Nirmala Sitharaman, The Finance Minister of India in her Union Budget 2022 presentation made key announcements that would benefit the MSMEs and recover the sector from the impact of Covid pandemic. One of the key announcements made by the FM was to allow the use of Surety Bonds as a substitute for the Bank Guarantees.

The Insurance Regulatory and Development Authority of India (IRDAI), to regulate and promote healthy and sustainability development of the Surety Insurance Business, has issued guidelines called as IRDAI (Surety Insurance Contracts) Guidelines, 2022 which shall come into force with effect from the new financial year. These guidelines will be subject to the eligibility criteria set out for the insurers registered under the Insurance Act, 1938 in which business of general insurance may also transact the business of surety insurance.

The issued guidelines by the IRDAI and the announcements by the FM on surety insurance shall be a huge support to the MSME work contractors and suppliers to reduce indirect cost. Gold Importers shall also find it useful for their procurements. Most of the time, the MSMEs are deprived of receiving orders due to no bank guarantee facility sanctioned by the banks or their funds are stuck as a margin money despite having the BG facility. To cover the risk of the BGs, the MSMEs also have to offer collateral security. These BGs however swallow the liquidity out of MSMEs suppliers by imposed fees, additional costs by the issuing banks.

As per the guidelines, the surety insurance contract shall be a guarantee contract under section 126 of Indian Contract Act 1872 and shall be deemed only if made by an insurer (Surety) involved in the business of general insurance registered under Insurance Act, 1938. The contract will be a legal agreement between the Surety who gives the guarantee, Principal Debtor of whose default the guarantee will be given to the Creditor. The types of surety contracts include Bid Bond, Performance Bond, Advance Payment Bond, Contract Bond, Customs and Court Bond and Retention Money.               

The Surety Insurance Contracts will be offered to Infra projects of private/government organization by the insurance company. The construction companies were hit hard during the Covid pandemic. The Ministry of Road Transport & Highways, Chambers Confederation of Indian Industry (CII) and Federation of Indian Chambers of Commerce and Industry (FICCI) also suggested the introduction of surety contracts by General Insurance Company amidst Capex Plan included in PM Gati Shakti Scheme.

In the event of default and the breaking of contract terms, the harmed party can claim to recover the losses. IRDA in the guidelines said, the surety contract shall not be issued to club multiple projects and on behalf of its promoters, group companies, subsidiaries or other related parties. The insurance company should meet the requirements of maintaining a solvency margin of not below 1.25 times of controlling solvency level specified by the Authority. The insurers can work together with Banks, NBFCs, other financial institutions for risk evaluation, technical support and data of cash flows into the projects.

KK Srinivasan, the former IRDAI member said that “these bonds are considerably risky and have the potential to eliminate reckless insurance companies. Banks having credit risks are swamped by the NPAs but in case of Insurers, they are way behind from building expertise for the risk assessment involved in these bonds”. As this is a new business, The insurance sector is yet to receive clarity of pricing of these contracts, risk assessment of the parties, reinsurance and recourse option against defaulting project contractors. “The regulatory bodies need to facilitate changes in laws such as the IBC and Indian Contract Act to bring surety contract bonds on par along with BGs regarding recourse to insurers to help the insurance industry to approach better surety solutions with more confidence” said the MD & CEO of ICICI Lombard General Insurance.

References:

https://www.irdai.gov.in/ADMINCMS/cms/frmGuidelines_Layout.aspx?page=PageNo4623

https://www.financialexpress.com/budget/msme-eodb-budget-2022-8-msme-related-announcements-fm-nirmala-sitharaman-made-and-heres-what-experts-have-to-say/2423236/

https://cleartax.in/g/terms/surety

https://www.suretybondsdirect.com/educate/what-is-surety-bond

https://www.livemint.com/insurance/irdai-issues-guidelines-on-surety-insurance-product-key-things-to-know-11641273769394.html

https://www.zeebiz.com/india/news-budget-2022-big-takeaway-for-general-insurance-companies-government-allows-surety-bonds-as-substitute-for-bank-guarantees-177892

https://timesofindia.indiatimes.com/business/india-business/budget-2022-insurance-guarantees-next-round-of-infra-build-up/articleshow/89284814.cms

https://indianexpress.com/article/business/budget/jal-nal-roads-get-record-outlays-surety-bonds-replace-bank-guarantees-free-up-capital-7752320/

https://indianexpress.com/article/business/market/surety-bonds-slow-take-off-likely-as-pricing-7755851/