Financial guarantee bonds are a type of surety bond that must be filed with the government agency (city, county, state or federal) responsible for regulating the business activity in the business’ jurisdiction as a condition of licensure for a business. In some cases, the bond must be filed with a private company (i.e. utility company, union, fuel supply company) as a condition for entering into a contract or business relationship with that company.
Financial guarantee bonds must be issued by insurance carriers admitted in the state where the bond is required. The insurance carrier issuing any surety bond, such as a financial guarantee bond, will also be referred to as the “surety company” or the “bond company”. Financial guarantee bonds refer to the business purchasing the bond as the Principal, the surety bond company as the Obligor and the government agency or private company requiring the bond as the Obligee.
Note: Financial guarantee bonds as discussed in this article should not be confused with “Financial Guaranty Bonds”, which are an entirely different type of bond that guarantees principal and/or interest payments on a financial obligation.
Financial guarantee bonds protect the Obligee by transferring to a surety bond company the risk that a business will not pay amounts due to the Obligee. The surety company provides the Obligee a guarantee (the surety bond) that the business will make payment for taxes, fees or other amounts due to the Obligee up to a limit specified in the bond (“penal sum” or “bond amount”). Ultimately, business owners are responsible for their obligations and required by law to reimburse the surety company for any payments made under the bond.
Common examples of violations triggering a bond payout include a business failing to pay utility bills, a contractor failing to pay wages or benefits to union employees, or a gas station failing to make payment for fuel supplies.
Financial guarantee bonds typically cost between 1.5% and 10% of the bond amount.
|Credit Score||Premium Rate||Bond Cost|
|800 or above||1.5%||$150|
|549 or below||10.0%||$1,000|
The actual cost of a specific financial guarantee bond can vary widely depending on the risk associated with the obligee, the type and size of financial obligations required, and the business owner’s license history, experience and creditworthiness. Surety bonds required by a local government (city or county) tend to have the lowest cost, while private, state or federal requirements have potentially higher costs and/or more strict underwriting requirements.
Depending on the relative risk of the bond and the underwriting practices of the surety, the bond company may require a personal credit check of the owner of the business applying for a financial guarantee bond to determine the premium rate and eligibility for the applicant. Most financial guarantee bonds will require a credit check. Ultimately, the surety insurance company determines how it will underwrite and price a surety bond.
The bond form is a tri-party agreement which defines the rights and obligations of the entity requiring the bond (obligee), surety company (obligor) and business (principal). While many bond forms use similar language, each bond form can be customized by the obligee requiring the specific bond and may contain provisions that increase potential costs for the surety company, which will ultimately be passed on to the principal via higher bond premiums, stricter underwriting or collateral. The primary text to consider in a financial guarantee bond surrounds (1) aggregate limits, (2) cancellation provisions and (3) forfeiture clauses.
Bond forms always specify the penal sum defined as the maximum amount of financial damages any single party can recover from the bond related to a single claim occurrence. Most bond forms also contain a clause which limits the amount of financial damages from all parties and all claims to a specific amount (“aggregate limit”), usually the same amount as the penal sum. For example, a $15,000 financial guarantee bond with an aggregate limit of $15,000 will pay out no more than $15,000, regardless of the number of damaged parties or claim occurrences. Bonds without an aggregate limit will be more expensive than a bond with similar coverage containing an aggregate limit.
Most bonds contain a provision allowing for the surety company to cancel the bond (“Cancellation Provision”) by providing a notice to the business and obligee requiring the bond with the cancellation taking effect within a set period of time, usually 30 days (“Cancellation Period”). Cancellation provisions allow the surety company to cancel the bond for any reason, but most often due to the principal failing to pay premiums due, claim payouts, or material changes in the business owner’s credit score. Financial guarantee bonds with no cancellation provision or cancellation periods greater than 30 days will be more expensive than a bond with similar coverage containing a standard cancellation provision.
Surety bond claims are paid by surety companies to damaged parties to reimburse that party for the financial loss incurred up to the bond penalty amount. Certain bonds contain a clause which requires the surety company to pay the full bond penalty to the damaged party, regardless of the actual damages incurred (“Forfeiture Clause”). Financial guarantee bonds with forfeiture clauses will be more expensive than a bond with similar coverage that does not contain the clause.
Suretypedia groups Financial Guarantee Bonds into 43 unique categories, primarily by industry and sub-industry. Below is a link to more information on each bond category: