Surety is an obligation by a financial institution (which for our purposes is an insurance company) to guarantee the contractual or commercial obligations of one party, the Principal, to another, the Beneficiary.
Surety bonds can be required under the terms of a contract, or in accordance with statutory or licensing requirements, to secure the performance of the Principal in its commercial or contractual obligations to the Beneficiary.
As illustrated below, a surety bond is a tri-partite agreement issued by an insurer, the Surety, providing monetary compensation to the Beneficiary in the event that the Principal fails to perform its contractual or commercial obligations.
A counter-indemnity is taken from the Principal (and potentially its parent company) allowing the Surety to seek reimbursement in the event the Surety has to pay a claim under the surety bond.
Why are insurer issued surety bonds superior to bank surety?
Bonds issued by a bank diminish available headroom under lines of credit and can limit opportunities for growth.
Insurers generally issue surety bonds on an unsecured basis, being provided on the assessment of a company's financial strength and proven track record. The issuance of surety bonds by an insurer does not impact working capital or bank borrowing facilities and therefore can provide a useful boost to a company's liquidity.