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State laws often require contractors to obtain a license bond and/or contract-specific bonds, as well as workers' compensation and liability insurance. The difference between contractors bonding and insurance is not always clear.

This creates confusion for contractor license applicants who wonder why they need both types of bonds and insurance.

Contractors bonding and insurance requirements

The licensing process for contractors typically requires them to obtain a contractor license bond and two types of insurance. While both the bond and insurance extend some kind of compensation or coverage, these apply to different parties and in different situations:

• contractor license bonds protect a contractor's clients and the public but require contractors to repay any compensation the surety extends to claimants;
• worker's compensation insurance policies cover employees in cases of work-related injuries; and
• employer liability covers employers from suits that arise in cases of work-related injuries.

What are contractor license bonds?

Contractor license bonds, and surety bonds in general, are more correctly described as a line of credit, rather than insurance. Upon getting licensed in many states, contractors need to obtain a license bond from a surety bond company against a premium. This bond is an agreement among the contractor, the state licensing agency or board and the surety company.

The bond places conditions on contractors to comply with state and federal laws and regulations for contractors. If a contractor violates the law, the licensing board may file a claim against the bond. Typically, state law also specifies the particular violations that are covered by the contractor license bond.

For example, according to the California contractor licensing law, property owners who contracted the contractor for construction work may file a claim against the bond if they have been damaged as a result of a violation on the part of the contractor of said law.

Bond claims can also be made against contract bonds, which include performance and payment bonds. These bonds are often required on specific federal or state projects. They guarantee that a contractor will perform work according to the conditions stated in the agreement between the project owner and the contractor. They also guarantee that contractors will pay to their subcontractors, suppliers and laborers for work and materials provided.

When a claim is made against the bond, it is investigated by the surety. If the surety concludes the claim is legitimate, it will usually pay compensation to claimants, up to the full amount of the bond. In turn, the bonded contractor must then repay the surety for the compensation it has extended. The contractor remains liable for his obligations, even though the surety company initially covers the claim. This is why bonds are equated to a line of credit, rather than insurance.

What are workers' compensation and liability insurance policies?

Unlike surety bonds, workers' compensation and liability insurance cover instances of:

• workplace injuries;
• injuries during work-related travel;
• injuries due to workplace violence;
• natural disasters;
• illnesses; and
• fatalities.

Workers' compensation insurance is a way of covering a contractor's employees. This insurance policy guarantees that employees will receive benefits such as medical care, disability income or rehabilitation, and will have expenses related to the injury covered. Usually, when employees are covered by employer's workers' compensation insurance, they automatically forgo the right to sue their employers for negligence.

Some employees may opt out of workers' compensation policies, or a particular employee or their particular injury or illness may not be covered by the insurance. In those instances, an employee may file a suit against the employer. This is when employers' liability coverage is required.

This type of insurance covers employers from suits arising in the cases named above, as well as in instances when third parties sue the employer or a family member of theirs files a suit. To apply, suits must be in relation to an employee's injury and employers must be legally liable for it.

Bottom line: contractors need both

Of course there are exemptions and strict conditions on both types of insurance policies. Yet, a significant difference between contractors bonding and insurance is that once an employer is insured, it do not have to repay the insurance company for those cases that are covered by the policy.

Furthermore, these policies are put in place to cover employees from work-related injuries, rather than instances of them not receiving their payment - which can be compensated under a payment bond agreement.

In order to protect both customers and the state from damages and violations. as well as employees and the employers themselves, a surety bond and insurance policies are required from contractor license applicants.