Summary: This article traces the evolution of regulatory framework for surety contracts in India, from its introduction in April 2022 to the current liberalised, principle-based framework introduced in 2024.
Introduction
In our previous article (available here), we examined the performance of surety insurance contracts in India, following their formal introduction in April 2022. In this article (Part II), we trace the evolution of surety insurance regulation in India in the past three years and examine how the Insurance Regulatory and Development Authority of India (“IRDAI”) has liberalised the framework. More specifically, we examine the IRDAI (Product) Regulations, 2024 (“Product Regulations”), and the master circular issued thereunder, both of which introduce a simplified “principle-based regime” and exclusively govern surety insurance contracts in India.
The Initial Framework
The foundation for surety insurance in India was laid when the IRDAI constituted a Working Group on July 1, 2020. This initiative came in response to a Ministry of Road Transport and Highways’ proposal, particularly in light of the pandemic’s impact on liquidity and cash flow in the banking sector. The Working Group’s recommendations led to the introduction of the IRDAI (Surety Insurance Contracts) Guidelines, 2022, which came into force on April 1, 2022 (“2022 Guideline”). The 2022 Guidelines established a comprehensive regulatory framework, specifically tailored towards the unique risks and features of surety products.
Progressive Deregulation
The 2022 Guidelines initially imposed several restrictions designed to ensure prudent market development. These restrictions were as follows:
| Aspect | Description |
| Contract Value Limitations | Original framework capped the limit of guarantee at 30% of the contract value, restricting scope of surety bonds. |
| Detailed Underwriting Prescriptions | Extensive requirements governed how insurers could assess and price surety risks. |
| Product Approval Requirements | Insurers needed specific regulatory approvals for product variations. |
| Limitation Premium | Premium charged for all surety insurance policies underwritten in a financial year restricted to maximum 10% of total gross written premium of that year, subject to maximum Rs 500 crore. |
Recognising the growing maturity of insurers and market demand, IRDAI has systematically relaxed many of these constraints, allowing insurers greater flexibility in product design and underwriting.
The Master Circular 2024: Principle Based Regulations
The most significant shift came with the IRDAI Master Circular on General Insurance Business, issued on June 11, 2024 (“Master Circular”), pursuant to the Product Regulations. The Master Circular consolidated various guidelines and notably reduced surety insurance provisions, marking a significant departure from the detailed framework under the 2022 Guidelines.
This principle-based approach reflects the IRDAI’s confidence in the industry’s ability to self-regulate, whilst focusing regulatory oversight on core principles rather than prescriptive rules.
Current Regulatory Landscape
Whilst IRDAI has liberalised most aspects of surety insurance, certain fundamental principles remain, to protect the integrity of the market and safeguard stakeholders:
Prohibition on Financial Guarantees
Financial guarantees are still not permitted in any form within surety insurance contracts. This includes any bond, guarantee, indemnity, or insurance covering financial obligations related to loans, personal loans, leasing facilities, or any arrangement primarily designed to raise finance or secure borrowed money. This restriction ensures that surety insurance remains focused on performance obligations rather than becoming a substitute for credit insurance.
Geographical Restrictions
Surety insurance contracts cannot be issued where the underlying assets or commitments are located outside India. Additionally, all payments under surety insurance contracts must be made in Indian Rupees. This restriction maintains regulatory oversight and ensures enforceability within the Indian legal framework.
Prohibition on Alternate Risk Transfer Mechanisms
Insurers are prohibited from entering into “alternate risk transfer” mechanisms in relation to surety insurance. This prevents complex financial engineering that could obscure the true risk exposure and maintains transparency in the surety market.
Contractual Nature
A surety contract is required to be structured as a “contract of guarantee” under Section 126 of the Indian Contract Act, 1872. Additionally, a surety contract is also, in principle, an insurance policy as it follows principles of utmost good faith, insurable interest, indemnity, contribution and loss minimisation. Also, it may be noted that the erstwhile 2022 Guidelines, specified that “A contract of Surety shall be deemed to be an insurance contract only if made by a Surety who or which, is an insurer registered under the Insurance Act, 1938, to transact the business of general insurance.” (emphasis ours). Although the Master Circular does not mention this language, it seems clear that a surety contract from an Indian insurer functions both as a contract of guarantee and as contract of insurance.
Three Important Considerations
Firstly, whilst surety contracts generally possess subrogation rights under Section 140 of the Indian Contract Act, 1872 (enabling sureties to step into the creditor’s position and enforce rights against the principal debtor), the Master Circular does not separately prescribe any provision on insurers’ subrogation rights. Being both contracts of guarantee and insurance, from both equitable and market perspectives, surety insurance contracts should be deemed to include subrogation clauses.
Secondly, we have discussed that a surety contract from an Indian insurer functions both as a contract of guarantee and as contract of insurance. Consequently, surety contracts require stamp duty assessment considering the characteristics of both elements.
Thirdly , under the Insolvency and Bankruptcy Code, 2016, insurance companies, though notified as “financial institutions” under Section 3(14), are not classified as “financial creditors” since their claims against contractors for counter-security are not treated as “financial debt”. In case of insolvency of the policyholder surety insurers are technically at a disadvantage compared to banks or financial creditors.
Concluding Thoughts
Today, surety insurance contracts operate under a principles-based framework with only essential restrictions focused on preventing financial guarantee exposure, maintaining geographical boundaries, and preserving contractual integrity. The evolution of regulatory provisions on surety insurance in India exemplifies the IRDAI’s balanced approach to market development and is also reflective of the IRDAI’s confidence in the industry’s growing capabilities. Given the market potential for surety contracts, this liberalised environment facilitated by the IRDAI positions the sector for imminent growth.
