YOU ASK:

Performance bond vs. professional liability insurance – what is the difference?

WE ANSWER:

Let's first define the two terms.

A Performance bond is a guarantee of compensation for monetary loss as a result of the failure of one party to meet his obligations as stipulated in the contract.

That means if you agree to finish, say, a software project for a client that you promised will be done by a certain date and will perform specified functions, and you fail to deliver it at the appointed time, you will have to pay the bond.

The bond can also kick in when the contractor fails to build the structure as stipulated by the specifications or blueprint agreed upon. This is usually used by building contractors, as well as software developers.

A professional liability insurance policy is a coverage against errors or omissions done by a professional that resulted in a loss for the client or customer - whether this loss was physical or financial (but in most cases, the loss is financial).

For instance, a fitness consultant provides fitness training and advice to clients. A client came to him for personal training. The exercise routine he provided aggravated an existing back problem and as a result, the client needed back surgery. The client can sue the fitness professional for the bodily injury and the need for surgery, as well as for pain and suffering.

Another example would be a stock broker who advised a client to buy a particular stock. This stock later plummeted in value. The client can then file a lawsuit, stating that the stock broker's bad advice caused him to lose a substantial amount of money.

Here are some areas of difference between the two:

  • Purpose. A performance bond is used to guarantee that a contractor will finish a project and ensure that the project meets the specifications. This includes protection against failures in workmanship or design defects. A professional liability insurance policy is used to protect the professional in case he makes an error that causes his client to suffer loss.
  • Coverage. Usually, the bond will hold until the project is finished and is signed off by the client. Professional liability, on the other hand, can cover previous mistakes where the loss is felt just recently.
  • Payments. The bond is put up by the contractor and will be paid to the client for default in the completion of the project. Upon the default of the contractor, the bond may be used to pay for inspection costs, administrative costs and the cost to finish the project. Professional liability insurance will pay for legal defense costs and will also pay for settlements or judgments with regards to the damages the professional is required to pay.
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