Govt considers financial creditor status for insurers issuing surety bond

To make surety bond business more attractive, the government is looking at making relevant changes in the Insolvency and Bankruptcy Code (IBC) to consider insurers as financial creditor in case of default of infra projects.

The surety bond issued by a general insurance company 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).

The surety is a company that provides the financial guarantee to the obligee (usually a government entity) that the principal (business owner) will fulfil their obligations.

According to sources, the Ministry of Corporate Affairs is looking into concerns raised by the insurers that they should have recourse to recovery on par with the banks as forwarded by the Department of Financial Services under the finance ministry.

The department is examining the issue and after careful examination, relevant changes would be made in IBC to provide financial creditor status to the insurer under the resolution process, sources said.

The general insurance companies are seeking changes in the 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.

The Surety Bond Insurance is a risk transfer tool for the principal and shields the principal from the losses that may arise in case the contractor fails to perform their contractual obligation.

Unlike a bank guarantee, the Surety Bond Insurance does not require large collateral from the contractor thus freeing up significant funds for the contractor, which they can utilise for the growth of the business.

With this new instrument of surety bonds, the availability of both liquidity and capacity will definitely be boosted; such products stand to strengthen the infrastructure sector.

Finance Minister Nirmala Sitharaman while presenting the Union Budget 2022-23, said that the use of surety bonds as a substitute for bank guarantees will be made acceptable in government procurement.

As per the Insurance Regulatory and Development Authority of India (IRDAI) guidelines, insurers can underwrite surety insurance policies of not more than 10 per cent of the total gross written premium, subject to a maximum of Rs 500 crore in a financial year.