Surety Bond / Contractor's Bond
Also known as: Performance Bond, License Bond, Contractor Bond
The surety company guarantees performance to the customer/state. If you fail, the surety pays out and seeks reimbursement from you personally. Different from insurance: insurance protects YOU; a bond protects the third party. Bond premium is typically 1-3% of bond amount per year, credit-driven.
Real-world scenario
Cedar Ridge Grading & Paving LLC, a mid-sized site-work contractor, is the apparent low bidder on a county road-widening project worth $1,850,000. To submit, they first posted a bid bond equal to 10% of the bid, or $185,000, guaranteeing they would sign the contract if awarded. Once selected, the county required both a performance bond and a payment bond, each with a penal sum of $1,850,000.
Cedar Ridge's surety underwrote the account using its financials: annual revenue of $6,200,000, net worth of $780,000, working capital of $420,000, and an available bank line of $500,000. Because the owner's personal credit score was 742 and the contract fit their track record, the surety charged a tiered rate — 2.5% on the first $100,000 and 1.5% on the balance — for a combined bond premium of $28,750. Cedar Ridge also signed a general indemnity agreement, giving the surety a right of indemnity for any loss.
Midway through the job, a paving subcontractor went unpaid and filed a claim for $95,000 against the payment bond. The surety investigated (spending $12,000 in fees), paid the sub $95,000, and then sought reimbursement from Cedar Ridge under the indemnity agreement. Cedar Ridge repaid the $95,000 plus $12,000 in costs and $8,500 in legal fees, avoiding a performance-bond default that could have cost $310,000 to hire a completion contractor. Total out-of-pocket — the $28,750 premium plus $115,500 in indemnified loss — came to $144,250 against a $1.85M contract.
How it affects your premium
Surety bond pricing is really a credit decision, not a loss-probability calculation — the surety expects to be repaid by the principal, so premium reflects how likely the business is to perform. Key drivers include:
- Bond type and purpose — A construction contract bond is priced very differently from a small commercial license-and-permit bond, which is often a flat annual fee.
- Penal sum (bond amount) — Larger bonds carry higher dollar premiums, though the percentage rate usually drops on tiered schedules as the amount rises.
- Personal and business credit — The owner's credit score, the company's net worth, working capital, and bank lines drive the rate; strong credit can mean 1-3% of the bond, weak credit 5-15%.
- Experience and track record — A contractor's history of completing similar-size jobs on time reduces perceived risk and lowers rates.
- Contract complexity and duration — Longer projects, unusual scopes, or warranty/maintenance obligations increase exposure and price.
- Indemnity and collateral — Personal guarantees, spousal indemnity, or posted collateral can unlock lower rates or larger bonding capacity.
Common misconceptions
Myth: A surety bond protects the business that buys it, like an insurance policy.
Reality:
It does not. A surety bond protects the obligee (the party requiring the bond); if the surety pays a claim, it turns to the principal for full reimbursement under the indemnity agreement. Genuine first-party protection comes from products like general liability or property coverage.
Myth: A surety bond and a fidelity bond are the same thing.
Reality:
They are different instruments. A fidelity bond is really insurance covering employee theft, while a surety bond is a three-party guarantee of performance or payment that the principal must repay.
Myth: Once you buy a surety bond, claims paid by the surety are covered losses you never have to worry about again.
Reality:
Every claim the surety pays becomes a debt you owe back. The general indemnity agreement you sign makes you responsible for the full payout plus investigation and legal costs.
Frequently asked questions
What is the difference between a performance bond and a payment bond?
A performance bond guarantees the project will be completed per the contract, while a payment bond guarantees subcontractors and suppliers get paid. On public jobs they are usually required together.
How much does a surety bond cost?
Contract surety bonds typically run 1-3% of the bond amount for well-qualified contractors, rising to 5-15% for weaker credit. Small commercial license-and-permit bonds are often a flat annual fee of $100 or less.
Do I have to repay the surety if it pays a claim?
Yes. When you obtain a bond you sign a general indemnity agreement, so any amount the surety pays out — plus its costs — becomes a debt you owe back to the surety.
Are surety bonds required on federal construction projects?
Yes. The Miller Act requires performance and payment bonds on most federal construction contracts above a threshold amount.
What is a maintenance bond?
A maintenance bond guarantees the contractor will fix defects in workmanship or materials for a set warranty period after the project is completed, often one to two years.
Sources cited
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