Why does “bonded, licensed and insured” matter?
“Licensed, bonded, and insured.” You may have come across these terms while setting up your business; or you might have been told as a customer to look for these things when searching for a contractor. While often used interchangeably, these three words mean very different things. It’s important to have a good grasp on the distinction between these terms as they can be informative when making business decisions. To help explain what these three words mean, we’ll cover the following today:
Being “licensed” has several positive implications for a business:
Not all businesses are required to be licensed, but generally speaking, skill-intensive businesses that can potentially cause damage to their customers will require licenses. Each state is different, but below is a list of common licenses that can be acquired from local state governments. These licenses are often mandatory.
Of all the licenses listed above, a contractor license is by far the most common license obtained in the US. 35/50 states require contractors to be licensed, and oftentimes there are different types of contractor license that need to be obtained depending on the type of contracting work you do.
For example, in the state of California, all contractors are required to be licensed with the California State License Board (CSLB), but there are 45 different types of contracting license that can be acquired, ranging from plumbing to refrigeration contractor. It’s important to figure out the type of license you need based on the type of work that you perform as a contractor. In some instances, multiple contractor licenses may be required.
Being bonded means that a business has a surety bond in place that is relevant to their business. A surety bond is a three party contract where (1) the surety company guarantees the completion of the obligations of (2) the principal to (3) the obligee. The surety company, therefore, protects the obligee (the party that purchased the service from the principal) from losses or failures of the principal. If damages occur, the customers of the principal can file a claim against the principal, and if the claim is deemed valid by the surety company, then the surety company would compensate the customer for their financial loss, up to the bond amount. Without a surety bond in place, the customers would have no protection against dishonest businesses. Surety bonds are often an effective tool for businesses to build trust with their customers.
Let’s tie this back to our previous California contractor example to illustrate what getting bonded means. As part of their licensing requirements, the CSLB (the obligee in this case) requires contractors (the principal) to get a $25,000 contractor license bond from an accredited surety company (the surety) as part of their licensing requirement. Only “bonded” contractors, meaning they were approved for and purchased a contractor license bond, will be granted a contractor license by the state. Contractors operating without a license in the state are operating illegally and can be subject to fines by the CSLB.
Now that we’ve explained what a surety bond is, let’s dive a bit into the classification of surety bonds. There are two types of surety bonds: commercial bonds and contract bonds.
The more commonly purchased bonds are commercial bonds. If you aren’t a contractor bidding on public projects, you most likely are looking for a commercial bond. There are thousands of commercial bonds in the US. Generally speaking, commercial bonds are cheaper than contract bonds and are quicker to issue. There are five major types of commercial bonds:
There are five main categories of commercial surety bonds:
On the other hand, contract surety bonds are specifically for construction projects that are of high value. They are generally more expensive to purchase and take longer to process. Here are the most common types of contract bonds:
Contractor bonds are primarily purchased for government construction projects. The Miller Act stipulates a contractor must have a performance, bid and payment bond in place to participate in the bid and work of any federal construction contract over $150,000.
The cost of a bond is also known as the premium. The premium is generally between 1% and 5% of the bond amount, which is usually determined by the obligee. If the business or individual is deemed to be at high risk of default, for example if they have a very low credit score, the premium could go up to 10% of the bond amount.
Some bonds can be “freely written”, meaning the price of the bond is fixed and is not affected by an individual’s credit score or financial situation. For example, we offer the $5,000 California Tax Preparer bond for $25 per year, no credit check required. Notary bonds are another common example of “freely written” bonds. These bonds are available without credit check because they are sufficiently low risk.
For bonds that are not “freely written”, there are four main factors that affect the cost of the premium:
In our experience, credit score drives 60% of the bond premium, industry experience drives 20% and business and personal financials drive 10% respectively. It’s important to note that each bond has its own weighting and formula. For some bonds, your credit score is the only factor that matters. In the US, surety companies are required to file their rates and formulas through SERFF (The System for Electronic Rates & Forms Filing). Curious consumers can look up the rates for their bonds through SERFF to better understand how their premium is determined and ensure they are receiving a fair price. However, we do warn you, SERFF filings can be a headache to navigate through since they are legal documents made for satisfying regulation.
Being insured as a business means obtaining a financial guarantee from an insurance company that they will cover your business’s financial losses. Unlike bonds, insurance is typically optional, but oftentimes a good idea for businesses. To be insured, individuals or businesses must sign a contract with an insurance company, also known as an insurance policy. The terms of an insurance policy vary depending on the needs of the insured and the appetite of the insured. An insurance policy may not necessarily cover a business’s entire financial loss, but rather a portion of the loss to make it more affordable for the insured to pay.
One example of businesses getting insured is contractors that get general liability insurance. While general liability insurance is not required for contractors, it’s highly recommended that contractors carry it, as it provides coverage for business liabilities the contractor may encounter. These liabilities can range from damage to their client’s property to damage to the business’s vehicles and employees. Businesses have free rein to choose how much losses they want to insure, this is also known as a coverage limit. In the event of a loss, the insurance company will compensate the business up to the coverage limit.
Without the proper general liability insurance in place, the business would need to pay for damages themselves. Some public contracting projects even require contractors to demonstrate proof of general liability insurance before they can bid on a job.
Although surety bonds and insurance both provide financial safeguards against risks, they differ in terms of who they are intended to protect. With a surety bond, a third party is promised payment if the policyholder fails to fulfill their contractual obligations. For instance, if a construction project is not completed according to the agreed terms, the surety bond will pay the client. However, the policyholder remains liable for any losses and the bond exists to safeguard the third party, not the policyholder.
On the other hand, insurance is designed to protect the policyholder from potential harm. When an individual or business purchases insurance, they pay a premium to the insurance company to receive coverage in the event of a negative occurrence, such as a car accident. In this case, insurance provides protection to the policyholder. The policyholder is not required to repay the insurance company in the event of payouts, though their premiums may increase after claims.
Getting licensed is often a legal requirement to operate a business within a state. This signals to customers that the business is legitimate and competent in its industries. It also shows a high level of expertise, especially since many licenses require businesses and individuals to pass exams. Licensed businesses also have to take on more accountability if something goes wrong. For consumers, licensed businesses pose lower risks than unlicensed businesses.
Getting bonded is important because it is often a prerequisite to getting licensed in many states. Bonds also provide a level of protection for customers and are helpful in building trust for the business. Bonds signal to consumers financial protection from possible damages or defaults. In 2022, the Surety and Fidelity Association of America (SFAA) found in a study that bonded contractor projects are 2.5 to 10 times more likely to be completed than unbonded projects. The same study also found that customers were also five times more likely to believe that the business they have hired will complete the project if the business was bonded.
Lastly, being insured is an important financial tool that protects a business for its liabilities and potential risks to the company. Insurance can repair or replace damaged property while also being able to cover potential costs. It offers a peace of mind to business owners that even if something really bad were to happen to their business, they would be covered.
For business owners, getting bonded, licensed and insured are cornerstones of running a business and a key tool to building trust with consumers. We recommend that all businesses look into getting bonded, licensed and insured. We are specialists in licensing and bonding here at SuretyNow, and we have friends who offer business insurance at great rates. Reach out if you have any questions related to getting bonded, licensed and insured.
For consumers, checking that a business is bonded, licensed and insured is an important step towards deciding if that business is trustworthy and safe. We recommend that all consumers check via the appropriate channels that a business has all three of those things (if applicable) before giving out sensitive information such as credit card information or SSN.