What is surety bond insurance and what are its benefits?
It offers businesses significant advantages over the bank guarantee
Surety bond insurance is a great unknown. Or it is for many businesses, who are unaware of the important advantages this type of insurance offers over its main competitor, the bank guarantee. This is not helped by the very small scale of this branch of the insurance sector, (although it has strong potential for growth), nor by a certain amount of confusion that exists in relation to credit insurance, to which it appears to be linked in many sector statistics. If you can spare a few minutes, we will tell you what surety bond insurance is and explain the main advantages that are leading to its growth.
In Spain, this insurance is regulated by Article 68 of the Insurance Contract Law. According to this law, “the insurer must, in a case where the policy holder fails to comply with their legal or contractual obligations, compensate the insured by way of compensation or penalty for the financial damages suffered, within the time-frames set down in the Law or in the contract. All payments made by the insurer must be reimbursed by the policy holder”.
In this definition, we find ourselves faced with the policy holder, company or individual who contracts the insurance policy, the insured party, to whom it is guaranteed that the obligations arising from a law or contract will be complied with, and the insurance company which, on one hand covers the policy taken out by the policy holder and, on the other hand, makes a guarantee to the insured party (in the face of a possible default by the policy holder) of a particular obligation, whether imposed by Law or freely entered into through a contract.
Surety bond insurance, which covers the risk of non-fulfilment of an obligation, must not be confused with credit insurance, as in the latter, not only is the policy holder also the insured party, but the insurance company protects against the risk of the permanent insolvency of the debtors.
Surety insurance vs bank guarantee
As we have already seen, surety bond insurance is used in situations where a business or an individual must guarantee, in relation to a third party, non-financial obligations deriving from a contract or law. Surety bond insurance has the same validity as a bank guarantee. However, in the case of businesses, it offers significant advantages which are worth highlighting:
- It is not reflected on the liabilities side of the balance sheet and, in addition, the insurance becomes a deductible expense in the operating account.
- It obviates the need to tie up cash, which is normally a requirement with bank guarantees. un requisito que sí suele ser habitual en los avales bancarios.
- It is not recorded on the Bank of Spain’s Risk Information Centre, the database that records the indebtedness of businesses. (H3) Unlike the bank guarantee, the insurance is not entered on this database. In this way, it eliminates bank risks and secures an improvement in the financial image. It facilitates the growth of the business, as in the future it leads to a greater capacity for borrowing or funding.
- It is cheaper. Unlike a guarantee from a financial entity, the surety bond insurance involves no notary costs or multiple commissions (for administration, examination, formalisation and even cancellation) which is normal practice with guarantees.
Surety bond guarantees and coverage
Surety policies have different applications, particularly among companies working with government agencies.
- A guarantee to repay the sums advanced for the purchase of dwellings. Purchasers of dwellings are guaranteed the repayment of amounts they advance to the developer before and/or during the construction of the dwellings, as well as statutory interest. The cover comes into effect if the developer does not hand over the property on the due date or does not repay the advances.
- Administrative guarantees. Those which allow the fulfilment of obligations pursuant to different legal regulations and access to grants and administrative authorisations (Customs, AENA, MEFF, FEGA, etc.).
- Guarantee of fiscal origin or contested administrative proceedings. They ensure the fulfilment of the final payment, a consequence arising out of the administrative decision that resolves the conflict which is, for example, due to disputed tax assessment, VAT compensations or before the Administrative Courts.
- Guarantees demanded by contracts with government agencies. Surety bond insurance guarantees the fulfilment of different contractual obligations with regard to government agencies: tenders (for companies that wish to access contracts for tenders or competitions), execution of works or the supply of services (once the contract has been awarded), extras, advances or procurement of materials, taxes on certifications, etc.
- Guarantees provided in regard to private companies. Those deriving from private contracts are similar to those demanded by government agencies.
Surety insurance industry growth
We are presented, therefore, with a useful insurance, one that offers significant advantages in comparison with the bank guarantee, and is a very positive solution for many sectors, including construction. “We saw the best example of the construction surety bond at the height of the construction crisis. At that time, surety bond insurance offered peace of mind to businesses and to society in general, to hundreds of thousands of cooperatives and buyers of off-plan homes, who were able to recover the money they had advanced,” explains Mario García Cueto, director general of Aserta España.
In spite of all this, it enjoys much lower popularity than the bank guarantee: surety bond insurance represents only 14% of the whole Spanish guarantee market, which is worth something over 700 million euros. This is far short of the percentage in the major countries around us, where the risk is shared with the banks, and where surety bond coverage reaches up to 50% of the market.
That’s the bad news. The good news is that in 2018 surety bond insurance was once again on the pathway to growth, when it exceeded 24.87% and the strong growth of 75.38% during the first half of 2019.
“I am confident that surety business insurance will grow, and to achieve this, we need to create niche markets and specific products. For example, policies for SMEs, to whom surety bond insurance provides important benefits, and contributes to the enhancement of credit standing in the eyes of the banks”, commented García Cueto.