Relevance: GS-3: Indian Economy, mobilization of resources, growth, development and employment.

Key phrases: Surety Bond, IRDAI, insurance companies, performance, infra sector

Why in News?

• 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

What is Surety Insurance Bond?

• A surety bond is provided by the insurance company on behalf of the contractor to the entity, which is awarding the project. When a principal debtor breaks a bond’s terms, the harmed party can make a claim on the bond to recover losses.
• It can effectively replace the system of bank guarantee, issued by banks for projects, and help reduce risks due to cost overrun, project delays and poor contract performance

Why India Needs Surety Insurance Bond?

• India has unveiled a plan to spend Rs 5 lakh crore on building roads infra in the next three years.
• Yet, the sector is prone to delays and cost overruns. Bad loan fears dissuade banks from providing guarantees to private contractors that bid for projects.
• Surety bonds are prevalent in the developed markets. In the U.S., the law mandates surety for every public project.
• Canada, European nations, Australia and New Zealand also offer such guarantees.

How Surety Insurance Bond Works?

• Surety insurance, also called an insurance bond or a surety guarantee, does not require a collateral, unlike bank guarantees.
• It’s a tripartite agreement between the contractor (principal debtor), the awarding authority like government departments (obligee) and an insurance company (surety) issuing the instrument.

There are of multiple types of such contracts like :

• Contract bond: Offers assurance to the public entity, developers, subcontractors, suppliers that the contractor will fulfil its contractual obligation. These include bid bonds, performance bonds, advance payment bonds and retention money.
• Advance payment bond: It's a promise by the insurance company to pay any outstanding balance of the advance payment in case the contractor fails to complete the contract as specified or doesn't adhere to the terms.
• Bid bond: Provides financial protection to the awarding authority if a successful bidder fails to sign the contract within a specified period of time.
• Customs and court bond: A public office such as tax office, customs administration or the court is guaranteed payment by the surety if the contractor fails to pay. Such an obligation could arise from a court case or while clearing goods from customs or losses due to incorrect customs procedures.
• Performance bond: Allows an obligee to call on the surety to meet obligations if the contractor defaults.
• Retention money: Money withheld by the beneficiary that is released to the contractor as working capital.

How it will provide booster shot to infra project?

• The move to frame rules for surety contracts will help address the large liquidity and funding requirements of the infrastructure sector.
• Surety bonds will create a level-playing field for large, mid and small contractors.
• 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.
• Insurers shall work together with financial institutions to share risk information.
• Hence, this shall assist in releasing liquidity in infrastructure space without compromising on risk aspects.

Source: Indian Express

Mains Question:

Q. A great boost to infrastructure development is need of the hour for Indian economy yet rising NPAs with Banks pose a deterrence in obtaining insured finance . In the light of the above statement and a recent notification by IRDAI facilitating Surety Bonds , bring out the benefits that can be obtained with such a move and the challenges therein .