The framework: booming infrastructure sector
To understand the potential of this opportunity, let's first set the context: India's infrastructure development.
Infrastructure development is pivotal to driving India's economy and serves as a catalyst for national growth. The government has prioritized creating world-class infrastructure and implementing policies and initiatives to ensure timely development in areas like power, bridges, dams, roads, and urban projects. These efforts also stimulate economic growth in related sectors, including housing and construction.
Significant investments are planned, with $1.4 trillion allocated to infrastructure from 2019 to 2023 and an additional $750 billion proposed for railway infrastructure from 2018 to 2030. It is estimated that India will need to spend $4.5 trillion on infrastructure by 2030. The National Infrastructure Pipeline has expanded from 6,835 to 9,142 projects across 34 sub-sectors in four years - nearly half of these projects are in the transportation sector, focusing heavily on roads and bridges. The fiscal year 2023-24 budget reflected this commitment with a 33% increase in capital investment outlay, reaching $122 billion, or 3.3% of GDP. In the interim budget for 2024-25, the capital investment outlay for infrastructure has been increased by 11.1% to $133.86Bn (3.4 %of GDP).
Despite the opportunities in infrastructure development, new players face challenges, especially in securing bank guarantees essential for obtaining contracts. While the government is awarding 50% of infrastructure contracts to new players with the aim of increasing competition and speeding up construction, tighter controls by Indian banks on issuing collateral-free bank guarantees due to past corporate failures have made it difficult for both new and existing players to compete for projects. There is also not enough supply of bank guarantees compared to the current (and forecasted) demand (more of this below).
The problem: bank guarantees are mandatory in construction contracts as they provide financial assurance to the project owner that the contractor will fulfill their obligations. Bank guarantees require valuable capital as collateral, up to 50-100% of the project's cost, limiting funds available for business expansion. This strains cash flows, hampers daily operations, and hinders growth opportunities. The bureaucratic process of securing and maintaining bank guarantees is time-consuming and diverts resources from core business activities. Additionally, increased costs and fees associated with bank guarantees reduce profitability and financial flexibility for contractors, with rising margin money and commissions making them increasingly expensive.
Therefore, given India's ambitious infrastructure plans and the inefficiencies (and insufficiencies) of bank guarantees, finding an alternative is of the utmost importance.
Enter: surety bonds
The answer to this problem is easy: surety bonds. But what exactly are surety bonds?
Surety bonds are financial guarantees ensuring that contractors meet their obligations to project owners. Involving three parties - the principal (contractor), the obligee (project owner), and the surety (insurance company) - surety bonds provide compensation or arrange for project completion if the contractor defaults. There are many types of surety bonds (advance, bid, contract, performance, etc.) - which for the sake of this article I will not cover.
Taking the POV of the principal, the benefits are numerous.
First, improved liquidity: unlike bank guarantees, which can freeze 20 to 50% of a contractor's cash flow, surety bonds do not require any collateral. This frees up significant assets for contractors, enabling them to expand their businesses and reduce debt, thereby alleviating financial pressures. Moreover, surety bonds do not impact the contractor’s borrowing capacity, unlike bank guarantees that can limit credit lines.
Second, access to financing: surety bonds can enhance contractors' access to financing and credit. These bonds provide lenders and suppliers with assurance of repayment in case of default, demonstrating the contractor’s financial stability, commitment to quality work, and ability to fulfill contractual obligations. This reassurance can help contractors secure favorable loan terms and necessary materials for projects.
Third, more accessibility: surety bonds are available to businesses of all sizes, including those with less-than-perfect credit, as their issuance is based on the business's overall strength rather than just its credit score. In contrast, bank guarantees are typically reserved for larger, well-established businesses with strong credit ratings, making surety bonds particularly beneficial for cash-strapped SMEs that cannot afford to tie up collateral.
Clearly, there are also many benefits for the obligee: assurance of higher scrutiny processes leading to risk mitigation and principal quality assurance, faster claim settlement, shorter delays in case of disputes and completion guarantee, and financial protection. It's a win-win for everyone involved.
Mind you, surety bonds are nothing new: they've been widely adopted for years in countries around the world. Take the U.S. as an example: since 1893, the U.S. Government has mandated that contractors on federal public work projects provide surety bonds to guarantee performance and payment of certain labor and material costs. The Miller Act of 1935 requires performance and payment bonds for all public work contracts exceeding $100,000. In Canada, surety bonds have 100% market share over bank guarantees for construction projects.
Surety bonds are a fairly new concept just in India - I'll cover the history of surety bonds in a minute. Let's first try to understand the size of the opportunity, and whether this is venture-backable or not.
