Insurance regulator aims to create market for surety bonds to fund road projects

The Insurance Regulatory Development Authority of India (IRDAI) has moved to establish a market for insurance of road projects by issuing surety bonds. The proposal will not only bring in new business for non-life insurers but also improve working capital situation of road developers and contractors.

On 1 July, IRDAI set up a nine-member committee to examine the possibility of general insurance companies (GICs) issuing surety bonds, an instrument that’s similar to a bank guarantee in some ways. The panel has been told to submit its report in 3 months. It has also been tasked to study the existing legal framework governing surety bonds and explore the possibility of any other sector, besides insurance, being able to issue surety bonds.

The regulator’s move comes after the ministry of road transport and highways, taking note of the cash flow issues in the covid-hit banking sector, requested it to examine possible offering of surety bonds by GICs, according to IRDAI’s 1 July letter order for setting up the committee.

A surety bond, which is essentially a guarantee backed by specialist insurers, is a payment undertaking issued by a third party on behalf of a seller/contractor to the buyer of his services. The surety bond provides protection to the buyer against any non-performance of the contractual duties and obligations by the seller/contractor. A bank guarantee is (BG) used for similar purpose but is issued by a bank.

Finance Minister Nirmala Sitharaman had in December unveiled the government’s plans create ₹1.02 trillion worth of infrastructure projects in 5 years, as part of the strategy to transform India into a $5 trillion economy by 2025. To leverage this chance, the infrastructure industry will need to scale up its capabilities on the resources required to procure bids, and to see the procured projects through completion.

Surety Bonds have globally emerged as a safer, more convenient and reliable mechanism of providing non-funded support to contractors through a project’s life cycle, right from the bidding phase till completion, even the defects liability period. Traditionally, in India, BGs have been the mainstay of banks and the go-to for construction / infrastructure companies, while the insurance sector has focused more on lines other than surety bonds. Experts say believe allowing surety bonds would bring down costs for contractors by bringing in more competition against BGs while also freeing up their capital.

“As governments and businesses roll out projects to revive the economy, sureties will enable more Indian contractors to bid and execute projects. This is a great step to cater to huge latent demand by bringing in the best global practices to India," Akshay Bhardwaj, executive vice president and practice leader (trade credit, political risk, structured finance and surety) at Marsh India Insurance Brokers Pvt. Ltd told Mint. Marsh is the world's largest player in assisting clients secure sureties.

Contractors often struggle to manage collaterals to secure funded and non-funded bank lines. Current Indian laws are unclear on existence and marketing of surety bonds even as they are not barred. IRDAI’s proposal could this finally remove that ambiguity and promote creation of a viable alternative to BGs.

Insurance companies may be more competitive in their rates for bond/guarantees than banks, and there is also lower volatility in their bond rates as insurance companies are not directly correlated to the financial markets (since the bulk of their exposure is in property and casualty insurance), Marsh’s Bhardwaj said.

Source: Live Mint