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Insurance Regulatory and Development Authority of India (IRDAI) has released final guidelines to ensure orderly development of surety insurance business in India. The IRDAI (Surety Insurance Contracts) Guidelines, 2022 will come into effect from April 1, 2022, the regulator said in a notification.

What is a Surety Bond?

A surety bond is a mechanism to transfer risk for businesses. It assures the project owner (typically a government entity) that the assigned contractor will perform the task as per the contract clause. The surety company pays the project owner the promised amount (as per the contract) in the event of a default. The company charges a fee to the contractor to write the surety bond.

What is the benefit to a contractor, infra player?

By issuing the surety bond, the contractor does not have to furnish a hefty bank guarantee. The bank guarantee blocks a huge amount. Surety bonds create a level playing field, empower the small and medium contracts to bid for a project at par with a large contractor with financial muscle.

Vikash Khandelwal, CEO, Eqaro Guarantees, a surety solutions provider, said, "The issuance of final guidelines for surety insurance by the IRDA is a landmark event that will herald a new era in the underwriting of construction-related risks and provide much-needed relief to the infrastructure sector. The norms will help regulate/develop Surety as a business in India which otherwise is an accepted norm in the western countries."

The final guidelines are on expected lines focusing on the overall risk management framework for the insurers. Allowing the surety insurers to work alongside the Banks and other financial institutions to share risk-related information & technical expertise will help foster a robust ecosystem and prevent contagion.

"However, it would have been ideal if the final norms had also provided for a specialist surety insurance company. There is also a 10% cap subject to a limit of 500 crores on the quantum of surety business that an insurer can write. The guidelines are also silent on the right of recourse available to a surety insurance company in the event of a default by the contractor. These are critical and may impede the creation of surety-related expertise and capacities and eventually deter insurers from writing this class of business," said Khandelwal.

According to the regulator, here are the types and definitions of Surety Contracts.

Advance Payment Bond: It is a promise by the Surety provider to pay the outstanding balance of the advance payment in case the contractor fails to complete the contract as per specifications or fails to adhere to the scope of the contract.

Bid Bond: It is an obligation undertaken by a bidder promising that the bidder will, if awarded the contract, furnish the prescribed performance guarantee and enter into contract agreement within a specified period of time. It 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, as per the Irdia press release.

Contract Bond: It provides assurance to the public entity, developers, subcontractors and suppliers that the contractor will fulfil its contractual obligation when undertaking the project. Contract bonds may include: Bid Bonds, Performance Bonds, Advance Payment Bonds and Retention Money.

Customs and Court Bond: This is a type of guarantee where the obligee is a public office such as tax office, customs administration or the court, and it guarantees the payment of a public receivable incurred from opening a court case,clearing goods from customs or losses due to incorrect customs procedures.

Performance Bond: It 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.

Retention Money: It is a part of the amount payable to the contractor, which is retained and payable at the end after successful completion of the contract, as per the Irdia press release.

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