A surety bond is a legally binding agreement ensuring the performance or obligations of one party (the principal) to another (the obligee) with the guarantee of a third party (the surety). When a surety bond is issued, the principal typically pays a premium to the surety company in exchange for the surety assuming certain risks.
In certain situations, the principal may request, and be entitled to, a refund of part or all of the premium. But there are also instances in which no refund will be given. The basic concept that determines whether or not a surety bond premium refund will be granted is earned premium.
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Earned Premium
A bond’s surety charges the principal a premium for providing coverage of a specific risk for a specific period of time. For example, a license bond required from a contractor, accountant, real estate agent, freight broker, or other state-licensed professional typically must be renewed every year or two. There must be an active license bond in place at all times to prevent license suspension or revocation. The premium paid by the principal is the cost for the surety’s service for that entire term and typically is not refundable unless the bond is canceled before its effective start date. The premium is considered earned once coverage begins.
Some surety bonds can be canceled before the end of the bond term once the risk covered by the surety no longer exists. In such cases, the earned premium is usually pro-rated, meaning it’s based on the amount of time the bond has been in effect prior to cancellation. For example, if a bond with a one-year term is canceled after six months, roughly half of the premium might be considered earned.
Earned income is nonrefundable, as the surety has already provided coverage and taken on the associated risks for that time period.
Minimum Earned Premium
Many surety companies stipulate a minimum earned premium in the bond agreement. This is the minimum amount of the premium that will be considered earned, even if the bond is canceled early. For example, if a bond with a premium of $1,000 has a minimum earned premium of $250, the surety will retain at least $250 even if the bond is canceled shortly after its purchase. The minimum earned premium compensates the surety company for the cost involved in providing the surety bond.
Unearned Premium
Unearned premium refers to the portion of the bond premium that the surety company has not yet earned because the bond has not been in effect for the full term. This amount corresponds to the remaining coverage period that the surety has not yet provided.
The unearned premium is typically refundable if a bond is canceled before the end of its term, subject to the terms and conditions of the bond agreement and the surety company’s policies. This is the amount that may be returned to the principal if the bond is no longer needed. However, some surety companies may use a “short-rate” basis for refunds, which means the refunded amount is slightly less than what would be calculated on a pro-rata basis as a penalty for early cancellation. And some bonds have no provision for refunding unearned premiums after a certain period.
Example
Consider a couple of scenarios of prorating earned income for a one-year surety bond with a total premium of $1,200.
If the bond is in effect for 4 months:
- If calculated on a pro-rata basis, the earned premium would be $400 (1/3 of the total premium, as 4 months out of 12 months have been covered).
- The remaining $800 would be the unearned premium, which could be eligible for a refund if the bond is canceled at this point.
If the bond is in effect for 9 months:
- The earned premium would now be $900 (3/4 of the total premium, as 9 months out of 12 have been covered).
- The unearned premium would be $300, which could potentially be refunded if the bond is canceled.
To recap, the earned premium is the portion of the bond premium that the surety company has earned by providing coverage, and it is generally non-refundable. The unearned premium is the portion that the surety has not yet earned and is typically refundable if the bond is canceled before the end of its term, subject to the terms of the bond agreement and the surety company’s policies.
When a Surety Bond Premium Refund May Be Possible
A premium refund may be possible under the following circumstances:
- When the principal cancels a bond before its effective date, a full refund may be granted because the surety company has not yet assumed any risk.
- When the bond is canceled early (after it has taken effect), a prorated refund may be possible for the unearned premium. The refund amount is typically calculated based on the time remaining in the bond term and any minimum earned premium requirements of the surety company.
- When a bond was purchased but never filed or activated because it was no longer needed, a refund may be possible, depending on the surety’s policy. However, some administrative fees might be non-refundable.
- When there was an administrative error, such as a bond being issued with incorrect information that prevents its use, a refund may be possible if a corrected bond cannot be issued.
When a Premium Refund May Not Be Possible
On the other hand, there are situations in which the principal may not be granted a premium refund, for example:
- When the surety company has a minimum earned premium requirement in excess of any earned premium.
- When a claim has been made against the bond.
- When a bond is non-cancelable or is issued for a short term.
- When the premium is considered fully earned at the time of issuance, which is common for bonds issued for events, temporary licenses, or short-term projects.
- When the premium for a multi-year bond is paid upfront.
- When the principal cancels a bond due to noncompliance with the bond term or there is the fraudulent intent to avoid claims or obligations.
Other Considerations
The terms and conditions for canceling a bond and the possibility of a refund vary significantly between surety companies. Some charge cancellation fees, which are deducted from the refund amount, while others may have policies that prevent any refunds after a certain period.
Additionally, certain states have specific regulations regarding bond cancellations and refunds. It’s essential to be aware of these regulations as they may affect refund eligibility.
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