Did you know that the first-ever surety bond investment product was launched on 19th December 2022? By May 2024, 700 surety insurance bonds were issued by various insurance companies in India. These bonds were valued at 3,000 crores.
Bonds are one of the safest investment options, especially government bonds. Typically, the principal purchases a bond, and the bond provider guarantees to safeguard the interest of the principal in case of an unfortunate incident. Bonds can be purchased against a contractor, employees, etc. Anyone looking for long-term wealth creation may purchase insurance bonds. In India, insurance bonds may offer dual benefits of life insurance coverage and investment. So, on the one hand, the life assured receives the life insurance coverage while the insurance company invests the remaining premium in securities for investment purposes.
In the past few years, insurance bonds have become increasingly popular, especially after government reforms. There can be different types of insurance bonds, as discussed further. Read on to learn more.
Types of Insurance Bonds
Insurance bonds are becoming quite popular since they also act as an alternative to bank guarantees. Hence, investors are able to avail multiple benefits. Primarily, there are the following types of insurance bonds available in India:
A surety bond is an insurance product that safeguards the finances of the investor/principal. In a surety bond, there are three parties involved:
The principal or the project owner
The contractor, the one obliged to fulfil the project needs
A surety provider, who may be a bank, insurance company, etc.
The surety insurance bond can be of different types like contract bonds, payment bonds, commercial bonds, maintenance bonds, etc.
The purpose of a surety bond is to compensate in case the contractor fails to fulfil their obligations. The surety insurance bond primarily guarantees the principal that their financial interests will remain safe even if the contractor defaults. Let's understand the surety insurance bond with the help of an illustration:
Company CDE is a renowned construction company. A university hired them to complete the construction of their new building along with the playground. The company CDE agrees to finish the task within 6 months and with a guaranteed quality level. The university has made sure that the company CDE obtains a surety insurance bond from an insurance company to ensure the quality of work.
However, after an agreed time frame, the company fails to wind up the project and the university is also not satisfied with the quality of work as mentioned in the agreement. So, the university (the principal) files a complaint against the company CDE to the surety provider. Upon investigation, the company CDE is found to be at fault, and so the university is compensated by the insurance company to cover their losses. Later on, the insurance company (the surety provider) settles their case with the company CDE.
There are several cases where an employer experiences loss due to dishonesty or fraud by the employees. To protect an employer from such a situation, a fidelity insurance bond can be issued. It is a part of the risk management for an employer or a company to get compensated against the dishonesty of employees. There can be different types of fidelity bonds like business service bonds, employee dishonesty bonds, etc.³
For instance, if employee A of a company PQR commits fraud, the company may also be exposed to legal penalties and other hassle. Due to the fraudulent activity of the employee, the company may have to bear certain fines and penalties along with the employee. So, here comes the fidelity bond that acts as an insurance policy against such losses. The fidelity bond provider will cover the losses that occurred due to such reasons.
Investment bonds are primarily insurance products and are offered, typically by life insurance companies. Generally, the insurance bond is issued in the form of term insurance or whole life insurance policy where the life assured (who may also be the policyholder) receives life insurance coverage as well. Along with this, the bond has an investment element where the investor may choose from the security like that in a mutual fund.
The issuer invests the pooled bond premium in securities like equities to create a high ROI (Return On Investment). In return, the investor receives the dividend or interest on a regular basis. If the agreed condition specified on the bond is met, the investor receives back the principal amount as well.
Conclusion
Insurance bonds become an essential tool when it comes to financial planning and risk management. Be it a company, an entity, or an individual, Insurance bonds can be quite useful. The principal of the bond receives the much-needed peace of mind and security against possible risks and losses. For instance, the fidelity bond ensures that the wrongful acts of the employees do not harm the finances of the company. On the other hand, a surety bond ensures the contractor's non-compliance does not impact the interests of the obligee.
If you are already planning to invest in an investment bond, understanding what an insurance bond is, how it functions, its types, and its risks are essential to understand. The bond requires you to pay a sum premium. So, calculating the cost of the bond and why you may need it helps you make an informed decision!