India’s insurance regulator has released draft rules for bonding contracts as the country seeks to support infrastructure, a sector vulnerable to delays, failures and litigation.
The 2021 IRDAI (Surety Insurance Contracts) Guidelines project will make it possible to offer surety or surety insurance. These are essentially collateral without collateral.
Surety insurance protects the contracting authority, such as the government, against poor service, project failure or contractor default. And for building contractors, they work as working capital guarantees.
One of the key conditions of the draft rules is that the collateral must not exceed 30% of the value of the project.
Why India Needs Surety Insurance
India has unveiled a plan to spend Rs 5 lakh crore on building roads for laying over the next three years. Yet the industry is prone to delays and cost overruns. Fears of bad debts dissuade banks from providing guarantees to private contractors who bid on projects.
Surety bonds are prevalent in developed markets. In the United States, the law requires a bond for every public project, according to Vikash Khandelwal, chief executive of Eqaro Guarantees. Canada, European countries, Australia and New Zealand also offer such guarantees, and the concept is catching up in Africa and Southeast Asia, he said.
How the deposit insurance works
Surety insurance, also known as insurance surety or surety, does not require collateral, unlike bank guarantees.
It is a tripartite agreement between the entrepreneur (principal debtor), the contracting authority as well as the administrations (bond) and an insurance company (surety) issuing the instrument.
These contracts are of several types:
-
Contractual deposit: Provides assurance to public entity, developers, subcontractors, suppliers that the contractor will fulfill his contractual obligation. These include bid bonds, performance bonds, prepayment bonds and holdbacks.
-
Advance payment deposit: It is a promise by the insurance company to pay any outstanding balance of the prepayment in the event that the contractor fails to perform the contract as specified or fails to meet the terms.
-
Bid bond : Provide financial protection to the contracting authority if a successful bidder fails to sign the contract within a specified time frame.
-
Customs and judicial bond: A public office such as the tax office, customs administration or court is guaranteed payment by the surety in the event of non-payment by the entrepreneur. Such an obligation could arise from a court case or during customs clearance of goods or losses due to incorrect customs procedures.
-
Performance bond: Allows the creditor to call on the surety to meet its obligations in the event of default by the contractor.
-
Hold money: Money withheld by the beneficiary which is returned to the contractor as working capital.
Who can issue bonds …
General insurance companies registered under the Insurance Act will be allowed to issue bonds to construction companies in India involved in road projects, residential or commercial buildings and other government or government infrastructure projects. private sector, depending on the project.
New businesses will need to register under the Insurance Act.
Since bonds do not require collateral, this is a business with no assets, Khandelwal said.
According to the proposed guidelines, the key parameters for a company issuing such bonds are as follows:
-
A solvency margin of 1.25 times or more.
-
Surety company’s premium subscribed not exceeding 10% of the total gross premium subscribed in a fiscal year, up to a maximum of Rs 500 crore.
-
Internal risk assessment mechanism / guidelines to assess the technical and financial soundness of the client before and after underwriting.
-
A limit of 30% of the value of the project for the guarantee or bond.
-
Contracts should only be awarded to specific projects and should not be awarded to multiple projects.
How will they help
The decision to frame the rules for surety contracts will help meet the infrastructure sector’s significant liquidity and financing needs, Khandelwal said.
The bonds will create a level playing field for large, medium and small entrepreneurs, he said. “Capacity, technical expertise, background will be the parameters to judge a developer rather than just his financial capacity. “
According to Abhaya Agarwal, partner, infrastructure department at EY, the surety insurance business will help develop an alternative to bank guarantees for construction projects. “This will allow efficient use of working capital and reduce the collateral requirement to be provided by construction companies.”
“Insurers need to work with financial institutions to share risk information,” he said. “Therefore, this will help free up liquidity in the infrastructure space without compromising the risk aspects.”
