Guarantee offers within the framework of insurance
This article examines how sureties are used in the insurance industry and how they are regulated in this context. Creditors and owners alike increasingly depend on these types of risk management mechanisms to ensure performance and fulfillment of the other party’s contractual obligations. These bonds and guarantees are generally offered by various international surety companies. The recent increase in demand for such instruments is particularly evident in the construction sector and compared to other infrastructure and engineering projects, often as a prerequisite for the execution of contracts.
A “bond” is a contract in which a surety provider or insurance company provides a guarantee to a creditor or a beneficiary that the principal debtor will meet its contractual obligations or pay monetary compensation to the obligee if the principal does not comply. his promise.
In the absence of specific standards for the insurance sector, sureties are largely governed by the principles contained in Articles 126 to 147 of the 1872 Law on Contracts, which expressly recognize guarantee contracts, an often used term of interchangeably with “surety”.
While insurance companies in many countries generally provide bonds as an alternative to bank guarantees, it has so far not been clear whether Indian insurance companies have been allowed to issue such bonds as no product bond is approved for distribution within the regulatory framework.
However, some developments(1) In recent years, appear to have been instrumental in the review by the Insurance Regulatory and Development Authority (IRDAI) of a regulatory framework governing the issuance of surety bonds by insurance companies. These developments include communications to IRDAI from the Department of Financial Services in 2016 to explore the possibility of introducing bonds in favor of the Central Council of Indirect Taxes and Customs, and the Ministry of Road Transport and Highways in 2020 to explore. the possibility of general insurance companies offering a bond to remedy the cash flow problems associated with the pandemic in the banking sector.
On July 1, 2020, IRDAI set up a working group (WG) to study the suitability of non-life insurance companies offering guarantees in India in order to “ensure the satisfactory completion of a project by a contractor and provide a performance guarantee to various government agencies. The task force report was released on September 30, 2020 and, in addition to providing some recommendations, also clarified that the task force viewed surety bonds as an alternative to financial guarantees, such as bank guarantees, and that if a “bond refers to the performance or delivery obligations to carry out the insured project, [a financial guarantee] refers to financial obligations to repay debts or loans ”.(2)
Following the recommendations made in the report of the working group, the IRDAI published on September 8, 2021 the “Exhibition project on IRDAI guidelines (surety insurance contracts)” (the draft guidelines) on September 8 2021 for the purpose of promoting and regulating surety insurance business in India. Here are some key points proposed in the draft guidelines:
- From the date of entry into force of the final guidelines, surety insurance business can only be taken out by a general insurance company registered with IRDAI or a new category of specialized or monoline insurers which will have ” limited registration for underwriting surety and trade credit insurance. Regarding the registration of new insurance companies to take out surety insurance in India, the draft guidelines outline the procedure for starting a surety insurance business in India, but specify that preference will be given to applicants whose promoters already carry out surety insurance business in any jurisdiction.
- Surety insurance contracts will be tripartite contracts between:
- the principal debtor;
- the creditor or the creditor; and
- the surety or the insurance company providing the performance guarantee.
- The draft guidelines allow surety insurance contracts to be offered to construction companies in India that cover road projects, residential / commercial buildings and other public or private infrastructure projects. However, surety insurance contracts should only be issued for specific projects and not combined for multiple projects.
- Registered insurance companies may offer surety insurance products once they have been deposited in accordance with the relevant product deposit guidelines specified by IRDAI. However, surety insurance contracts cannot be issued for credit enhancement of financial instruments, and alternative risk transfer mechanisms are not permitted. In addition, no single or global risk can be taken out if it is disproportionate to the capital of the insurance company.
- The draft guidelines recognize prepayment bonds, tender bonds, contractual bonds, customs and judicial bonds, performance bonds, holdbacks and surety insurance contracts as types of bond contracts. bond.
- The draft guidelines also prescribe specific operational requirements, including a board-approved underwriting philosophy, a solvency margin, a total gross premium written and a risk assessment mechanism for insurance companies operating in insurance companies. deposit insurance.
The proposed framework seems to offer the various market players a highly sought-after insurance product, particularly in the construction sector which, until now, had to resort either to bank guarantees (which implied certain pledges and commissions) or to surety insurance offered by insurance companies after obtaining regulatory approvals.
The draft guidelines have not yet been implemented and IRDAI has requested comments and suggestions from stakeholders by September 28, 2021.
For more information on this topic, please contact Celia Jenkins Where Anuj Bahukhandi at Tuli & Co by phone (+91 11 2464 0906) or by email ([email protected] Where [email protected]). The Tuli & Co website can be accessed at www.tuli.biz.