This is how insurers advanced
As a number of banks were in danger of collapsing during the 2008-2011 banking crisis, new bank solvency requirements were imposed. The Basel standards governing this were tightened. As a result, more capital had to be held for outstanding liabilities (including guarantees). Insurers fall under the so-called Solvency legislation. In this, the requirements are less stringent than under Basel standards. So the insurance industry saw opportunities and insurers entered the financial guarantees market. They did so rapidly: in the Netherlands, the number of providers increased rapidly. In parallel with this development, recipients of guarantees started to find insurers' guarantees increasingly acceptable. This was partly due to insurers' ever-improving ratings. An additional advantage of insurers is that they often have a more extensive branch network abroad. While banks' international branch network has virtually disappeared since the crisis. This allows insurers - in countries that require it - to issue guarantees locally. Add to this the fact that, unlike banks, guarantee facilities through an insurer are in principle not deducted from the credit facility. With insurers, there is no restriction on working capital.
Common forms with practical examples
- Offer/Inscription guarantees
This guarantee is intended to provide clarity to the client about the quality of the bidders.
Case study:
A few years ago, the Bangladesh government issued a tender for the provision of temporary power supply. From the specifications, it was soon clear that a large number of gensets were involved (at least 50 units). Eventually, more than 100 companies signed up. These turned out to be mainly local companies, which owned only one genset, for example. The tender was withdrawn and re-launched, with the requirement that a tender/tender guarantee was issued of $ 250,000. The result: only four (high-quality) parties signed up.
- Advance payment guarantees
In a contract for the delivery of capital goods, for example, a payment schedule is generally included. For example, 30% on acceptance of the order, 50% on a certain milestone and 20% on delivery of the project/good. The so-called down payment of 30% is intended to allow the contractor of the contract to purchase the required materials.
Case study:
A shipyard takes an order to build a ship. Special steel and equipment/engines have to be purchased for this construction. With the down payment, the shipyard can in principle pay for the purchase. The client asks for a prepayment guarantee for this down payment. After all, he wants to be sure that the money will be used for that purpose. If not, the client will reclaim the money via the guarantee.
- Performance guarantees
Several payments are going to be made during the project (in the above example 50%). The client does want to know whether the project is going according to plan and being executed. Checkpoints are therefore included that allow him to monitor this.
Case study:
The shipyard will receive a follow-up payment when the hull of the vessel is completed and when the vessel is launched. In return for this payment(s), the client will request a performance bond.
- Maintenance guarantees
After the machine or project is delivered, the client wants assurance that it meets the pre-prescribed specifications and performance. If it does not, the contractor has to fix it. For this, the client often demands a Maintenance Guarantee, so that he can make sure it happens within a certain time.
Case study:
A Dutch contractor is building a factory in Egypt to produce insulation boards made from straw waste. The specifications stipulate that the factory has a production rate of 90%, 24 hours a day, six days a week. 10% is intended for maintenance and contingency. Two months after completion, the production rate is only 50% because the process has to be stopped regularly due to breakdowns. If this is not resolved within a certain time, the client will lose its maintenance guarantee claim.
Furthermore, there are specific guarantees prevalent in the market, including:
- Customs guarantees
These guarantees basically always occur when excisable goods are involved and have to be made to customs (tax authorities).
Case study: A producer of alcohol stores large quantities of alcohol through an external terminal. Alcohol carries a significant percentage of excise duty, which is paid as soon as the alcohol enters circulation. Until then, the owner has to provide a customs guarantee to the tax authorities worth the total amount of excise duty. This is to prevent the alcohol from entering circulation without excise duty.
- Rent guarantees
One of the most well-known forms of guarantee in which the rent payment of real estate is guaranteed for a certain period of time. This form is generally a bit trickier, as the term is often as much as 5 to 10 years.
Three tips for working with guarantees
- When accepting an order, check carefully that there are sufficient guarantee facility/working capital is to meet the obligations of the contract.
- Insurers basically provide no individual guarantees but facilities.
- Don't wait for the bank to refuse a guarantee facility/expansion. The insurer prefers not to be the 'last resort'.
More information on guarantee facilities through insurers? Then contact the specialists at Xolv or view our special page about Guarantees.
