Surety bonds: Slow take-off likely as pricing, reinsurance concerns remain

What is the News?

In Budget 2022-23, the government has allowed the use of surety insurance bonds as a substitute for bank guarantees in case of government procurement and also for gold imports.

What are Surety Bonds?

A surety bond is a legally binding contract entered into by three parties—the principal, the obligee and the surety.

The obligee, usually a government entity, requires the principal, typically a business owner or contractor, to obtain a surety bond as a guarantee against future work performance.

What is the aim of Surety Bonds?

Surety bonds are mainly aimed at infrastructure development mainly to reduce indirect costs for suppliers and work contractors, thereby diversifying their options and acting as a substitute for bank guarantees.

These bonds are provided by the insurance company on behalf of the contractor to the entity which is awarding the project. When a principal breaks a bond’s terms, the harmed party can make a claim on the bond to recover losses. 

Hence, it can effectively replace the system of bank guarantees issued by banks for projects and help reduce risks due to cost overrun, project delays and poor contract performance.

What are the issues with the decisions taken in the Budget on Surety Bonds?

Firstly, the surety bond is a risky concept and insurance companies in India are yet to achieve expertise in risk assessment in such business.

Secondly, there’s no clarity on surety bonds pricing, the recourse available against defaulting contractors and reinsurance options. These are critical and may impede the creation of surety-related expertise.

Source: This post is based on the article “Surety bonds: Slow take-off likely as pricing, reinsurance concerns remain” published in Indian Express on 5th Feb 2022.