What is Surety Bond Insurance?

What is a Surety Bond?

• A surety bond is a promise to be liable for the debt, default, or failure of another.
• It is a three-party contract in which one party (the surety) guarantees the performance or obligations of a second party (the principal) to a third party (the obligee).

About Insurance Surety Bonds: 

• It is a financial instrument, where insurance companies act as 'Surety' and provides the financial guarantee that the contractor will fulfil its obligation as per the agreed terms.
• It is a risk transfer mechanism wherein an insurer provides a guarantee to a beneficiary or obligee that the principal or contractor will meet his contractual obligations.
• In case the principal fails to deliver his promise, a monetary compensation is paid to the obligee by the insurer.
• There are 3 parties involved:
  • The Surety (Insurance Companies) will provide the financial guarantee to the Obligee /beneficiary.
  • Obligee or Beneficiary (example-Government, Infrastructure Development Authorities etc.) -the party that needs the surety and is often the beneficiary of the surety bond.
  • Principal (could be the owner or contractor)-the party that purchases the Surety bond from an insurer as a guarantee and undertakes a commitment to perform the obligations as per the contract entered.
• Who can buy the policy?
  • A surety bond is provided by the insurance company on behalf of the contractor or business owner to the entity which is awarding the project as a guarantee against the future work performance to Obligee.
• Advantages:
  • It will act as a security arrangement for infrastructure projects and will insulate the contractor as well as the principal.
  • Unlike a bank guarantee, the Surety Bond Insurance does not require large collateral from the contractor thus freeing up significant funds for the contractor, which they can utilize for the growth of the business.
  • The product gives the principal a contract of guarantee that contractual terms and other business deals will be concluded in accordance with the mutually agreed terms.

Q1: What is a bank guarantee?

A bank guarantee is a guarantee given by the bank on behalf of the applicant to cover a payment obligation to a third party. In other words, the bank becomes a guarantor and is answerable for the person requesting the guarantee in the event that they are unable to make the payment they have agreed with a third party.

Source: NHAI says ₹3,000 cr. insurance surety bonds issued by insurers so far