The Indian Surety insurance business will assist in developing an alternative to bank guarantees for construction projects. This shall enable the efficient use of working capital and reduce the requirement of collateral to be provided by construction companies
There is no clarity on pricing, and reinsurance options due to current Locus standi around indemnity document. Indian Contract Act and Insolvency and Bankruptcy code does not recognize rights of Insurers at par with financial creditors yet and thus Insurance Companies do not have recourse to recovery like banks in case of any default
Road Transport is a critical infrastructure for the economic development of a country.
The Government of India (GOI) and Ministry of Road Transport and Highways (MORTH) with National Highways Authority of India (NHAI) is committed to construct two Lacs kms of highway in India by 2025.
The infrastructure development and its maintenance projects/tenders are awarded to Clients (contractors) contingent upon submission of relevant bank guarantees.
Often these bank guarantees are provided by the banking fraternity, however, many a times there is a constraint on capacity of these banks and the extra burden cannot be fulfilled.
Surety bond overcomes this challenge and precisely helps contractors by diversifying their options and acting as a substitute for bank guarantee. They are the most comprehensive risk management tool in existence today and are mainly aimed at infrastructure development.
Surety bonding is a highly specialized, complex, and meticulous process which require specialized consultants for placement. It is a three-party contract by which one party (the surety underwriter/insurer) guarantees the performance or obligations of a second party (the contractor) to a third party (the Project Owner), in our case the MORTH/ NHAI.
It is a promise given by Surety underwriter to the project owner that they would be liable for the debt, default, or failure of the contractor and would bear cost of invocation. It provides financial protection to the ‘Project Owner’ against loss due to the inability/ non – performance as per terms, conditions, and obligations of the Contractor. Thus, this product caters to all contracts where one needs to submit guarantees especially focusing on infrastructure.
While International Surety market provides different types of specialised Bonds like Financial Bond, environmental bond, Mining rehabilitation Bond etc. IRDAI has restricted the usage in India to only two types of Bonds i.e., Contract Surety and Commercial surety. Contract surety comprises of Bid, Advance Performance and Retention bonds and commercial surety encompasses Custom and Court bond.
The Project owner, NHAI awards the roadway development projects to local or international contractors through a rigorous process including submission of guarantee. These projects are worth Trillions of rupees and Surety becomes the best option for contractors which will fulfil their requirement. Guarantee would be obtained from Indian insurance companies which would be supported by international reinsurers.
In Jan 2022, IRDAI issued surety guidelines, which allowed Indian insurance companies to issue Surety in India, and in Feb 2022, Ministry of Finance, India also amended the general financial rule, and included Surety Bond as Security instrument. These are welcomed steps, however, surety in India is ‘work in progress’ and involves various challenges.
There is immense opportunity for surety market including NHAI, however Surety is a new concept and insurance companies in India are yet to achieve expertise. It is a challenge to assess the risk of contractor in terms of a comprehensive track record including financial numbers, total exposure, disputes, invocation data, etc. in terms of availability, transparency, and accuracy.
There is no clarity on pricing, and reinsurance options due to current Locus standi around indemnity document. Indian Contract Act and Insolvency and Bankruptcy code does not recognize rights of Insurers at par with financial creditors yet and thus Insurance Companies do not have recourse to recovery like banks in case of any default.
Aimed at boosting the infrastructure sector, the Government has launched National Infrastructure Pipeline (NIP) in 2019, wherein it has planned to invest about INR 102 trillion on infrastructure projects by 2024-25 and around INR 20 trillion, will be spent on road projects.
As per general requirement of contract, contractors must submit Advance and performance guarantees in tune of ~ 25%. The Roadway infrastructure project itself will open the enormous opportunity of around Rs 5 trillion guarantee requirement in the next 5 years in India. To meet the increasing demand surety bonds will have to seriously compliment the banking fraternity.
For smooth placements of surety bonds, policy restructuring is recommended.
We need a standardization of Surety document, transparency, and availability of data. Insurance company and Bankers should have mandatory and periodic sharing of exposure duly authenticated by contractors to share risk information to assist in releasing liquidity in infrastructure space without compromising on risk aspects.
Any invocation of BG or Surety should be promptly shared between both parties as a good practice. Treatment of insured should be the exact same as invocation of BG situation.
Surety bond placements needs to be governed by IBC rather than ICA, and instead of recognising them as operational creditors, they should be recognized as financial creditors. This policy reform will overcome the major challenge of recourse to recovery in case of any default.
The move to frame rules for surety contracts will help address the large liquidity and funding requirements of the infrastructure sector. It will create a level-playing field for large, mid and small contractors.
The Surety insurance business will assist in developing an alternative to bank guarantees for construction projects. This shall enable the efficient use of working capital and reduce the requirement of collateral to be provided by construction companies.
The market needs more awareness and advocacy of this product and the solutions it provides for their business.
Roadways is just part of the opportunity lying ahead of us, if properly harnessed in all sectors, the potential of surety market is “Trillions of rupees.’’ .
The author is National Head, Structure, finance, surety, political Risk Insurance & Trade Credit, Gallagher Insurance