To begin, in insurance underwriting it is assumed that there will be losses. These expected losses are actuarially predictable and are the basis for the insurance premium. However, contract surety is not actuarially rated since losses are not expected. Issuing bonds for contractors is essentially the extension of credit. Contract surety underwriters must carefully underwrite each account and each bond for an account, while attempting to achieve a “zero” loss ratio. This unique characteristic of surety is compounded by the fact that surety credit is priced relatively cheaply in relation to other forms of credit, such as bank credit.
Surety also differs from insurance in that insurance is a “two-party” relationship. A contract of insurance exists between the buyer of the policy and the insurer, in which the insurer will pay in the event of a loss under certain agreed upon conditions. Surety is a “three-party” relationship, one party guarantees or promises to a second party the successful performance of a third party. The fundamental relationship is between an owner of a project to be constructed and the contractor; their relationship is defined in law by the contract between them. The bonding company, the surety, is secondarily liable and guarantees that the principal shall perform the terms of the contract, and will pay labor and material suppliers. These items are guaranteed through “faithful performance”, “labor and material” or “payment” bonds.
An insurance policy is usually cancelable under certain circumstances such as non-payment of premium, and claims may be denied for certain reasons. In contrast, the contract surety bond is essentially a non-cancelable and irrevocable obligation. This obligation could conceivably go on forever unless and until; the surety is exonerated by the faithful performance of the terms of the contract.