Insurance Bonds in Construction: What They Are and How They Work

Joey Randazzo
September 24, 2022
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Imagine a potential customer with a huge construction project in mind. When they start looking for someone to complete their build, they’ll want to choose someone based on their stellar reputation. 

But what if they don’t really know anything about the potential construction companies?

Possible clients want their money and their interests safeguarded, so they’ll be looking for companies that have obtained insurance bonds. This may be one of the most important things you can do to build trust in your company.

But what is an insurance bond in construction? And how do they work?

Keep reading to find the answers to these important questions and more.

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What Is an Insurance Bond in Construction?

An insurance bond is a type of construction bond that guarantees contractors will fulfill their end of an agreement and that all work will comply with …

… regulations. 

These bonds for construction are used by investors in building projects to insure against financial loss caused by a contractor’s failure to meet contractual specifications or complete a project.

Since clients may be entrusting huge sums of money to construction businesses, it makes sense that in most cases general contractors are required to have bonding for construction. Insurance bonds in construction help the customer have peace of mind and establish trust between all responsible parties.

How Construction Surety Bonds Are Different From Guarantees

Insurance bonds in construction are a type of surety bond. Many people use the phrase surety bond interchangeably with a guarantee, but the two terms actually mean slightly different things and are unique legal entities.

A guarantee is an independent promise made by the bank or insurer and only gives assurance that something will be completed on time. Unless there is an abuse of rights, there is no condition in which the guarantor can get out of fulfilling their obligation.

But an insurance bond is protection provided by a bonding company that protects property or work completion when one party doesn’t hold up their end of the contract. This surety bond is an accessory security, so it follows the main obligation and ensures performance within its limits.

A construction insurance surety bond can only exist for a valid agreement. If there is a disagreement over the terms, the guarantor is allowed to oppose payment until the principal is unable to perform its obligations or a final judicial decision in favor of the beneficiary has been reached.

Bonds for construction work are based on a three-party agreement between the:

  • Principal 
  • Obligee
  • Obligor

You’ll learn about these parties in-depth later.

How Insurance Bonds Are Different From Construction Insurance

Construction insurance is a contract between an insurance company and your business. If you make a claim and it is covered under your policy, the insurer is expected to pay and you don’t have to reimburse them in any way.

But it’s different with an insurance bond. A surety bond is like a line of credit. If a claim is made, you as the borrower must pay — not the lender that provided the surety.

It generally works like this:

  1. A claim is filed by the impacted party.
  2. An investigation is conducted by the surety provider.
  3. If the claim is found to be valid, the surety provider will cover the initial costs.
  4. You pay back the claim costs to the insurance bond provider. 

Both construction insurance and insurance bonds are important in this industry. When potential customers see that companies are bonded and insured, they know they can trust that company to do the job — or be forced to pay.

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What Is the Purpose of a Construction Insurance Bond?

The purpose of an insurance bond in construction is to provide a guarantee to the customer that the project they envision will eventually be completed, even if the initial contractor fails to finish or goes bankrupt.

This takes any risk on the part of the customer of an unexpected loss — due to delay or incompletion, for example — and transfers it to the bond provider. The bond provider in this case may be a bank or an insurance company.

How a Construction Bond Works

The way construction bonds work is pretty straightforward. 

If the construction company obtaining the bond doesn’t follow the terms of the contract, the customer who hired them to do the work can file a claim seeking damages against the surety bond company.

As long as the claim is valid, the bond company will remedy the situation through payment or other means. Then, as we said before, the bonded party is expected to pay back the claim.

Insurance bonds in construction work by guaranteeing that the customer gets compensated for any damages and the contractor is held financially responsible.

The Parties Involved in a Construction Bond

Bonds for construction work are based on a three-party agreement between the:

  • Principal — the contractor needing the bond
  • Obligee — the project owner requiring the bond; and
  • Obligor — the surety provider who sells the bond

Let’s explore each of these parties and their responsibilities in detail.


The principal in a construction bond is the contractor. They are responsible for:

  • Getting the bond
  • Renewing it; and
  • Paying any binding claims filed against it

The Benefits for the Principal

Construction bonds benefit the principal by making potential customers more confident in hiring them.

Since they know the construction company will be held accountable and their own interests will be protected, project owners can hire without hesitation. This means a construction company, the principal, will be able to secure a greater number of jobs.


The obligee is the client or project owner. If the principal causes damages, the obligee has the right to file a claim against the construction bond seeking compensation.

The Benefits for the Obligee

The obligee benefits from the construction bond by having mitigated risk in the case of unfulfilled contractual obligations. Filing a claim against the bond means they can be compensated for any unmet benchmarks or lost time.


The obligor is the surety bond agency.

They issue bonds to the principal and pay claims made by the obligee. They also demand repayment from the principal — including interest and fees — once any claims have been paid.

3 Types of Construction Bonds

When you see someone referring to construction bonds, they may be talking about one of three different types of bonds. 

While each one is slightly different, construction companies usually need all three and may get them from the same bond provider.

Let’s look at the differences between the three main types.

#1: Bid Bonds

The first construction bond required in the process, a bid bond confirms to the obligee that the principal will obtain the required performance bond once they are awarded the contract.

If a contractor wins a bid and then doesn’t commit to the project, the client may file a claim against the bid bond. Many large public-sector projects use bid bonds as part of their process.

#2: Performance Bonds

Performance bonds are guarantees that the construction project will follow the terms of the contract and reach completion. 

If a contractor doesn’t finish on time or meet agreed-upon standards for …

  • Budget
  • Quality
  • Consistency; or
  • Any other components of performance

… these losses will be covered by the performance bond. 

#3: Payment Bonds

Payment bonds hold contractors accountable for paying any suppliers or subcontractors they work with throughout the project.

If anyone who has done work on the project hasn’t been paid in full, they may file a claim against the surety bond for complete compensation.

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People in the construction business implement strict guidelines to ensure that all parties involved are compensated if things don’t go just right. Insurance bonds are just one way to do this.

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