Contractors typically need financial assurance to participate in construction projects. Two of the most common options are surety bonds and letters of credit (LOCs). Both forms of contractor financial assurance can satisfy project owner requirements, but they have different upfront costs, claims handling procedures, and impacts on a contractor's financial flexibility.
Below, we outline the major differences between surety bonds vs. LOCs. We also explain how this knowledge can enhance agents’ credibility and increase their value with their contractor clients.
In the construction industry, project owners want financial assurance that their contractors will complete their work as promised and pay their subcontractors and suppliers on time. If a contractor fails to meet their obligations, the project owner can draw on that financial assurance to offset losses and keep their project on track.
Two of the most common forms of contractor financial assurance are surety bonds and LOCs. While they serve a similar purpose, they carry distinct advantages and drawbacks.
As an insurance agent, helping your contractor clients choose the right solution can distinguish you as a trusted advisor. At United Casualty and Surety Insurance Company (UCS), we help insurance agents do just that with our flexible bonding solutions.
A surety bond establishes a legal agreement between the following three parties:
If the principal fails to meet their contractual obligations, their obligee can seek compensation from the surety by filing a claim. The surety will investigate the claim before providing funds up to the total bond amount. After that, the principal must pay their surety back in full.
To obtain a surety bond, contractors only need to pay a fraction of the total bond amount, typically ranging from 1% to 3%. This is known as the bond premium. Underwriters base contractors’ premium rates on their character, credit, capital, and other financial factors.
Since surety bonds have relatively low upfront costs, they empower contractors to pursue new projects without significantly compromising their liquidity.
Learn More: Why Private Construction Projects Pose Unique Bonding Challenges
Three common types of construction surety bonds include:
Learn More: 6 Essential Bonds To Support Your Contractor Clients' Business Growth
An LOC is a direct financial instrument issued by a bank that guarantees a contractor’s payment to their project owner if they fail to meet their obligations. To obtain an LOC, contractors must pledge cash or assets as collateral, often equal to 100% of their LOC’s value.
This collateral requirement can tie up contractors’ working capital, limiting their liquidity and borrowing capacity. As a result, contractors who use LOCs typically have less money available for labor, equipment, new bids, and other growth-focused investments.
Another key difference is that banks don’t investigate project owners’ claims before extending payment. They pay project owners immediately on demand, regardless of whether the contractor disputes the claim. The contractor must then reimburse the bank in full.
Despite these downsides, LOCs are useful for new contractors who want to gain experience before qualifying for surety bonds. They may also be suitable for small, one-off projects that don’t require a formal bond line. However, the disadvantages of relying on LOCs often outweigh their convenience as contractors grow.
Learn More: A Growth Opportunity for Agents: Meeting the Bonding Needs of Today’s Small Businesses
Here’s a quick comparison that clearly outlines the key differences every agent should understand about surety bonds vs. LOCs:
|
Surety Bond |
Letter of Credit |
|
|
Cost |
Premium based on risk (typically 1% to 3%) |
Full collateral or credit line required |
|
Collateral Requirement |
Usually none |
Often 100% of LOC value |
|
Impact on Liquidity |
Preserves working capital |
Ties up working capital and reduces cash flow |
|
Underwriting Approach |
Based on character, capacity, and capital |
Based on available assets or cash |
|
Claims Handling |
Surety investigates before payment |
Bank pays immediately on demand |
|
Long-Term Relationship |
Builds trust and gradually increases bond line capacity |
Transactional with no established path for growth |
The U.S. insurance industry is highly competitive, employing over three million Americans. To grow and retain your client base, you need to differentiate yourself from other agents.
One of the most effective ways to stand out is by strengthening your surety expertise. When you can clearly explain the differences between surety bonds and LOCs and guide contractors toward the option that best supports their growth, you elevate yourself from a basic policy provider to a trusted advisor.
Here’s how to put this valuable expertise into action:
By taking this advisory approach, you can enhance your agent value, deepen client trust, and position your agency as an indispensable resource for growing contractors.
Learn More: How Trust in a Surety Partner Impacts Business Growth
While surety bonds offer better long-term value in most scenarios, there are some situations where an LOC can serve as a practical short-term solution, such as:
In cases like these, you can suggest LOCs as a temporary solution to help your contractors secure work now while they establish their bond eligibility.
If you want to set your contractor clients up for success, add surety bonds to your suite of risk management solutions. Every bonded project can gradually expand your clients’ capacity and enhance their reputation among project owners.
At UCS, we can help you make this transition with ease. As a surety-only company, we’re dedicated to helping insurance agents navigate surety bonding complexities with confidence. We stand out for our:
With our support and surety expertise, you can empower your contractor clients to move beyond the limitations of LOCs and unlock greater growth potential.
In summary, surety bonds and LOCs are both useful tools to offer contractor financial assurance. However, surety bonds provide superior financial flexibility, growth potential, and underwriting oversight.
If you’re ready to help contractors transition from restrictive LOCs to strategic bonding solutions, UCS can support you every step of the way. Contact our team today to learn how we can help your clients build capacity and win more work.
A: Yes. In some cases, project owners may require both forms of security, especially on large or high-risk projects. An LOC can serve as an additional financial guarantee alongside a performance or payment bond.
Most contractors prefer to rely solely on surety bonds once they’ve established a strong bonding relationship, since they offer the same protection without tying up valuable capital.
Key takeaway: It’s possible to use both, but building bond capacity with a trusted surety company is more cost-effective long term.
A: Not necessarily. While an LOC doesn’t involve a premium, it ties up a contractor’s collateral or limits their borrowing power, both of which carry real financial costs. Surety bonds have a small upfront cost, but they preserve the contractor's working capital.
Key takeaway: Surety bonds preserve liquidity and are often the more economical choice overall.
A: Some project owners prefer LOCs because banks pay them on demand without investigation. However, this immediate-payment structure increases contractors’ risk exposure significantly.
Surety bonds provide fair treatment for all parties with their thorough claims review process and detailed underwriting. They also give project owners greater confidence, as bonded contractors have already been pre-vetted and approved by a third party.
Key takeaway: LOCs are easier to call but lack the balanced protection of a surety bond.
A: Insurance agents can help contractors get bonded by reviewing their financial statements and working capital, educating them on the benefits of bonding, guiding them through their applications, and partnering with a trusted carrier like UCS.
Key takeaway: Agents who guide contractors through the bonding transition can strengthen their long-term relationships and help clients free up capital for growth.
A: Bonding enables contractors to preserve their capital and grow their businesses by steadily increasing their bond capacity over time. Surety bonds also strengthen their credibility and financial reputation in their industry by providing project owners with verified performance assurance.
Key takeaway: Surety bonds support both project success and long-term contractor growth.
Deloitte. 2026 global insurance outlook.
CoinLaw. US Insurance Industry Statistics 2025: Facts, Figures, and Emerging Trends.
https://coinlaw.io/us-insurance-industry-statistics/