What does “licensed, bonded, and insured” mean? Let us help explain the differences between the three terms and why all three are important for construction contractors.
If you’ve ever worked in construction or have hired a contractor recently, you know that almost every construction contractor advertises their business as “Licensed, Bonded, and Insured.” These three key pieces are the basic requirements for any trusted contractor. But it’s also important to understand the difference between each term. Below we’ll review what it means to be bonded, and how it differs from the contractor being insured. We’ll also explain the types of contractor insurance policies a contractor needs to carry in order to be ‘licensed, bonded, and insured.’
Licensed: A Contractor’s License
Being ‘licensed’ means your contractor has a valid contractor’s license from the state and/or a local contractor licensing authority. In most states, the law requires contractors to have a contractors’ license before accepting new contracts. This license is typically issued by their state’s licensing board.
The purpose of the licensing system is to ensure that every contractor in that state or municipality has a basic level of competency, knowledge, and financial stability. Furthermore, the system also helps ensure that there are ways for clients, creditors, and governments to hold their contractors accountable in the event of a dispute. As contractor fraud can be a common issue, the licensing system is critical for creating accountability.
As part of the licensing process, the contractor is required to take at least one exam that test’s their knowledge of the construction field.
Another requirement is for the contractor to submit their financial records as part of the licensing process. The state licensing board needs to know that they are financially sound to sustain the business. The contractor must prepare to submit bank statements, tax records, and other financial documents during the process. The board will also check their FICO score and require additional items for applicants with low credit scores.
Contractors that accept large commercial contracts may need different licensing than contractors who only do home remodeling. Subcontractors such as plumbers or electricians also need different types of licenses.
The process for becoming a licensed contractor differs, depending on the type of contractor and their state, but in most cases, the process involved the following steps:
- Study for and pass all required state licensing tests.
- Apply for the state licensing board. The process includes an application fee, and submitting the following documents:
- Financial Records
- Business Plan
- Passing Exam Scores
- Proof of Insurance
- Proof of Contractor Surety Bond
- Passing Background Check
- Any Additional Required Licenses
A contractor license is the bare minimum that a responsible contractor needs before accepting new contracts. If you are planning on hiring a contractor, check your state’s contractor database to ensure they are licensed.
The next step for a contractor is the surety bonds and insurance required to obtain their contractor’s license.
Bonded: Contractor’s Surety Bond
Being a ‘Bonded’ contractor means your contractor has purchased a surety bond to guarantee their legal and financial obligations. Most states require construction contractors to obtain surety bonds.
What is a surety bonds?
A surety bond is a legally binding three-party contract. The relationship is as follows:
- The principal (ex: the contractor) is the business that pays the surety to guarantee their legal and financial obligation.
- The oblige (ex: the state licensing board or the client) requires the surety from the principal in order to obtain the bond. They can file against the bond if they believe the principal has violated the terms of the contract.
- The surety (ex: an insurance or surety bond company) guarantees the principal’s legal and financial obligation in return for a premium.
The bond contract specified the legal and ethical code of conduct for a contractor. If the state licensing board or the contractor’s client believes the contractor has violated or not fulfilled the bond’s terms, the injured party has the right to file a claim if they don’t receive compensation from said contractor.
When the oblige (board or client) files a bond claim, the surety will verify if the the claim is accurate and covered by the bond. If accurate, the surety will pay the claimant (oblige). The bonded principal (contractor) must pay the surety back for the full amount that is paid to the claimant.
To obtain a surety bond:
- The contractor must find a surety or surety bond broker that offers the bond(s) they require.
- A quote is requested, and the contractor provides their basic business and financial documents
- A surety underwriter will analyze the contractor’s risk level and create a quote that provides coverage based on their results.
- The surety or broker will send a final quote to the contractor for the surety bond cost.
- Once the bond premium is paid, the surety sends the final bond paperwork to the contractor to sign and have on-hand.
If a contractor advertises themselves as ‘bonded,’ they are typically referring to a general contractor license bond, guaranteeing that they will obey the law. Additional types of surety bonds exist, such as bid and supply bonds.
Insured: Contractor’s Insurance
Being ‘Insured’ means the contractor has purchased an insurance policy to protect against the risk that comes with construction and maintenance work. These are usually high risk and often increase with the size and complexity of a project. Common construction risks include property damage and worker’s compensation.
One of the biggest differences for contractors between having insurance and being bonded is which one takes on the risk. For the insurance policy, the risk transfers to the insurer. With a bond, it usually places the risk on the bonded principal (the contractor).
As the client, the main difference is which instances are covered by bonds, and which instances are covered by insurance. Both usually can cover the cost of hiring a new contractor to finish the job if the original contractor fails to pay the subtractors or complete the job.
Insurance specifically covers things like liability from injuries that happened on the job or if there was any damage to the client’s property. In most states, a contractor must have some or all of the following insurance coverage:
- General Liability: This protects your company from claims of third-party bodily injury or property damage caused by your company. If a person walks into your office or onto a job site and slips and falls or is hit by falling debris caused by your workers in the course of your business, your contractor general liability policy would kick in.
- Worker’s Compensation: Workers’ compensation covers injuries to your employees who are injured while in the course of their work.
- Vehicle Liability Insurance: This covers injuries or property damage caused by a contractor’s vehicle.
- Pollution Liability Insurance: Protects against liability from damage caused by hazardous waste materials.
To obtain insurance coverage, a contractor must contact an insurance company, like Hertvik Insurance Group, and apply for the policies they need. Similar to a bonding company, we use an underwriting process to determine whether the contractor is a good risk. We even offer insurance packages that combine multiple products into one single affordable policy.
Becoming “licensed, bonded, and insured” is a complex and long process for contractors. Hertvik Insurance Group provides you with insurance coverage for your unique needs. Search for a bond or get started today with a quote.