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Surety Bonds Versus Cash and Money Markets

July 9, 2022

Surety Bond Vs. Cash and Money Markets

 

Surety Bonds are often compared to Cash or Money Markets when it comes to providing financial protection. Learn the advantages and disadvantages of these products.

 

What is a Surety Bond?

 

A Surety Bond is a three party agreement that provides a promise from one party to another and is guaranteed by a third party surety bond company. The party making the promise is called the Principal. The party receiving the promise is called the Obligee. The third party that is responsible for guaranteeing the Principal’s promise is the Surety Bond Company. In exchange for guaranteeing the promise, the surety bond company receives the payment of a bond premium.

 

What is Cash?

 

Cash is money in the form that is ready to be spent such as coins or currency. Cash does not have to be converted to be spent like receivables or checks. 

 

What are Money Markets

 

Marketable Securities are investments that are liquid and can be easily converted to cash, without a loss in value. These investments are generally due in 90 days or less. Examples of marketable securities include Certificates of Deposits, savings accounts and some government bonds.

 

Advantages of Cash and Money Market Versus Surety Bonds

 

Cash and Money Markets have some advantages over surety bonds. These advantages include cost, ease of obtaining and time. 

 

 

This shows three boxes with 3 advantages of cash over surety bonds. The background is a pile of cash.

 

Cost

 

Surety Bonds generally cost between 0.5% - 3% of the obligation amount. This can either be a one time cost, or an annual cost depending on the obligation. Alternatively, cash and money markets earn money. As of July, 2022, the average money market rate is about 1% according to Nerdwallet.com. Using cash and money markets earn money where surety bonds cost money.

 

Ease in Obtaining

 

Some Surety Bonds are instant issue and can be obtained with very little information. However, most surety bonds require at least a credit check on the Principal. Other bonds require additional information such as financial statements, applications, resumes, etc., so that the surety bond company can underwriter the Principal and underlying obligation.

 

On the other hand, cash and money markets can be obtained by anyone with no underwriting. Usually, one must just open an account at a financial institution. This makes using these financial tools very quick and easy. 

 

Time

 

Surety Bonds go through underwriting. More complicated obligations take time for underwriters to review information and provide approval. Alternatively, cash can be used right away and money markets can be set up very quickly in most cases.

 

Advantages of Surety Bonds Versus Cash and Money Markets

 

Surety Bonds have advantages over Cash and Money Markets. These advantages include Opportunity Costs, Claims Investigation and Not Being Fully Funded.

 

Opportunity Costs

 

Although Surety Bonds have a direct financial cost, they are usually far cheaper in terms of opportunity costs. Surety Bonds are considered a form of unsecured credit. That means that it does not tie up the Principal’s resources such as borrowing, cash or hard collateral. These resources can instead be used for other purposes such as investments or operations of the Principal’s business.

 

Alternatively, cash and money markets struggle to keep up with inflation. That means that these tools generally lose buying power over time. This is a major advantage for surety bonds. Using surety bonds allows someone to invest their cash somewhere that it can generate a more substantial return.

 

Claims Investigation

 

Surety Bonds require that a trained professional investigate claims to make sure they are valid before paying the claim. This protects the Principal on the bond from frivolous claim activity. 

 

Cash and money markets used to guarantee obligations are taken immediately in a claim situation. Usually the person or company posting these resources must litigate and seek civil remedies to get them returned. This can be costly and time consuming. 

 

Surety Bonds are Not Fully Funded

 

Surety Bonds are written on a percentage of the Principal’s financial strength. That means the Principal does not have to fully fund the surety bond obligation in most cases. For example, to get a $1,000,000 surety bond, a Principal may only need $100,000 in net worth to qualify for the bond. Alternatively, someone using cash or money markets would have to fund the full $1,000,000. Having the resources to qualify for a surety bond may be significantly easier. 

 

Surety wooden blocks over cash wooden blocks on the left. On the right, three boxes showing the advantages of surety bonds over cash.

 

Surety Bonds are a significantly better way to cover obligations than Cash or Money Markets for most people and businesses. They do have a cost but more than make up for it when you look at opportunity costs and claims. Another common tool to guarantee financial obligation is an Irrevocable Letter of Credit. You can read more about how they compare to surety bonds here. For more information on surety bonds, visit our Surety Bond FAQ page. Additionally, contact the bond experts at Axcess Surety anytime for all your surety bond questions.

 

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