for from a Surety.

CCI / DCI (Counter Corporate Indemnity / Deed of Counter Indemnity) – The minimum security that any Bond is written upon. This is a document that would be signed by the Director to agree that should the bond be called upon; the Surety are within their right to recoup costs. This may be through an administrator.

Multi Party CCI/DCI – When the Company is part of a group of companies or has links due to common directors the Surety may ask for cross company indemnity arrangements, this may be due to the parent company having a stronger financial standing.

Personal Guarantee – Could be required if the company’s assets are not strong enough to support the Bond. This gives the Surety the right to pursue cost recovery against the Directors personal assets should the Bond be called upon.

Cash Collateral - An amount, potentially up to the full amount of the Bond would be held in an Escrow account and used if the Bond is called upon. If not, they are released back upon Expiry of the Bond subject to no claims or pending claims.

So Why do people buy Performance Bonds

A Performance Bond is often mandatory and the Principal may not have any option if the contract dictates it, it is intended to ensure that the Principal will complete the works on time and to the required standard. This ultimately offers peace of mind to the Obligee and protection that if the Principal defaults on the contract that the Surety will reimburse them for quantified and ascertained losses.

Types of Bond Wordings

The bond wording is often supplied by the Obligee commonly included in the tender, there are various wordings they may supply with the most common being an ABI Wording, this wording is fair on both parties and is tested in court. Other various forms of wording can be provided including an On-Demand Bond, which as the name implies is very onerous on the Principal and Surety to pay ‘on-demand’ of an alleged loss. Other wordings can include an adjudication clause or a hybrid wording which can be on-demand for certain claims such as insolvency. Clearly the type of wording required can affect the Bond Fee payable and also any security the Principal may be asked to offer.

Suretyship is a complex market with many variables however the team at Surety Bonds and Guarantees are always available to provide advice and support to either party and make the process hassle free and simple.

Should you have any questions we would welcome your call and look forward to helping in any way we can.

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SB&G - 02476 017646