IRDAI Guidelines for Surety Insurance Contracts

The Insurance Regulatory and Development Authority of India (IRDAI) has introduced new guidelines for surety insurance. These guidelines shall apply from April 1st, 2022. It is a three-party policy wherein the insurance company guarantees the bond (second party) performance to the customer (third party). As per the suggestions of the working committee, the IRDAI came up with a draft of new regulations last September, aiming to promote surety bonds. Read this page to know what new guidelines are.

Introduction to the IRDAI Guidelines for Surety Insurance

The IRDAI has considered it necessary to promote and regulate Surety Insurance Business, under section 14 (2) (i) of IRDAI Act, 1999. So, the following regulations are going to come into force –

  • All the insurance companies registered under the Insurance Act, 1938 for the business of general insurance may transact the business of Surety Insurance in compliance with the eligibility criteria as set out in the guidelines.
  • After the commencement of guidelines, no person should transact the business of Surety Insurance unless the person is an Indian Insurance Company as per Section 2 (7A) of the Insurance Act, 1938.
  • This is a contract of guarantee under Section 126 of the Indian Contract Act, 1872 to perform the promise or discharge the liability of a third person upon default. The person who offers the guarantee is the “Surety”; the person who has defaulted is the “principal debtor”, and the one who gets the guarantee is the “creditor”.
  • A contract of Surety is deemed to be an insurance contract if it is made by a Surety who or which is an insurer as per the Insurance Act, 1938.
  • General insurance companies shall commence surety insurance if they meet the requirement of maintaining a solvency margin of not less than 1.25X the control level of solvency as specified by the authority. In case the solvency margin is less than the threshold limit at any time, the insurer stops underwriting the new Surety Insurance business.
  • The premium for all Surety Insurance policies underwritten in a financial year shall include installments due in subsequent years. And this shall not exceed 10% of the total gross written premium of that financial year, subject to a maximum of INR 500 Crores.
  • The board of the insurance company should approve the underwriting philosophy on Surety Insurance business with adequate underwriting competence and skills, risk management and infrastructure for underwriting Surety Insurance.
  • Risk assessment mechanism, internal risk management guidelines are there to evaluate the technical/financial strength of principal before and after underwriting the Surety Insurance.
  • Banks or other financial institutions such as NBFCs can share risk information, technical expertise to monitor projects, cash flow and other aspects with the insurer.
  • The Board of Directors of the insurance company should approve the methodology and procedures to set the maximum limit of accumulation of risks per contractor and their group companies or firms. And the insurer must build a maximum retention limit for risk accumulation in the underwriting policy and philosophy.
  •  Infrastructure projects of government or private in all modes get Surety Insurance Contracts .
  • The Contract Bonds are Bid Bonds, Performance Bonds, Advance Payment Bonds and Retention Money. Apart from Contract Bonds, the insurer underwrites Customs or Tax Bonds and Court Bonds.
  • The limit of guarantee should not be more than 30% of the contract value.
  • The insurer shall not issue a Surety Insurance contract on behalf of the promoters or their subsidiaries, groups, associates and related parties.
  • The insurance company shouldn’t enter into an “alternate risk transfer” mechanism.
  • No Surety Insurance contract covers financial guarantee. A Financial Guarantee comprises any bond, guarantee, indemnity or insurance, providing financial obligations for loan, leasing facility, etc. A bank, credit institution, financial institution or financier in respect of the payment or repayment of borrowed money or any contract, transaction or arrangement, guarantee the same.
  • The insurer ensures no single risk and aggregate risk is disproportionate to the capital
  • Surety Insurance contracts are in compliance with applicable laws.
  • Surety Insurance contracts won’t be available if the underlying assets or commitments are outside India.
  • Payment for risks covered under the Surety Insurance contract shall be made in INR
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These guidelines set the minimum underwriting requirements the insurer needs to accept the business of Surety Insurance to ensure its ability to manage the portfolio or meet the reasonable expectations of the policyholders. The insurers must have due regard to all relevant factors, including the quality of the business portfolio and risk exposure, to determine whether the additional levels of underwriting safeguards need to be maintained.

Types of Surety Contracts

Check out the different types of surety contracts below –

Advance Payment Bond

A promise by the Surety Provider to pay the outstanding balance of the advance payment if the contractor doesn’t complete the contract as per specifications or fails to adhere to the terms and conditions of the contract.

Bid Bond

An obligation undertaken by a bidder that if awarded the contract, furnishes the prescribed performance guarantee and enters into a contract agreement within a specified period. Here, obligee gets financial protection if a bidder receives a contract under the bid documents, but cannot sign the contract and provide any required performance and payment bonds.

Contract Bond

Contractors’ assurance to the public entity, developers, subcontractors and suppliers that they fulfill its contractual obligation when undertaking a project. This may include Bid Bonds, Performance Bonds, Advance Payment Bonds and Retention Money.

Customs and Court Bond

A type of guarantee where the obligation is tax office, customs administration, etc. any public office. This guarantees the payment of a public receivable incurred from an opening of the court case, clearing goods from customs or losses due to incorrect customs procedures.

Performance Bond

It protects the obligee if the principal or contractor doesn’t perform the bonded contract. If  the obligee declares that the principal or contractor is in default, the contract terminates. And this calls upon the Surety to meet the obligations under the bond.

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Retention Money

A part of the amount is payable to the contractor, retained and payable at the end after the completion of the contract.

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