The Purpose of Performance Bonds

Performance Bond
Performance Bond

Performance bonds is a surety bond that is issued by an insurance company or a financial institution like a bank that guarantees the completion of a contract by a contractor in a satisfactory manner.

The way that this works is that when a contractor bids on a construction job, a bid bond is usually required, in order to bid the job. Once the job is given to the winning bidder, a payment and performance bond is required as security that the job will be completed.

An example of the workings of performance bonds is that a performance bond will be issued for a client for which the contractor is building a building. If the building for some reason is not constructed in the manner spelled out by the contract, the client is then guaranteed a certain compensation for any loss financially up to the amount of the bond. Most often this occurs due to bankruptcy of the contractor.

The development of real property is one of the more common instances of the use of these types of bonds, as owners and investors want to be reassured that their investment will not go by the wayside should a contractor go bankrupt. Another use of a performance bond is when commodities are being sold that the commodity will be delivered as ordered for a certain price at a certain time.

To further add solid reassurance in these sort of transactions, you will find that a performance bond is issued along with a payment bond, or titled as a “performance and payment” bond. This form simply guarantees that the costs of material and labor will be paid for by the contractor.

Surety Bond Companies are institutions are firms that specialize in the issuance of these types of bonds. The premium that is paid is based upon the type of bond being issued, the amount of the bond, and the financial risk of the applicant.

Currently, surety bond companies have statistics on just about every risk that could occur for various types of bond risks. For example, a construction project in the mountains of Alaska may have a higher risk factor than an apartment construction project in Atlanta.

There are currently over 25,000 categories of Surety Bonds in the United States, and each faction has its own bond amount. The bond rates are then based upon the risks for that particular category, and then a premium of between 1% and 15% is charged on the bond amount.

If a company has an excellent performance record as far as their ability to complete projects on time and as specified in the contract, then they will enjoy a lower bond rate, than a company who has a history of late completion dates and any financial issues along the way.

The concept of a bond is simply a way to help investors and owners be able to make prudent decisions in regard to the safety of capital and the likelihood of the successful completion of a project.