General insurers in alien territory on surety bonds

Mumbai: General insurance companies are wading into unchartered territory with surety bonds as they grapple with regulatory, process and product related challenges on the unique product announced in the budget.

Surety bonds issued by insurance companies are designed to provide a guarantee to government agencies or companies for the delivery of projects. Small businesses buying these unsecured bonds will pay a premium to an insurance company in exchange for an underwriting guarantee in case of a default in a project.

Although the Insurance Regulatory and Development Authority (IRDAI) has given regulatory approval, insurance companies are unsure about how reinsurance companies will underwrite this risk, which is crucial for them to launch this product.

"The question is how to protect policyholders and shareholders. General insurance by definition is an indemnity product which means it guarantees to restore a person or an object as he was when he or she took the policy. The surety bond being proposed is without collateral and is fraught with risk. It is not purely an insurance product and is not like a bank guarantee so it's still alien territory," said D Varadarajan, Supreme Court lawyer and an expert in insurance law.

Guidelines issued last month by the IRDAI said insurance companies can offer six types of sureties namely, advance payment bond, bid bond, contract bond, customs and court bond, performance bond and retention money.

Insurance companies are still in the process of filing for approval of these products with the IRDAI and are in dialogue with reinsurance companies to design, price and underwrite this new product.

Experts said that while the move may be beneficial for small entrepreneurs who do not have the luxury of offering a collateralised bank guarantee, the cost, simplicity and acceptance of the product would determine how many small entrepreneurs actually use it. "We are also working with the reinsurers and the legal team to work out the details. We are awaiting inputs from reinsurers. Unlike a bank guarantee there is no collateral in this product which is the issue. Banks have been offering guarantees for many many years now whereas for insurance companies this is the first time so what is the recourse available for insurance companies which could also have an impact on the capital and reinsurance arrangements which we need clarity on," said TA Ramalingam, chief technical officer at Bajaj Allianz General Insurance Co.

Because of its uncollateralized nature, this newly approved product from the IRDAI is likely to be more expensive than a bank guarantee, experts said.