“Insurers should partner banks to issue Surety Bonds”,​​​​​​​ says IRDAI Panel

Surety bonds – a brief introduction

Surety is a form of financial credit known as a bond guarantee. The transaction always involves three parties: the obligee, the contractor, and the surety. A surety bond protects the obligee (the party to whom the bond is paid to in the event of a default) against losses, up to the limit of the bond, that result from the contractor’s (the party with the guaranteed obligation) failure to perform its obligation. The surety, for example an insurance company, assumes the obligation if the contractor cannot.

How do surety bonds work?

Surety bonds are designed to ensure that contractors act in accordance with certain laws. They provide obligees with financial guarantees that contracts and other business deals will be completed in accordance with mutual terms. If the contractor breaks those terms, the harmed obligee can make a claim on the surety bond to recover losses incurred. The surety company then has the right to reimbursement from the contractor in the case of a paid loss or claim.

Surety bonds are especially important in the construction industry. They typically come in three types:

• Bid bonds – these are sometimes required by governments to guarantee that contract bids are made in good faith.
• Performance bonds – these ensure the construction work will be completed on time and to the required standard.
• Payment bonds – these give financial protection to subcontractors and others who provide services and materials to the construction company

The benefits of surety bonds

The Surety bonds by insurance companies will provide an alternative option to bank guarantees, which can free contractor’s capital as they may not require ‘collateral’ Bank Guarantee.

Surety Bonds are proven risk management mechanisms with a long history that help ensure public and private owners execute their construction projects in accordance with the plans and specifications and ensure subcontractors and suppliers are paid. Surety bonds help provide owners of construction projects with guarantees of success and enhanced reputations.

Indian Insurance Market Updates

• A Working Group (WG), headed by former CMD of New India Assurance, on suitability of offering of Surety Bond by the Indian insurance industry, has favoured such a move.
• The requirement has arisen because banks are not forthcoming as they were doing earlier to provide performance securities at the same cost. Now, banks in some cases want 100 % margin money before issuing bank guarantees. Highway sector is executing around Rs 5 lac crores projects at the moment and performance security varies to 5 % to 10 %, which this sector requires. Therefore WG has recommended that the IRDAI may issue separate guidelines to regulate the business of Surety Bond Insurance. The IRDAI may allow the insurers to enter into Surety Bond insurance business with solvency margin above a certain threshold.
• Initially it may be limited to only for performance guarantee i.e., project execution only. Maintenance aspects (for highways) which will come after completion of the project shall be treated as a separate annual contract with separate premium
• Specialist underwriters are required for dealing with Surety Bond. However, it may not be a challenge for Indian context as engineering underwriters with financial knowledge can be trained as focus on assessing risk is largely on contractor’s profile, moral hazard, credibility and past performance.
• It is recommended to have reinsurers supporting surety to have minimum A rating (S&P), or equivalent besides technical capabilities on underwriting, risk assessment, claims processes and portfolio monitoring of insurers and preferably with branch in India including IFSC, GIFT City.

Key points on panel suggestions

• Instead of Insurance industry handling alone, a mechanism is required wherein the banking sector and the insurance sector could collaborate for sharing of customer information since banks have more experience in managing these types of risks
• To start with performance bonds / surety bonds can be issued limited to the projects of NHAIs only and not for all the contractors.
• The rate should be determined by a market agreement

Beacon Capabilities

• Team of 180 experienced and certified insurance professionals
• 8 branches across India including Office in GIFT City
• Experienced Project Insurance Underwriters with engineering background
• Composite Broker transacting in both Direct & Reinsurance business
• Global connection with S&P-A rated re-insurance market with good solvency margin
• Concluded project insurance requirement for many NHAI projects