Performance Bond, Insurance Guarantee and Credit Insurance… Aren’t these also Financial Guarantees?

Over the last couple of years you get questions consistently being posted as to whether performance bond, insurance guarantee and credit insurance granted by insurers can also be categorised as financial guarantee. Conceptually, Performance Bond, Insurance guarantee and Credit Insurance are basically synonymous with Financial Guarantees. Maybe I should not use the word “synonymous” but rather “a subset of” to be more realistic in that sense.

If we write financial guarantee without knowing why, this may spell trouble...

If we write financial guarantee without knowing why, this may spell trouble...

On the question of what exactly are performance bond, insurance guarantee and credit insurance designed for? In their broad insurance sense, they are designed as follow:

Performance bond – A performance bond is a surety bond issued by an insurance company (surety) or a bank to guarantee satisfactory completion of a project by a contractor. Performance bonds are commonly used in the construction and development of real property, where an owner or investor may require the developer to assure that contractors or project managers procure such bonds in order to guarantee that the value of the work will not be lost in the case of an unfortunate event (such as insolvency or refusal to complete on the part of contractor). Usually the bond ensures payment of a sum (not exceeding a stated maximum) of money in case the contractor fails in the full performance of the contract. A performance bond is in reality not an insurance policy because of the existence of the counter indemnity clause. If the bond is cashed by the principal, the payment of that claim amount is recoverable by the guarantor (or surety) from the contractor and other parties guaranteeing the issuance of the bond). This counter indemnity clause is standard security in the surety market and provides the Surety with a legally binding undertaking from the contractor to indemnify against any claims and costs that may arise whilst acting as Surety for that particular client.

Insurance guarantee – An insurance contract that guarantees a prescribed amount would be paid in any event of a default by the guaranteed (“first party”) party in a “Three-party contingent liability” agreement. Under such agreement the third-party (the guarantor or “insurer”) agrees to be directly or collaterally responsible for the obligation (contract fulfillment, loan) of a first-party (the principal) to a second-party (government, bank, client) in case the first-party defaults or fails to fulfill its part of a deal. In effect, signing such a guarantee as a guarantor is like signing a blank check. Also called bond in certain cases or practices.

Credit Insurance – Policy bought to cover a credit risk, which can simply means risk of non-payment or default by debtor or buyer up to a certain amount. It may also take the form of a credit derivative, which usually takes the form of Option or swap contract, just like those CDS and CDO that brought the downfall of Lehman Bros. and AIG if that what I called some simple illustration of their meanings.

Cock is Penis, Penis is Cock????

Cock is Penis, Penis is Cock????

Simply summing them up, all these three categories of product in fact contain financial guarantee elements although their coverages are focused toward certain risk profiles – performance bond is in respect of contract and contractor’s obligations, Insurance guarantee contractual aspect is quite similar to those of performance bond especially in respect of the “Three-party contingent” agreement however is more general in its approach, lastly Credit Insurance is more clearly focused towards trading activities.

After having gone through the various technical aspects of these three major categories of guarantees, so what was the big fuss all about until I have to write these uninteresting subject in this blog! I meant the fuss within the Malaysian markets…..

The main issue is if the Malaysia Central Bank (or bank Negara Malaysia) has given the green-light for the non-life insurance industry to underwrite performance bond, why can’t the industry also innovate to expand the  very profitable performance bond portfolio?  

The markets have been trying some forms of break-out by trying to repackage those financial guarantee risks so that these can be brought under the categories of performance bond that are allowable by PIAM (or in effect the Central Bank).

We did see some companies going to an extent of issuing performance bond to guarantee the performance of Travel Agency and also Foreign Workers’ Employment Agency!

So what exactly is the type of financial guarantee (or performance bond) allowed by PIAM (or Persatuan Insuran Am Malaysia) or BNM?

The JPI20/2006 issued by BNM dated 5th October 2006 specifically states no insurer is allowed to issue any form of bond or financial guarantee except the following:
  1. Performance bonds that are directly linked to the performance of contractor in the construction of real properties….
  2. Advanced payment bond in respect of government projects only
  3. Administrative bond
  4. Tender bond
  5. Custom and Excise bond
  6. Supply bond
  7. Foreign Workers (except foreign maids) insurance guarantee or bond
  8. Trade Credit Insurance (but subject to prior approval from BNM)

Issuing Performance Bond like 007 JAMES BOND?

The conclusion is therefore not difficult – “THERE IS LITTLE ROOM FOR ANY CREATIVITY AND INNOVATIVENESS HERE!” So just keep things simple….. and keep your excess creativity in your closet before you becomes James Bond007!

Before we end this boring blog, it is good if we are also aware of the availability of Financial Guarantee Insurance facility in Malaysia. This new category of insurance is now offered by the country first financial guarantee insurer (set up in May 2009 and is AAA- rated) – Danajamin Nasional Berhad which is also regulated and under the supervision of  BNM. However, Danjamin only provides financial guarantee insurance to issues of private debt and Islamic securities. Its aim is to facilitate capital-raising by Malaysian companies from the capital markets by providing financial guarantee insurance to protect the holders of private debt securities against any missed payments or defaults.

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5 comments for “Performance Bond, Insurance Guarantee and Credit Insurance… Aren’t these also Financial Guarantees?

  1. Performance Bonds Insurance
    May 1, 2012 at 13:28

    Insurance policy should provide good coverage in all situations.This performance bond insurance option should be taken from a very good insurance provider as it will enhance your pay and make your money worth.

  2. July 17, 2010 at 01:27

    Companies in the construction industry should understand performance bonds. Performance bonds differ in many ways from payment bonds. While payment bonds are designed to assure compensation to subcontractors and suppliers, performance bonds seek to secure completion of the project or award of damages to the owner for default by the general contractor.

    • July 17, 2010 at 09:29

      Performance Bond and Payment Bond…. For Malaysian insurance practitioners, they are familiar with Performance Bond but NOT the term Payment Bond, simply the regulatory authority does not allow such bond to be writing by the insurance industry. TQ for the info.

  3. Anonymous
    December 13, 2009 at 02:17

    This means that performance bonds, insurance guarantee and credit insurance are termed as financial guarantees in the broad sense?

    • December 15, 2009 at 01:21

      I supposed there are the same – from the broad category. From Malaysian perspectives, all these naming do not matter, whatever you called it or them, they must first and foremost fall within those category of admitted policy under the insurance Act or by the Central bank before they can be underwritten by the local insurers.

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