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California contractors often confuse contractors bonding with liability insurance as they are both highly common in the California construction industry with more than 95% of contractors utilizing bonding according to some estimates, while liability insurance is perhaps the most common form of insurance purchased.  Many contractors understandably think they are quite similar when in fact, they couldn’t be more different.  In this article, we’ll discuss many of the similarities and differences between a contractors bond and liability insurance based on how they are utilized in the California construction industry.

Who Benefits From A Contractors Bond vs. Liability Insurance?

A contractor’s license bond is a type of commercial surety bond required by the state of California for the benefit of a contractor’s customers or employee’s should they be financially damaged as a result of a contractors unlawful actions.  With this in mind, a contractors bond is not for the direct benefit of a contractor, but to protect others from a contractors harmful or negligent actions as defined in the California business and professions code.

Liability insurance on the other hand, is generally an elective coverage for most California contractors, unless they are organized as an Limited Liability Company (LLC).  Many prudent contractors elect to purchase liability insurance to provide added protection for themselves in the event of a bodily injury or property damage claim.

What Are The Coverage Options For A Contractors Bond vs. Liability Insurance?

California contractors are required to maintain an active $15,000 license bond (or cash equivalent) on file with the CSLB as a condition of being licensed.  The amount of the bond is fixed by law, which means a contractor cannot request a higher or lower bond amount, though currently a bond of qualifying individual is for the lesser amount of $12,500.  As such, there are no elective coverage options for contractors license bonds in California for contractors to choose between.

Liability insurance, on the other hand, is available in many different coverage limits with some policies starting at a limit of around $250,000 and extending into the 10’s of millions through excess liability policies, with limits of 1 million being a very common coverage amount for small contractors.  Because liability insurance is generally not mandated by law for most California contractors, they are free to choose whichever limits they are approved for by the insurance company and are also willing to pay for.

How Much Does A Contractors Bond Cost vs. Liability Insurance?

The cost of contractor’s bonding in California can vary widely as a result of many factors including credit score and license history, among other variables.  Contractors with good credit and a clean license history will often times see bond rates of about $100 per year for the $15,000 license bond, while those with poor credit or other license issues could see rates as high as $2000 per year under some circumstances.  As each surety uses their own unique proprietary rating system, bond premiums can vary greatly between surety’s.

As with contractor’s bonding, the cost of liability insurance can fluctuate widely depending upon coverage’s chosen, construction trades, payroll, as well as many other factors set forth by each insurance company.  Generally speaking, many policies start at around $700 per year and go up exponentially based on some of the factors listed previously, as well as many others not discussed.

How Are Rates Determined For A Contractors Bond vs. Liability Insurance?

As mentioned, each surety will utilize its own proprietary rating system to determine how much a particular bond will cost each contractor, but nearly all will evaluate a contractors credit and contractors license history, with some rare exceptions.  Many will also surcharge some higher risk classifications such as c-39 roofers or c-53 pool contractors.  Because a contractors bond is a type of surety bond that requires indemnification, many surety’s rely heavily on credit scores to evaluate a contractors ability to repay them in the event of a claim.  Much as a bank would not willingly make a loan to an individual with limited means of repaying it, a surety is looking for a similar level of security when issuing a contractors bond.

By contrast, many insurance companies do not use a contractors credit when preparing their rates, though some probably do when permitted by law.  Many insurance companies will rely heavily on the type of work a contractor is doing as well as their revenue and payroll figures to give them a sense of the risk posed by a particular contractor, and their likelihood of having a claim.  Liability insurance involves risk pooling, a common insurance mechanism, whereby premiums are collected from a large pool of policy holders that is then used to pay the claims of a small few, if and when they should occur.

How Are Claims Handled For A Contractors Bond vs. Liability Insurance?

A key distinction between a contractors surety bond and liability insurance comes into play in the event of a claim.  Contractor bonds require indemnity, meaning if a bond company has to pay out as a result of a contractors unlawful actions, the contractor is required to repay the surety the amount of the claim, plus expenses.

Liability insurance on the other hand, generally does not require indemnity.  If a covered claim occurs, the contractor typically does not have to reimburse the insurance company for the claim under ordinary circumstances.  When a claim is filed on a liability insurance policy, the insurance company will review the claim and the policy to determine if the event in question is covered by the policy.

Conversely, when a claim occurs on a contractors bond, the bonding company will review the facts of the case, request information from involved parties and gather any information provided by the Contractors State License Board to determine if a violation of the business and professions code has occurred, which in turn determines if the bond company will pay out on a particular bond.

Does Each Contractors Bond or Liability Insurance Policy Contain Coverage Exclusions?

All contractors license bonds regardless of the bond company issuing the bond, function in a similar manner with regards to when a claim is valid or not.  Contractors license bonds in California generally do not contain exclusions in the traditional sense, whereby for example, a bond from company “x” covers something excluded by company “y”.  With a contractors bond, the entity requiring the bond (the state of California) defines what the law (and in turn a violation of the law, ie valid claim) is under the business and professions code.  The surety does not have a choice to cover some items, and not others.  With this in mind, however, each bond company will have variations in their contract with each contractor specifying the nature of the surety bond relationship in the event of a claim, such as the terms of repayment, legal venues, as well as other contractual agreements and stipulations.

By comparison, virtually all liability insurance policies will have coverage exclusions of some sort, with some policies having more exclusions than others.  What is, and is not covered in the event of a claim can vary greatly between insurance policies, added or removed endorsements and insurance companies with regards to liability insurance.

 

By Jeremy Schaedler

 

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