Insurers seek legal recourse for surety bond biz, urge changes in key laws

Reach out to reinsurers for expertise on surety bonds business

General insurance companies are seeking changes in Indian Contract Act and Insolvency and Bankruptcy Code (IBC) to bring surety bonds at par with bank guarantees when it comes to recourse available to them in case of a default.

In her budget speech this year, the finance minister said that surety bonds can be used as a substitute for bank guarantees for government procurement in order to reduce the indirect cost for suppliers and work contractors. The insurance industry has hailed this as a very positive move as this will give a big boost to project financing with overall improvement in project viability.

The general insurance companies are evaluating various aspects of the surety bonds business, including pricing, reinsurance arrangement, and the risk factor associated with it, before filing products with the insurance regulator.

They are also reaching out to reinsurers for expertise and policy wordings, given this is a new line of business.

The insurance regulator in January this year came out with a framework for development of surety insurance business in the country, which will come into effect from April 1, 2022, that allows Indian general insurers to commence surety insurance business, if they have 1.25 times the solvency margin they are required to keep. The insurance regulator mandates insurance companies to maintain solvency of 1.5x at all times.

A surety bond is a three-party contract by which one party (the surety) guarantees the performance or obligations of a second party (the principal) to a third party (the obligee).

A senior insurance executive with a private insurer said that the regulator has allowed it from April 1 but in terms of how the insurers will do the business, what will be the reinsurance arrangement - all the aspects are being looked at and also people’s comfort in being able to do this business. Depending on each company’s appetite, some may decide to do the business and others may choose not to do it.

TA Ramalingam, Chief Technical Officer, Bajaj Allianz General Insurance said, “Considering it’s a new line of business, reinsurance support can be helpful in terms of policy wordings as reinsurers have experience in this business in the Middle East, Europe, and other places for years now. Their support will also be required to start this line of business in the initial years as there are capital implications.”

In a budget note, PwC said, the introduction of surety bonds will open up a fresh stream of insurance revenue and capital; it could even invite many specialised insurance companies with foreign capital to India.

The Indian insurers are also seeking legal recourse against defaulting contractors to whom the surety bonds are issued. Interestingly, the working group, which the insurance regulator had formed to study the viability of the surety bonds business, had recommended a robust legislation for surety bonds and other non-fund based guarantees as a necessary condition for them to be introduced.

“Surety bonds may also be included in other Acts such as Insolvency and Bankruptcy code, 2016 and given equivalent status as bank guarantees to ensure speedy and effective resolution and enforcement of indemnity by surety providers”, it had said.

Bhargav Dasgupta, MD&CEO, ICICI Lombard General Insurance has urged the regulatory bodies to facilitate changes to laws such as the Indian Contract Act and the IBC and bring surety bonds on par with bank guarantees regarding recourse available to issuers. “This will help the industry approach surety solutions with much more confidence, but it will be even more a viable proposition for all stakeholders”, he said.

The framework released by the insurance regulator says that the extent to which an insurer can underwrite surety business should not exceed 10 per cent of their gross written premium subject to a maximum of Rs 500 crore. And, the limit of guarantee shall not exceed 30 percent of the contract value. Further, they need to have a board-approved underwriting philosophy on the surety insurance business, incorporating all aspects for managing this business.

Also, they can work together with banks or other financial institutions such as NBFCs to share risk information, technical expertise to monitor projects, cash flow amongst other aspects. They can also work with contract awarding authorities in order to evaluate the risk with more information and data. Experts believe, allowing the surety insurers to work alongside banks and other financial institutions to share risk-related information and technical expertise will help foster a robust ecosystem and prevent contagion.