Performance Bond
Also known as: Contract Performance Bond
The surety company pays the project owner if the contractor fails to perform — then seeks reimbursement from the contractor. Bond amount typically 100% of contract value. Premium 1-3% of bond amount annually.
Real-world scenario
Cascade Ridge Builders LLC, a general contractor with about $12,000,000 in annual revenue, is awarded a public school-district gymnasium project worth $4,000,000. Before construction can start, the district requires a performance bond equal to 100% of the contract, so Cascade Ridge asks its surety for a bond with a penal sum of $4,000,000. The surety underwrites the firm's $1,200,000 net worth and $850,000 in working capital, then issues the bond at a rate of 1.5% on the first million and 0.9% above that — a premium of roughly $42,000. Because it was a competitive public job, Cascade Ridge had already posted a bid bond of $400,000 (10% of its bid) and now also buys a matching payment bond of $4,000,000 to protect subcontractors and suppliers.
Eighteen months in, a cash-flow crisis forces Cascade Ridge to walk off the job with $1,100,000 of contract balance remaining and the gym only 72% complete. The district declares a default and calls the performance bond. The surety hires a replacement contractor whose completion bid comes in at $1,650,000 — $550,000 over the remaining contract funds. The surety also incurs $95,000 in consultant, legal, and re-bidding costs, for a total loss of $645,000 against the $4,000,000 penal limit.
Critically, a performance bond is not insurance for Cascade Ridge: under its indemnity agreement, the firm must repay the surety every dollar. The surety pursues the company and its owners personally for the full $645,000, plus a one-year maintenance bond obligation valued at $100,000 that still covers latent defects.
How it affects your premium
Performance bond premiums are a service fee for the surety's credit backing, not a loss-based insurance rate — so pricing turns mostly on the contractor's financial strength and the size and risk of the job. Typical rates run from roughly 0.5% to 3% of the contract (penal) amount:
- Contract size and penal sum: Larger contracts often earn tiered, lower marginal rates, but the total dollar premium still climbs with the bond amount.
- Contractor financial strength: Working capital, net worth, bank lines, and audited financials drive the rate; weak balance sheets pay more or get declined.
- Credit and personal indemnity: Owner credit scores and the willingness to sign a personal indemnity agreement directly affect approval and price.
- Project type and complexity: Public work, tight schedules, hazardous scopes, or unfamiliar trades raise the rate versus routine private jobs.
- Experience and track record: Years in business, completed similar-size projects, and a clean claims history lower the rate.
- Bond form and obligee terms: Federal jobs under a Miller Act bond, onerous default language, or warranty extensions can increase cost.
- Backlog and single-job limits: Sureties cap aggregate work-on-hand; a bond that stretches your program may carry a surcharge or added collateral.
Common misconceptions
Myth: A performance bond protects the contractor if the job goes bad.
Reality: It protects the project owner (the obligee), not the contractor. Because you sign an indemnity agreement, you must repay the surety for every dollar it pays out on your default.
Myth: A performance bond is just a type of insurance policy.
Reality: It is a three-party surety bond, not two-party insurance — the surety expects zero losses and treats it more like extended credit. See contract vs commercial surety for how construction bonds differ from license bonds.
Myth: One performance bond also covers my subcontractors and suppliers if they aren't paid.
Reality: No — payment protection comes from a separate payment bond. The performance bond only guarantees the work is completed per the contract.
Frequently asked questions
What is the difference between a performance bond and a payment bond?
How much does a performance bond cost?
Do I have to repay the surety if it pays a claim on my performance bond?
When is a performance bond legally required?
What is the difference between a bid bond and a performance bond?
Sources cited
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