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Why in the News?
Recently, the Ministry for Road Transport & Highways (MORTH) has asked insurance regulator IRDAI to develop a model product on Surety Bonds in consultation with general insurers.
Key Points:
What is a Surety Bond?
A surety is a person or party that takes responsibility for the debt, default or other financial responsibilities of another party.
A surety is often used in contracts where one party’s financial holdings or well-being are in question and the other party wants a guarantor.
Surety bonds are financial instruments that tie the principal, the obligee—often a government entity—and the surety.
In the case of surety bonds, the surety is providing a line of credit to the principal so as to reassure the obligee that the principal will fulfill their side of the agreement.
How does Surety Bond Functions?
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.
Issues Involved:
Surety bonds, a new concept, are risky and insurance companies in India are yet to achieve expertise in risk assessment in such business.
Further, there’s no clarity whether surety bonds will get the required reinsurance support.
Benefits of Surety Bonds:
Boost to Infrastructure Development: Surety bonds are aimed at infrastructure development, mainly to reduce indirect cost for suppliers and work-contractors.
Replacing the Bank Guarantee: These 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.
Surety bonds help provide owners of construction projects with guarantees of success and enhanced reputations.
News Source: The Indian Express
