SURETY BONDS

 

Latest Context

Some of the top general insurers recently declared plans to issue surety bonds, including New India Assurance, SBI General Insurance, etc., but no one has been able to do so due to a lack of supporting materials.

• The Insurance Regulatory and Development Authority of India (IRDAI) is under pressure from the Ministries of Finance and Road Transport and Highways to encourage the insurance sector to introduce surety bond products.

What is Surety Bond?

About:

• Surety Bonds are a type of insurance policy protecting parties involved in a transaction or contract from potential financial losses due to a breach of contract or other types of non-performance.
• It is a special kind of insurance because a three-party agreement is involved. In a surety agreement, there are three parties:

1. Principal – The party that purchases the bond and undertakes an obligation to perform an act as promised.
2. Surety – The insurance company or surety company that guarantees the obligation will be performed. If the principal fails to perform the act as promised, the surety is contractually liable for losses sustained.
3. Obligee - The party who requires, and often receives the benefit of the surety bond. For most surety bonds, the obligee is a local, state or federal government organization.

• The insurance provider offers a surety bond to the organisation awarding the project on behalf of the contractor.
• It will enable contractors to complete their projects financially without relying solely on bank guarantees.
• Aim: The primary purpose of surety bonds is to lower indirect costs for suppliers and work contractors, so increasing their options and serving as a replacement for bank guarantees.

• Benefits:

1. Surety bonds protect the beneficiary against actions or occurrences that jeopardise the principal's underlying obligations.
2. They ensure the fulfilment of a range of commitments, including licences and business undertakings as well as building or service contracts.

How does it support the infrastructure project?

• The decision to establish guidelines for surety contracts will aid in addressing the infrastructure sector's significant liquidity and funding needs.
• It will level the playing field for big, medium-sized, and little contractors.
• The development of an alternative to bank guarantees for construction projects will be aided by the surety insurance industry.
• This will make it possible to utilise working capital more effectively and lessen the need for construction companies to put up collateral.
• To communicate risk information, insurers and financial institutions must collaborate.
• As a result, this will help release liquidity without sacrificing risk factors in the infrastructure industry.

Challenges with the Surety Bonds

• Since surety bonds are a novel idea, they carry a high degree of risk, and Indian insurance firms have not yet mastered the art of assessing that risk.
• Pricing, the penalties available against defaulting contractors, and reinsurance possibilities are also unclear.
• These are crucial and may prevent the development of experience and capacity in the surety industry, ultimately discouraging insurers from taking on this type of business.
• No primary insurer may issue any policy without the necessary reinsurance backup, and surety bonds require substantial reinsurance assistance.
• A tripartite contract that ensures compliance, payment, and/or performance should be enforceable legally by the Indian company that issues surety bonds.
• Insurance companies do not have access to recovery like banks do in the event of a default since the Indian Contract Act and the Insolvency and Bankruptcy Code do not yet recognise insurance rights on par with financial creditors.

 

Q. With reference to ‘IFC Masala Bonds’, sometimes seen in the news, which of the statements given below is/ are correct? (UPSC-2016)

1. The International Finance Corporation, which offers these bonds, is an arm of the World Bank.

2. They are the rupee-denominated bonds and are a source of debt financing for the public and private sector.

Select the correct answer using the code given below:

(a) 1 only

(b) 2 only

(c) Both 1 and 2

(d) Neither 1 nor 2

Ans:(c)