If the ‘principal’ defaults on its obligations, the surety will pay the obligee and try to recoup the costs from the principal. Surety bonds are typically issued by large insurance companies as well as their subsidiaries, as well as by financial institutions. Before agreeing to issue a surety bond, the surety will perform a thorough investigation on the “principal”; such as, their ability to complete the project, their past performance history, credit rating and their management structure.
This will allow the surety to determine the risk level of the principal, as well as determine which premiums to charge, which can vary between 2% and 10% of the amount of the bond. Principals in sectors that have a greater risk of default, such as contractors, typically pay high premiums in order to obtain surety bonds.