Fidelity and Surety Bonds
Fast Facts
- Bonds, like insurance, are based on the principle of guaranteed performance.
- Two main types of bonds:
- Fidelity Bonds: Guarantee the honesty of a person in a trusted position, commonly used by financial institutions and public entities.
- Surety Bonds: A surety (usually an insurance company) guarantees that the principal will fulfill a specific obligation to the obligee.
Fidelity Bonds vs. Employee Theft Insurance
- Fidelity bonds guarantee an employee’s honesty and indemnify the employer if the employee is dishonest.
- Employee theft insurance protects against losses from employee theft (e.g., embezzlement).
Surety Bonds vs. Liability Insurance
- Surety bonds are three-party contracts; insurance is a two-party contract.
- Surety bonds cover all defaults; insurance covers only accidental losses (subject to exclusions).
- Surety bonds are noncancellable; insurance policies may be cancellable.
Fidelity Bonds
Fidelity bonds guarantee the honesty of individuals in trusted positions, often in employer-employee relationships or for public officials.
Nature and Purpose
- Indemnify employers for losses due to an employee’s dishonest or fraudulent acts.
- Public officials bonds indemnify public agencies if officials fail to perform duties faithfully.
- More common in financial institutions and public entities than commercial businesses, which often use crime insurance for employee theft coverage.
Financial Institution Bonds
These bonds provide coverage tailored for banks, credit unions, and similar institutions, including:
- Loss from employee dishonesty
- Forgery
- Counterfeit currency
- Loss of money and securities
- Damage to personal property during burglary or robbery
Standard Form No. 24 (by Surety and Fidelity Association of America) is the industry standard for financial institutions.
Insuring Agreements
- Fidelity (Basic): Covers losses from employee dishonest acts with intent to cause loss or gain improper financial benefit.
- On-Premises (Basic): Covers loss/damage to money, securities, and other property on premises (e.g., bank robbery).
- In-Transit (Basic): Covers loss/damage to money and securities while in transit.
- Counterfeit Money (Basic): Covers losses from accepting counterfeit currency.
- Forgery or Alteration (Optional): Covers losses from forged/altered financial documents.
- Securities (Optional): Covers losses from forged/stolen securities.
- Fraudulent Mortgages (Optional): Covers losses from fraudulently obtained mortgages.
Public Official Bonds
- Guarantee faithful performance of elected/appointed officials (e.g., judges, sheriffs, treasurers).
- Forms: Individual, Name Schedule, or Position Schedule bonds.
- Noncancellable during the official’s term; terminates when a successor is appointed.
- Discovery period: 6 months to 3 years to report losses after bond termination.
Surety Bonds
Surety bonds involve a surety guaranteeing that the principal will fulfill obligations to the obligee, often tied to an underlying contract.
Key Parties
- Principal: The party whose performance is guaranteed (e.g., contractor).
- Obligee: The party receiving the guarantee (e.g., project owner).
- Surety: The insurer guaranteeing performance.
Surety vs. Insurance
| Aspect |
Surety Bonds |
Insurance |
| Contract Type |
Three-party contract |
Two-party contract |
| Coverage |
All defaults, regardless of cause |
Fortuitous losses, subject to exclusions |
| Loss Expectation |
Underwriter expects no losses |
Underwriter expects some losses |
| Subrogation |
Against principal |
Against negligent third parties, not insured |
| Collateral |
May require personal assets |
Not required |
| Cancellation |
Noncancellable |
May be cancellable |
Types of Surety Bonds
- Contract Bonds:
- Bid Bonds: Guarantee contractor will perform at bid price if awarded.
- Performance Bonds: Guarantee contractor will complete work per contract.
- Payment Bonds: Guarantee payment to suppliers/subcontractors.
- Indemnity Bonds: Protect obligee from principal’s failure (e.g., lease bonds).
- Tax Preparer Bonds: Protect clients from fraud by tax preparers.
- Financial Guarantee Bonds: Enhance financial credibility/stability.
- Freight Forwarder Bonds: Ensure payment to motor carriers.
- License and Permit Bonds: Guarantee compliance with laws/regulations.
- Fiduciary Bonds: Ensure faithful performance by court-appointed fiduciaries.
Key Takeaways
- Bonds involve a three-party relationship: surety, principal, and obligee.
- Fidelity bonds focus on employee honesty; surety bonds ensure contractual obligations.
- Surety bonds are noncancellable and cover all defaults, unlike insurance.
- Contract bonds (bid, performance, payment) are critical in construction projects.