Contract surety bonds: vital to Alaska's construction industry: making sure project owners are safe.

• Author: Barbour, Tracy
• Position: BUILDING ALASKA

In Alaska and other parts of the country, contract surety bonds are an integral part of the construction business for contractors as well as project owners. A surety bond is a written agreement in which one party, the surety (usually an insurance company), obligates itself to a second party, the obligee, to answer for the default of a third party, the principal.

Contract surety bonds provide financial security and construction assurance on building and construction projects by assuring the project owner (the obligee) that the contractor (the principal) is qualified to perform the work and will pay subcontractors, laborers and material suppliers. In essence, a bond protects the project owner against losses resulting from the contractor's failure to meet a certain obligation.

Like an insurance policy, surety bonds are a means of transferring risk and providing for the event of a financial loss. But that's where the similarity ends. Unlike a traditional insurance policy, surety bonds agreements are between at least three parties. And surety bonds don't protect the person purchasing the coverage. Instead, they provide coverage for someone else: the project owner.

Surety bonds are a financial instrument, not a traditional insurance product, says Linda Hall, director of the Alaska Division of Insurance. She explains: "In a typical insurance product--a homeowners' policy, for example--when a claim occurs and is paid, there is no recourse for the homeowner to repay the insurance company. The collective premiums paid by the policyholders of the company are used to pay the claims that take place. When a surety bond is secured for a specific purpose, the principal on the bond also becomes an indemnitor in the case of the default of the principal or contractor. The principal on the bond would be obligated to reimburse the insurance company for any losses they are required to pay in the case of the default." [ILLUSTRATION OMITTED]

In Alaska, contract surety bonds are normally required on most public construction projects, as well as larger private projects, according to Hall. However, she says: "Bonds are not required in all cases. Generally, the requirement depends on the work, the size and scope of the project, possibly the qualifications of the contractor for the type of project being bid, the time period it is estimated to take to completion (multi-year projects), the financial status of the contractor and other considerations."

BONDING SERVES A UNIQUE PURPOSE

There are a variety of surety bonds available to cover different situations. The most common types of...