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A surety bond is an unusual form of insurance in that one person or organization pays for it, while another receives the benefit.
It’s easier to understand with an example. Imagine a contractor is building a new office building for a government agency. The agency naturally wants a guarantee that the taxpayer won’t be left out of pocket if the contractor fails to deliver the offices as promised.
The answer is a surety bond. The contractor pays a premium to an insurer to purchase the surety bond. The insurer then pays the necessary compensation to the agency if the contractor fails to deliver. The big difference between this and ordinary insurance is that the insurer can and will go after the contractor to get this money back. The point of the surety bond is that the agency gets the assurance that it won’t have to chase after the money itself.
While government agencies commonly insist on a surety bond, it can work with any two organizations. The one that purchases the surety bond is “the principal,” while the one that gets any payout is “the obligee.”
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