Surety is a specialist product line that is often referred to as a contract guarantee, a guarantee bond, a surety bond or an insurance backed guarantee. A surety bond is an obligation formed via a tri-partite agreement between the Bonded Principal, the Employer (also known as the Beneficiary) and the Guarantor. This is issued by the Guarantor in line with an underlying contract or commercial obligation which, if called upon, will provide monetary compensation to the Employer in the event of the Principal’s contractual default or failure.

No, surety is not insurance.

Although surety bonds are often issued by insurance companies (Sureties), they can also be issued by banks (as a bank guarantee). Surety is a tri-partite agreement between the Bonded Principal that procures the bond in favour of the Employer (effectively the insured) which is issued by the Guarantor (the insurance company or bank) whereas insurance is a bi-partite agreement between the insured and the insurer. It is important to note that unlike with insurance, there is no transfer of risk with surety, as the Bonded Principal is still required to fulfil their obligation.

In the insurance sector, a surety is an insurance company. At Lockton we have access to all regulated global and UK surety providers either through our London office or our wider global network.

The surety market considers there to be two broad categories of bonds: Contract Surety and Commercial Surety. At Lockton, we place bonds within both categories and can cover all bond types within these. For example, a common surety bond is a performance bond (predominantly focused on the construction sector), however we can also issue bonds such as deferred consideration bonds which are common amongst companies making large acquisitions. Commercial bond types relate more to the replacements of (Standby) Letters of Credit ((LOC) / SBLC / SLOC).

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How a bond value is calculated will depend on the type of bond being requested.

Typically, a performance bond would be 10% of the contract value. Bonds that are directly linked to a monetary value (such as an advance payment bond or a deferred consideration bond) will be issued to the monetary value. Bond wordings can also stipulate that the bond value reduces upon certain milestones being achieved, such as practical completion certificates or fixed dates.

The cost of a bond depends a great deal on the financial strength of the Bonded Principal (and usually its ultimate parent company). In essence, the stronger the balance sheet, the cheaper your bonds will be.

Other factors that could influence cost of a bond could include although are not limited to the bond’s duration, previous trading performance and the nature/form of bond being issued (i.e. a conditional style wording vs a more onerous wording).

Due to being a product linked so closely with current and forecasted financial performance, a surety bond will rarely be issued for a period of more than 5 years.

Generally, a performance bond will typically be in place for 1-3 years, Highways and Infrastructure bonds (Section Bonds) will be in place for a minimum period of 2 years and bonds linked to monetary values will be in place for between 6 months and 4 years.

Some bonds such as environmental bonds and regulatory bonds, amongst others, could be in place for a 1 year period and have a requirement to be "renewed" annually.

The expiry provision of a bond will depend on the type of bond being issued. The most common expiry seen within bonds in the construction sector are Practical Completion "PC", a fixed number of days or months after Practical Completion (e.g. PC plus 12 months). For bonds outside of the construction sector, a common expiry event will be a fixed expiry date. Expiry provisions such as Making Good Defects are commonly pushed back on by the surety market as they can be often challenging to achieve and can lead to large overrun periods.

Unlike a general insurance product, a bond is a legal obligation that cannot be cancelled for any reason other than its specified expiry provision being achieved.This is often achieved via a fixed expiry date or proven by the relevant certificate being issued by the Beneficiary or its representative once the Bonded Principal has fulfilled their contractual obligations. As such, payment for the bond is required upfront and in advance of the bond being issued.

In the insurance sector the most common form of bond is a conditional bond.

Adjudication bonds and on-demand bonds are also available on a case-by-case basis. A conditional bond requires damages to be established and ascertained by an appointed representative before any bond claim is paid.

An adjudication bond (or a financing bond) allows for a claim to be settled promptly on independently qualified estimated damages. This form of bond includes a right to a Final Determination allowing for an under/over (re)payment mechanism to be activated once the true damages have been established and ascertained at the end of a contract.

An on-demand bond enables a claim to be paid “immediately” without any requirement to prove damages. These are extremely powerful instruments for the Employer, and they are seldom issued as performance bonds in the UK construction sector although they are more commonly found in commercial surety products.