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What is Surety Bonds? – Indian Economy


Why in NEWS

  • Recently, in 2022 – 2023 Budget, government allowed the Substitution of Bank guarantees with Surety Bonds for government procurement and Gold imports.

What are Surety Bonds ??

  • Promise by a surety or guarantor to pay one party (the obligee) a certain amount if a second party (the principal) fails to meet some obligation, such as fulfilling the terms of a contract.
  • It is a legally binding contract
  • Person or company providing the promise is also known as a “surety” or as a “guarantor“ ( mostly governments )
  • Mainly aimed at infrastructure development, provided by the insurance company on behalf of the contractor to the entity which is awarding the contract
  • Protects the beneficiary against acts or events that impair the underlying obligations of the principal

Advantages of Surety Bonds

  • Boost infrastructure projects
  • Helps to balance the liquidity and funding needs in infrastructure development
  • Equality among small, medium and large contractors
  • Develops an alternative to bank guarantees and enable the efficient use of working capital and reduce the requirement of security assets
  • Mutual sharing and gathering of risk information may assist in liquidity formation without compromising on risk factors

Problems with Surety Bonds

  • New concept and a risky one
  • Indian insurance companies have yet to develop experience in risk assessment about Surety Bonds
  • The pricing, the remedy available against defaulters, and reinsurance alternatives on surety bonds are all unclear
  • Lack of surety related skills and capacity infrastructure (both physical and intellectual)

Guiding agency in India

  • The insurance regulatory and development authority of india (IRDAI)
  • Announced final guidelines to guarantee that the surety insurance industry in India
  • IRDAI (surety insurance contracts) guidelines will be in force, from april 1, 2022

Surety Bond guidelines by IRDAI

  • Insurance companies can issue the much-anticipated surety bonds now
  • Premium charged for all surety insurance policies underwritten in a financial year, including all payments payable in following years for those policies, shall not exceed 10% of the total gross written premium for that year, up to rs.500 crore.
  • Insurers can offer contract bonds, which assure the government, developers, subcontractors, and suppliers that the contractor will complete the project as planned.

Contract Bonds  ??

1) Bid Bonds

  • Provides financial protection to an obligee if a bidder is awarded a contract pursuant to the bid documents, but fails to sign the contract and provide any required performance and payment bonds

2) performance Bonds

  • Provides assurance that the obligee will be protected if the principal or contractor fails to perform the bonded contract.
  • If the obligee declares the principal or contractor as being in default and terminates the contract, it can call on the surety to meet the surety’s obligations under the bond

Contract Bonds ??

3) Advance Payment Bonds

  • Pledge by the surety provider to pay the outstanding balance of the advance payment if the contractor fails to finish the contract according to specifications or adhere to the contract’s scope

4) Retention money

  • Portion of the contract payment that is held back and paid out after the project is completed successfully.

Surety Bond guidelines by IRDAI

  • The limit of guarantee should not exceed 30% of the contract value.
  • Surety Insurance contracts should be issued only to specific projects and not clubbed for multiple projects.

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