IRDAI Introduces Booster Shot of Surety Bonds for Infrastructural Sector

IRDAI Introduces Booster Shot of Surety Bonds for Infrastructural Sector

Executive Summary:

This article describes:

• • • This article throws light on IRDAI (Surety Insurance Contracts) Guidelines, 2022
    • Introduction of Surety Bonds, Underwriting Guidelines, its advantages to the Infrastructural Sector

Introduction:

The lovely month of February also well known for the Budget Month. On 1st February, as per our financial tradition, honorable Finance Minister Ms. Nirmala Sitharaman presented our Union Budget 2022. Insurance Regulatory Authority of India (IRDAI), under the jurisdiction of Ministry of Finance, has welcome new year with introduction of “Insurance Regulatory Authority of India (IRDAI) (Surety Insurance Contracts) Guidelines, 2022” and gives new ray towards advancement and rapid growth in Infrastructure Sector.

COVID-19 pandemic has hampered growth in many sectors and the major impact has been witnessed in the Infrastructure sector. Many Infrastructure projects have been adversely affected by cost overrun. Over the last few years, infrastructure companies had a difficult time obtaining bank guarantees or had to pay a hefty premium to obtain them. With the introduction of IRDAI (Surety Insurance Contracts) Guidelines, 2022,dated on 3rd January, 2022, India’s insurance regulator has provided support opportunity to infrastructure sector, which is prone to delays and defaults by offering surety insurance or bonds without a collateral. As per the Union Budget, 2020 announcement, sureties have been proposed as an alternative to bank guarantees and Infrastructure businesses will now be able to provide guarantees in the form of insurance coverage.

Applicability of IRDAI (Surety Insurance Contracts) Guidelines, 2022:

The IRDAI (Surety Insurance Contracts) Guidelines, 2022, shall be applicable with effect from 1st April,2022.These guidelines shall be applicable to all Insurers registered under the Insurance Act, 1938 who transact in “General Insurance” business and wish to transact in Surety Insurance business.

What is Insurance and Surety Insurance Contracts?

In general sense, Insurance protects the business owner, home owner, professional, Individual and more from financial loss which is uncertain. Whereas, Surety insurance refers a contract to perform the promise or discharge the liability of a third person in case of default.

As Insurance can be classified under general, medical, health, accidental insurance. Surety Insurance can be classified under advance payment bond, bid bond, contract bonds, customs and court bond, performance bonds and retention money.

Insurance is a bipartite contract which includes Insurer and Insure whereas Surety Insurance Contracts is tripartite contract which includes the person who gives the guarantee is called the “Surety”. The person in respect of whose default the guarantee is given is called the “Principal debtor”, and the person to whom the guarantee is given is called the “Creditor”. Surety Insurance Contracts, guarantees given to Government (Creditor) against poor services, default on part of Contractor (Principal Debtor) by Insurance Company (Surety) without a collateral.

In simple terms, it assures the project owner (typically a government entity) that the assigned contractor will perform the task as per the contract clause

Essential Features of Surety Insurance Contract:

• It shall be a contract of guarantee under Section 126 of the Indian Contract Act, 1872. It is a contract to perform the promise, or discharge the liability of a third person in case of his default.
• A contract of Surety shall be deemed to be an insurance contract only if made by a Surety who or which, is an insurer registered under the Insurance Act, 1938 to transact the business of general insurance.

IRDAI Guidelines on Underwriting of Surety Insurance Business:

• Insurance Company shall be registered with IRDA (Insurance Regulatory and Development Authority of India)
• Insurance Company shall
  • Maintain solvency margin of not below 1.25 times of the control level of solvency specified by the IRDAI.
  • Charge premium which shall not exceed 10% of the total gross written premium of that year, subject to maximum of Rs.500 crores
  • Ensure the limit of guarantee shall not exceed 30 percent of the contract value.
  • Have board approved underwriting philosophy, adequate competence and underwriting skills, risk management and required infrastructure for underwriting, Risk management mechanism.
  • Ensure the limit of guarantee should not exceed 30 per cent of the contract value.
  • Submit the data of Surety Insurance contracts underwritten to the Insurance Information Bureau of India (IIBI) as prescribed, and insurers must keep all relevant records and data pertaining to Surety Insurance business and submit to the Authority as and when requisitioned.
• The insurer shall not issue any Surety Insurance contracts on behalf of its promoters/their subsidiaries, groups, associates and related parties.
• Surety Insurance contracts shall be issued only to specific projects and not clubbed for multiple projects.
• Surety Insurance Contracts may be offered to infrastructure projects of Government/Private in all modes.

Insurance Company can collaborate with banks and other financial institutions, such as NBFCs, to share risk information, technical skills for project monitoring, cash flow, and other factors, as well as contracting awarding authorities, to evaluate risk with more information and data

Conclusion:

The concept of Surety Bond is much well known in developed countries. In USA, it is mandatory to have “Surety bonds” for all public, government projects. Though, this concept of Surety Bonds is totally new for India, by considering the need of time and to give big push to infrastructure projects, this concept of Surety Bonds should be warmly welcomed by Indian Economy. These guidelines will ensure orderly development of the surety insurance business and surety bonds market

This shall be best alternate for Bank Guarantee, and this will help in large liquidity and funding requirements of the infrastructure sector. Surety insurance will benefit the Indian infrastructure sector, which is prone to delays and defaults, and will assist contractors by allowing them to better utilize their cash.

In Union Budget for 2022-23, Honorable Finance Minister stated that the usage of surety bonds as a substitute for bank guarantees in government procurement will be made acceptable in order to minimize indirect costs for suppliers and work-contractors.

Regards,
Legal Team

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