Private School Bond Information
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What is a Private School Bond?
Private school bonds are a type of surety bond that guarantees the return of prepaid tuition and fees in the event that a school closes and fails to refund that money.
Private school bonds are usually classified as a type of license bond because obtaining one is a condition for receiving a license to operate in a particular state. In some states, they are regarded as performance bonds. In some states, they also guarantee that a school will honor other contractual obligations or pay monetary damages if they lose accreditation, refuse inspection, or distribute false or misleading information about the school.
Who Needs Them?
Forty-three states plus the District of Columbia currently require private school bonds:
District of Columbia
If you plan to operate a private school in one of these states, you will need to purchase a private school bond and renew it before its expiration date. Not maintaining an active bond in force at all times can result in suspension or revocation of the school’s license.
A wide range of educational institutions may be considered private schools, including private K-12 schools, career schools such as cosmetology schools, vocational schools, business schools, driving schools, and more. Be aware that some states refer to a private school bond by another name that specifies the types of schools subject to the bonding requirement.
Some private school owners may choose to purchase a private school bond even though their state does not require one. Voluntarily purchasing a private school bond engenders confidence on the part of students and parents—confidence that the school will deliver the desired educational services and live up to their expectations. Voluntary bonding gives a private school a marketing advantage over its unbonded competitors. It also provides motivation to exercise good judgment in managing the school and making it profitable.
Why Are They Needed?
The states that require private school bonds do so to provide financial protection for students and parents in the event that a school closes due to insolvency or any other reason. Tuition is paid at the beginning of a term or semester before the student has received the instruction to be provided in exchange for that tuition. (As it is used here, “tuition” includes all fees, charges, the cost of books purchased, and prepaid room and board if applicable.)
Under the “fee for services” principle, it is a service provider’s responsibility to reimburse customers who have not received the services they have paid for. With annual private school tuition in the U.S. averaging nearly $27,000 (excluding parochial schools), there is a good amount of money at stake.
Private school bonds also promote good governance, because they legally obligate private schools to abide by certain laws or risk having to pay monetary damages to parties financially harmed by a violation of those laws.
In short, bonding establishes accountability for monetary losses stemming from poor financial management or malfeasance by a private school’s administrators.
How Do They Work?
The surety bond agreement for a private school bond is legally binding on all three parties involved, known as the obligee, the principal, and the surety.
The obligee, the state agency or department requiring the bond, establishes the required bond amount or provides the formula for calculating it. The most common methods for determining the required bond amount are:
- A percentage of the school’s total revenue for the prior year
- A percentage of the maximum prepaid, unearned tuition for a semester, quarter, or year
- A flat fee, which may be different for accredited and nonaccredited schools or degree-granting and nondegree-granting schools
- An amount sufficient to fully repay all tuition costs if the school closes
The principal, the private school owner, is legally obligated to comply with applicable laws and the terms of the surety bond agreement and to pay all valid claims against the bond.
The surety, the bond’s guarantor, investigates every claim received and determines its legitimacy. When possible, the surety may attempt to negotiate an amicable settlement. If no settlement is reached, the surety typically won’t wait for the principal to pay the claim. Instead, having guaranteed the payment of claims, the surety will pay it initially and then collect repayment from the principal. That payment represents an extension of credit to the principal, creating a debt that the principal must pay to avoid being sued by the surety.
How Much Do They Cost?
The annual premium for a private school bond is the product of multiplying two figures: the required bond amount established by the obligee and the premium rate set by the surety. But it’s not a foregone conclusion that an applicant will be approved for a private school bond. That depends on how risky the surety’s underwriters think it is for the surety to pay claims on behalf of the principal.
The underwriters will inspect the applicant’s business experience, financial strength, and credit history, as well as the school’s enrollment and revenue from tuition. The goal is to determine not only the risk of the surety not being repaid for any credit extended to the principal, but also the likelihood of the school closing its doors without refunding prepaid tuition.
A principal with a good track record in business should have the financial acumen to keep their private school from becoming insolvent. And a high personal credit score is proof of a history of financial responsibility and repayment of debt.
A principal meeting this description presents a low risk to the surety and, therefore, will be assigned a low premium rate. The risk to the surety is higher when the principal is less qualified, which warrants a higher premium rate and could even be denied a private school bond.
The average well-qualified principal will pay a premium rate in the range of one to four percent.
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