NHAI’s Use of Insurance Surety Bond in Monetisation Bid

  • November 11, 2023
  • Posted by: OptimizeIAS Team
  • Category: DPN Topics
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NHAI’s Use of Insurance Surety Bond in Monetisation Bid

Subject: Economy

Section: Monetary Policy

  1. Introduction:
    • The National Highways Authority of India (NHAI) has adopted an innovative approach by accepting an insurance surety bond for the Toll Operate Transfer (TOT) Bundle 14 monetisation program.
  2. Nature of Instrument:
    • An insurance surety bond serves as a form of bank guarantee (BG) in the road infrastructure sector for the monetisation of bids.
    • This marks the first instance of utilizing this innovative financial instrument in the road infrastructure sector for monetisation purposes.
  3. Collaboration and Implementation:
    • NHAI collaborated with the Highway Operators Association of India (HOAI), SBI General Insurance, and AON India Insurance to implement this initiative.
    • The insurance surety bond has been issued for NHAI’s monetisation bid of TOT Bundle 14 at a rate of 0.25%, and it does not require any margin money.
  4. Benefits and Savings:
    • The use of an insurance surety bond at a low rate translates into significant cost savings for concessionaires.
    • These savings enhance liquidity in the market and create a favorable environment for the growth and development of the road sector.
  5. Industry Benchmark:
    • NHAI’s adoption of insurance surety bonds sets a new benchmark for the industry, emphasizing the importance of innovative financial solutions in the evolving landscape of road infrastructure development.
  6. Encouraging Private Participation:
    • The move is expected to encourage greater private participation in the highway sector, contributing to the overall “Ease of Doing Business.”
  7. NHAI’s BG Statistics:
    • NHAI has received a substantial volume of Bank Guarantees (BGs) since 2022, amounting to ₹15,000 crore.
    • The large volume of BGs offers significant potential for insurance companies, and the wider adoption of surety bonds is poised to boost capital availability for road projects.
  8. Additional Security and Adoption Appeal:
    • NHAI has urged insurance companies and contractors to consider insurance surety bonds as an additional mode of submitting bid security and/or performance security.
    • Over 40 surety bonds have already been issued for various NHAI contracts, showcasing the appeal and adoption of this financial instrument.
  9. Government Recognition:
    • The Ministry of Finance has equated electronic Bank Guarantees (eBG) and insurance surety bonds with bank guarantees for all government procurements.
  10. Impact on Infrastructure Development:
    • Instruments like insurance surety bonds contribute to strengthening national highway infrastructure development, with positive cascading effects on the economy.

Surety Bond

  1. Definition:
    • A surety bond is a written agreement that guarantees the compliance, payment, or performance of a specified act.
    • It operates as a unique form of insurance involving three parties: Principal, Surety, and Obligee.
  2. Three Parties Involved:
    • Principal: The entity purchasing the bond and committing to performing a promised act.
    • Surety: The insurance company guaranteeing the performance, assuming liability if the principal fails.
    • Obligee: The party requiring and benefiting from the surety bond, often a government organization.
  3. Purpose and Provider:
    • Surety bonds are provided by insurance companies on behalf of contractors to the entity awarding a project.
    • It facilitates financial closure for contractors, offering an alternative to bank guarantees.
  4. Aim in Infrastructure Development:
    • Aimed at infrastructure development to reduce indirect costs for suppliers and contractors, diversifying options.
    • Acts as a substitute for bank guarantees, enhancing efficiency in project financial closure.
  5. Benefits:
    • Protects the beneficiary against acts or events that compromise the principal’s obligations.
    • Ensures the performance of various obligations, from construction contracts to licensing agreements.
  6. Boost to Infrastructure Projects:
    • Framing rules for surety contracts addresses liquidity and funding needs in infrastructure.
    • Creates a level playing field for contractors of different sizes.
    • Assists in developing an alternative to bank guarantees, optimizing working capital and reducing collateral requirements.
    • Encourages collaboration between insurers and financial institutions for risk information sharing.
  7. Issues with Surety Bonds:
    • New concept in India; insurers lack expertise in risk assessment.
    • Lack of clarity on pricing, recourse against defaulting contractors, and reinsurance options.
    • Requires extensive reinsurance support, and primary insurers cannot issue policies without proper backup.
    • Legal enforcement of tripartite contracts and recognition of insurers’ rights under Indian Contract Act and Insolvency and Bankruptcy Code are challenges.
  8. Overall Impact:
    • Despite challenges, surety bonds have the potential to release liquidity in the infrastructure space while managing risks effectively.
    • Addressing issues and building expertise can make surety bonds a valuable tool for contractors and project stakeholders.

About National Highways Authority of India (NHAI)

National Highways Authority of India (NHAI) is an autonomous agency under the Ministry of Road Transport and Highways (MoRTH), Government of India.

Established in 1988, NHAI is responsible for the development, maintenance, and management of national highways and road networks in India.

Key Functions of NHAI:

  1. Highway Development: NHAI is involved in the planning and implementation of highway development projects across the country. This includes the construction of new highways, widening and improvement of existing highways, and the development of expressways.
  2. Monetization of Highways: NHAI explores various models for monetizing operational highways, such as Toll-Operate-Transfer (TOT) and Infrastructure Investment Trusts (InvITs). These initiatives aim to attract private investment and generate revenue for further infrastructure development.

Different models related to infrastructure development and public-private partnerships (PPP)

  1. Lease Contract Model:
    • Asset is leased to either the private or public entity.
    • The private entity can earn revenue from operations.
  2. Build-Lease-Transfer Model:
    • The private entity owns the asset and leases it to the public entity.
    • Public entity makes the capital investment.
  3. Build-Operate-Transfer (BOT) Model:
    • Public entity retains ownership.
    • Private entity is responsible for construction (typically greenfield projects).
  4. BOT Annuity:
    • Adopted for highway projects with limited revenue potential.
    • Private entity designs, builds, manages, and maintains the asset.
    • Receives a fixed annuity from the public entity at regular intervals.
  5. Engineering-Procurement-Construction (EPC) Model:
    • Private entity designs, finances, and builds the asset.
    • Ownership is transferred to the public entity.
    • Private entity does not handle operations and management.
  6. Hybrid Annuity Model (HAM):
    • Public entity finances 40%, private entity finances 60% of the project cost.
    • Ownership and operations remain the responsibility of the public entity.
    • Private entity provide engineering expertise.
economy NHAI's Use of Insurance Surety Bond in Monetisation Bid