Surety bonds have recently come into the limelight due to the announcement in India’s 2022-23 budget. In an effort to boost infrastructure development, the government now allows the use of surety insurance bonds. These act as a substitute for bank guarantees in cases of government procurement and gold imports. Alongside this, the Insurance Regulatory and Development Authority of India (IRDAI) has released its final guidelines which will regulate the orderly development of surety insurance business in India. Furthermore, these IRDAI (Surety Insurance Contracts) Guidelines, 2022, will come into effect from April 1st, 2022.
Understanding the Concept of a Surety Bond
A surety bond is a legally binding contract involving three parties; the principal, the obligee, and the surety. The obligee, typically a government entity, requires the principal, usually a contractor or a business owner, to get a surety bond, which serves as a guarantee against future work performance. Aimed predominantly at infrastructure development, these bonds are intended to reduce indirect costs for suppliers and work-contractors, offering them alternative options and acting as a bank guarantee substitute.
Potential Issues Surrounding the Decision Taken in the Budget
While the decision to allow surety bonds seems progressive, this new concept also brings along uncertainties and risks. Indian insurance companies lack the expertise required for risk assessment related to this type of business. Additionally, there is no clarity on critical issues such as pricing, recourse against defaulting contractors, and reinsurance options. These factors could potentially impede the creation of surety-related expertise and capacities, and deter insurers from writing this class of business.
The Role of Surety Bonds in Boosting Infrastructure Projects
The move to frame rules for surety contracts could potentially address the large liquidity and funding requirements of India’s infrastructure sector. It presents a level playing field for contractors of all sizes. Moreover, it opens up an alternative to bank guarantees for construction projects. This will facilitate the efficient use of working capital and minimize the need for collateral by construction companies. Insurers partnering with financial institutions to share risk information could further enhance liquidity in the infrastructure sector without compromising on risk aspects.
IRDAI Guidelines on Surety Bonds
Insurance companies can now launch surety bonds, following the newly released IRDAI guidelines. The regulator has put a cap on the premium charged for all surety insurance policies underwritten in a financial year. The total amount should not exceed 10% of the total gross written premium of that year, capped at Rs 500 crore. Insurers are now permitted to issue contract bonds, which assure public entities, developers, subcontractors, and suppliers that the contractor will fulfill its contractual obligation when undertaking a project. These contract bonds include Bid Bonds, Performance Bonds, Advance Payment Bonds and Retention Money. Each of these bonds provides unique financial protection and assurance to different parties involved in the contract. However, IRDAI has specified that the guarantee limit should not exceed 30% of the contract value and that these contracts should be issued only for specific projects and not multiple projects collectively.