Understanding insurance bonds – an in-depth guide

Ensuring that contractual obligations and legal requirements are met in today’s complex business and financial landscape is crucial. Insurance bonds, also known as surety bonds, play a vital role in this regard. They provide an essential layer of security and trust, ensuring that commitments are fulfilled and protecting stakeholders’ interests in case of a loss.

Understanding insurance bonds is of great important. This article delves into the different types of insurance bonds, the parties involved, the requirements for purchasing these bonds, and many other relevant details.
What is an insurance bond?
An insurance bond is a three-party agreement that guarantees the performance of an obligation or compliance with a law. It safeguards the financial interests of project owners.
Who are the parties to an insurance bond agreement?
  1. Principal:  The party required to secure the bond, such as a contractor. The principal is responsible for fulfilling any obligations outlined in a contract.
  2. Obligee: An obligee is often a business or project owner who needs assurance that a principal will satisfy its obligations as defined in the contract. The obligee is the one who request the bond from the principal and would be indemnified by the surety if the principal is not able to fulfill its contractual obligations.
  3. Surety: The insurance company that issues the bond, guaranteeing the principal’s or the contractor’s performance.
Are bonds insurance policies?
Bonds are not insurance policies per se. Rather, they are legal agreements involving three parties: the principal, the obligee and the surety. Insurance bonds promise that if the principal doesn’t fulfill their obligations, the obligee will get compensated. Essentially, a surety bond acts as a safety net, ensuring the obligee doesn’t lose money if the principal fails to do their job. This setup helps build trust and reliability in various business deals and legal agreements.
Types of insurance bonds
Contract bonds
Contract bonds ensure that contractors fulfill their contractual obligations. Common types include:
  1. Bid bond/tender security: A bid bond is a written guarantee provided by a third-party guarantor, typically an insurance company, which guarantees that the bidder will enter into a contract if awarded. If the contractor fails to honor the terms of the bid, the bond provides financial compensation to the project owner, typically covering the difference between the contractor’s bid and the next lowest bid.
  2. Performance bond: A written guarantee from a third-party guarantor, usually an insurance company, submitted to a project owner by a contractor on winning the bid to ensure the full performance of the project.  A performance bond ensures payment of a sum (bond amount) of money in case the contractor fails in the full performance of the contract.
  3. Advance payment bond: This bond provides security to the party making an advance payment under a contract. This bond ensures that if the contractor fails to fulfill their contractual obligations, the guarantor will reimburse the advance payment to the project owner.
  4. Supply bonds: Guarantee that suppliers will deliver materials or equipment as agreed.
Custom bonds
Custom bonds, or customs bonds, are essential for ensuring compliance with customs regulations and facilitating international trade. The various types of customs bonds are explained below.
  1. Clearing agents bond: Ensures clearing agents meet customs obligations, including accurate paperwork and timely duty payments, protecting the government from losses due to errors or negligence.
  2.  Warehousing bond: Covers goods in bonded warehouses, ensuring importers comply with customs regulations and pay duties when goods are removed for consumption, aiding inventory management and deferring duty payments.
  3. Custom petroleum bonds: Covers the importation, storage, and distribution of petroleum products, ensuring compliance with customs, environmental, and safety regulations, and guaranteeing payment of all applicable taxes and fees.
  4. Temporary importation bond: Covers goods imported temporarily for re-exportation, allowing duty-free importation if re-exported within a specified period, and guaranteeing payment if goods are not re-exported or regulations are violated.
  5. Removal bonds: Covers the movement of goods between bonded warehouses or to different locations, ensuring compliance with customs regulations and guaranteeing payment of duties if goods do not reach their destination or if regulations are breached.
  6. Transshipment bonds: Covers goods transferred between vessels or transport modes under customs control, ensuring compliance with regulations and guaranteeing payment of duties if goods are diverted or fail to comply during transshipment.
  7. Re-exportation bond: Covers goods imported for later exportation, allowing duty-free importation if exported within a specified timeframe, and guaranteeing payment if goods are not exported or regulations are breached.
  8.  General transit bond: Covers the transportation of goods under customs control within a country, ensuring compliance with regulations and guaranteeing payment of duties if goods do not reach their destination or if regulations are violated.
  9. Particular transit bond: Similar to general transit bonds, but specific to particular shipments, ensuring compliance with customs regulations during transit and guaranteeing payment of duties if goods do not reach their destination or regulations are breached.
How does insurance bonds work?
When a principal is required to obtain a bond, they apply to a surety company. The surety company evaluates the principal’s creditworthiness, financial stability, and experience before issuing the bond. If the principal fails to meet the obligation, the obligee can make a claim on the bond. The surety will investigate the claim and, if valid, compensate the obligee up to the bond’s value. The principal is then responsible for reimbursing the surety for the amount paid.
What doesn’t an insurance bond cover?
Insurance bonds do not offer liability coverage, meaning they don’t cover legal defense costs, settlements, or judgments. They also won’t pay out if someone involved in the project dies or becomes disabled, nor will they compensate if the principal fulfills their obligations but the obligee is unhappy with the service or final product.
Underwriting requirements for insurance bonds
Underwriters or insurance companies generally ask for critical information about the client to be insured, the details of the risk, and other important specifics when deciding whether to accept, reject, or apply certain terms and conditions to the bond application.  The precise requirements may vary depending on the type of bond needed, but typically include the following information.
  1. Details of the bond applicant
    1. Name and address
    2. Email and telephone number
    3. Office location and GPS address
    4. Incorporation and commencement certificate
    5. Companies’ regulations / constitutional document
    6. Three years of audited financial statements
    7. Company’s statement of affairs
    8. Board resolution supporting the Application
    9. Records of past performance (Completed,_ Incomplete, and Terminated Projects)
    10. Experience in similar contracts
    11. Current projects / contracts
    12. Experience of directors and managers
    13. Financial status of directors
  1. Details of the Beneficiary / Employer
    1. Name and address
    2. Email and telephone number
    3. Office location and GPS address
  1. Details of the contract to be performed
    1. Detailed description of the work
    2. Work site location(s)
    3. Total contract value
    4. Total bond amount which is usually a percentage of the total contract sum
    5. Executed contract documents
    6. Proposed start and completion date
Insurance bond rating
In Ghana, all insurance companies are required to strictly comply with the minimum bond rates approved by the National Insurance Commission (NIC) in accordance with section 256 of the Insurance Act 2021 (Act 1061)
Importance of insurance bonds
  1. Insurance bonds protect obligees from financial losses if the principal fails to fulfill obligations.
  2. Obtaining an insurance bond demonstrates the principal’s reliability and commitment, providing financial support in case of breaches.
  3. Insurance bonds are often required for legal compliance in various industries.
  4. The surety benefits by charging the principal a premium, earning a profit even if covering a loss.
Insurance bonds are important tools that help manage risk and ensure people and businesses keep their promises in different industries. By knowing about the various types of bonds and what they do, businesses and individuals can better handle the challenges of contracts and legal requirements. Whether it’s for construction projects, getting business licenses, or dealing with legal issues, insurance bonds offer crucial financial protection and peace of mind.
>>>the writer is a Chartered Insurance Practitioner (ACII-UK), an accomplished writer and author, and an Associate in Risk Management (ARM) from The Institutes, USA. Additionally, he holds a Master’s in Business Administration degree with a specialization in Finance from the University of Ghana Legon. He has a decade of experience within the Ghanaian insurance industry and currently a manager at Star Assurance Limited. He can be reached via +233249236939 and or [email protected] / [email protected]

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