Bonds are NOT a Form of E&O Insurance

Reader Martin Greenberg brought up a good point in a comment on my recent post “The Importance of E & O Insurance.”

“In the state of Arizona,” he wrote, “the licensing bureau offers a choice. E&O coverage or post a bond. Since few inspectors are successfully sued and plaintiffs rarely win more than a few thousand dollars, bonds make sense. However, the inspector is ultimately responsible for paying the claim in the event a plaintiff is successful.”

A number of states that require a license to perform home inspections also require that Home Inspectors carry Errors and Omissions Insurance in certain minimum amounts as a condition of licensure. The intent is to assure that the inspector will be able to respond financially in the event that her negligence causes harm to one or more of her clients. A handful of states allow Home Inspectors to fulfill their financial responsibility requirement by securing a surety bond.

The most important thing to understand about surety bonds is this: they are not insurance. They are a guarantee that, if the obligor [the Home Inspector] fails to fulfill an obligation that is covered by the bond [pay a judgment], the surety [bond insurer] will pay and then go against the obligor [home inspector] to be reimbursed. Most of us are familiar with the concept of bail bonds. If the defendant fails to appear for trial, the bail bond is forfeited.

The problem with claims against home inspectors that reach the lawsuit stage is not the size of the awards; though, contrary to the writer’s assertion, they can, in fact, be quite sizable. It is the size of the legal costs that, in professional liability cases, where the defendant almost always prevails, ensures that any victory will be a Pyrrhic one.

Another problem with surety bonds is that underwriters require the obligor [home inspector] to have substantial assets, usually 5 times the amount of the bond. Otherwise, the obligor has to collateralize the bond.

Thus, a $50,000 bond would require an obligor to have $250,000 in unencumbered assets in order to qualify. Or to assign collateral to the surety in the amount of the bond. The fees for bonds range from 1% to 3% - depending on the creditworthiness of the obligor - with a minimum premium of about $250. Thus, a $50,000 bond could cost upwards of $1500.00. A million dollar E & O policy would not cost much more than that, provide substantially more protection and not encumber or imperil assets.

Thus, while a bond might satisfy a statutory licensing requirement, the obligor is essentially self-insured. And would still have to hire and pay for her own counsel.