Surety bonds' market faces multiple growth challenges despite govt push

The issuance of such bonds remains muted due to several challenges, such as collaboration between banks and insurance firms, data sharing, and regulatory parity, among others

Despite a regulatory and government push, surety bonds — touted as an alternative to bank guarantees — have not gained as much traction as was initially expected. This is largely due to legal challenges in recovery, as insurers are not treated on par with banks under the Insolvency and Bankruptcy Code (IBC), and lack of reliable data which affects accurate pricing and discourages participation from reinsurers.

 

Surety Bond insurance acts as a risk transfer mechanism protecting the project owner from potential losses if the contractor fails to fulfil their contractual obligations. They are legally enforceable tripartite contracts that guarantee compliance, payment and/or performance. Additionally, they indemnify the client against damages resulting from non-performance.

 

Essentially, the insurer provides an underwriting guarantee for a premium against default in the execution of a project. One party (the surety) guarantees the performance or obligations of a second party (the principal) to a third party (the obligee).

 

The insurance regulator had, in January 2022, evolved a framework for the development of the surety insurance business in the country, which came into effect on April 1, 2022. The finance minister in her Union Budget speech in 2022 had said that surety bonds can be used as substitutes for bank guarantees in government procurement in order to reduce the indirect cost for suppliers and work contractors.

 

Currently, only a handful of insurers offer surety bonds, including New India Assurance, ICICI Lombard General Insurance, SBI General Insurance, HDFC Ergo General Insurance, Tata AIG General Insurance, Universal Sompo General Insurance, and IFFCO Tokio General Insurance. Bajaj Allianz General Insurance was the first to launch such a product.

 

“Despite regulatory concessions, surety bonds have yet to progress as expected. The legal framework remains a bit of a challenge, particularly due to inconsistencies in how insurers and banks are treated — especially under the Insolvency and Bankruptcy Code (IBC), where banks enjoy stronger recovery rights. Recovery mechanisms are generally more favorable to banks, giving them a clear advantage,” said Sharad Mathur, managing director and chief executive officer at Universal Sompo General Insurance.

 

“Additionally, insurers struggle to obtain reliable data, which affects accurate pricing and discourages participation from reinsurers. There is also a significant gap in information sharing vis-a-vis banks, with insurers often lacking access to critical details of the projects. However, the potential for this segment remains very strong—surety bonds could emerge as one of the fastest-growing lines of business for general insurers, driven by their low claims ratio and increasing demand from MSMEs and Contractors”, he said.

 

To be able to broadbase the product, insurers have been demanding changes to the Indian Contract Act and the IBC to bring surety bonds on par with bank guarantees when it comes to recourses available to them in case of default.

 

The issuance of surety bonds also remains muted due to several challenges including – collaboration between banks and insurance companies, data sharing, regulatory parity, inability to strengthen the enforceability of agreements between insurers and bond beneficiaries, industry experts said.

 

The insurance regulator had also formed a taskforce to address this issue, comprising banks, insurers and reinsurers to drive growth in the segment.

 

Amit Roy, partner and leader (insurance and allied businesses) at PwC India said, "We are definitely on the right track on surety bonds. While the industry may lack the necessary skills, it is important to recognize that surety bonds in India are still in a nascent stage—there is a lack of sufficient data and skilled professionals to underwrite it effectively. Banks have been providing bank guarantees for years, insurers will need more time in the segment where they lack proper underwriting infrastructure.”

 

“It’s a gradual road, but there is progress being made. There is definitely potential in the segment for insurers but before fully diving in, a strong underwriting ecosystem, experienced handlers, and transparency on contract terms are essential. Also, the reinsurers will have to become more active in the segment to boost growth," Roy added.