How big is this opportunity?
Let's run a back-of-the-envelop calculation of how large the opportunity is.
Surety bonds are generally required for 5 to 50% of a project's value, so let's go with 25%. Considering the $122Bn investment planned by GOI in infrastructure in 23-24, this means that the surety bond required (if surety bonds were to cover the entire market need) is to the tune of $30Bn. Assuming a 2.5% GWP (it could range anywhere between 0.5% and 10% of the bond amount) it's a $763m revenue opportunity for an insurer. Another way of looking at this is by evaluating the gap between the availability of bank guarantees and the demand for the same. According to a report by The Infravision Foundation, the availability for bank guarantees is around $41Bn in FY25, versus a requirement of $114Bn - that's a staggering $73Bn gap that needs to be filled by some alternative.
Not large enough? I'll let you decide. Before jumping to conclusions though, let me point out that surety bonds are not confined to being solely used for infrastructure development projects. While my entire discourse has been on that, I did not mention that surety bonds can be effectively used in place of bank guarantees for a plethora of usecases.
One is EXIM: traders, and specifically mostly importers, are often required to purchase letters of credit from banks to guarantee that they will make the payment, within the stipulated time period of the invoice, to the supplier of goods upon receiving the goods. The cool thing is that LoCs can be replaced by surety bonds. Similarly, manufacturing is another large "tappable" market: in fact, the manufacturing industry is the second-largest consumer of surety bonds after the infrastructure sector; e.g., performance surety bonds are used to provide performance guarantees for equipment and machinery, as the bond acts as a guarantee of the delivery and installation of equipment and machinery. Last, financial services is another non-obvious market that can be served. According to guidelines (namely, FLDG) from the RBI, any fintech player in India acting as a lending service provider must provide a bank guarantee equal to 5% of the entire loan portfolio to the bank through which it is placing the loans. Given that bank guarantees can be replaced by surety bonds, this opens up another massive addressable market for a surety bonds issuer.
So, let's run the calculation for the same, and see how big the opportunity actually is.
Taking EXIM, letters of credit are required for 5-100% of import value. With India importing $714 billion in 2023, and assuming 25% of these imports are paid in advance, the surety bond requirements to cover all trade would be $267 billion. At an average premium value of 2%, this translates to a GWP of $5.35 billion.
Let's take manufacturing. India's manufacturing exports reached $450 billion in FY23-24. Assuming that bid or performance bonds are required for 25% of these cases, and with an average premium value of 2%, the Gross Written Premium (GWP) would be $2.25 billion.
Last, let's consider the financial sector. Bank guarantees are required for 5% of the entire loan portfolio, which can be completely covered by surety bonds instead. Given that $208 billion in loans were disbursed by NBFCs and $7 billion by other fintech lenders in 2022, the surety bond requirements to cover the loan portfolio would be $10.75 billion. Assuming an average premium value of 2%, this results in a GWP of $215 million.
Cumulatively, it looks like a pretty large opportunity to me! Given InsurTech's multiples, the market is surely large enough for a unicorn outcome.
So: where is India at, in terms of market adoption? Let's dive in!
A brief history of surety bonds in India
I've quickly summarized the main events by date since surety bonds have been introduced in India - let's walk through them.
Jan/April 2022: in January 2022, the Insurance Regulatory and Development Authority of India (IRDAI) introduced a framework for surety insurance, set to be implemented on April 1, 2022. The IRDAI (Surety Insurance Contracts) Guidelines, 2022 came into effect, enabling Indian general insurers to offer surety insurance products. This date marked the official commencement of surety bond operations in India's insurance market.
December 19, 2022: India's first surety bond insurance product was launched by the Road, Transport, and Highways Minister Nitin Gadkari. This significant event introduced surety bonds to the Indian market, aimed at reducing infrastructure developers' reliance on bank guarantees. Bajaj Allianz General Insurance was the first company to launch this product, marking a crucial milestone in the adoption of surety bonds in India, followed by New India Assurance.
May 2023: in May 2023, SBI General became the third insurer to launch a surety bond product.
June 2023: six months after the launch of the first surety bond product, there were still no significant adoptions of the instrument.
September 2023: despite announcements from leading insurers like New India Assurance, ICICI Lombard General Insurance, SBI General Insurance, and Bajaj Allianz General Insurance, the market for surety bonds struggled due to the absence of essential supporting elements.
May 2024: By May 2024, insurance companies had issued approximately 700 surety bonds valued at around INR3,000cr/$360m. At a workshop organized by the National Highways Authority of India (NHAI), it was revealed that 164 insurance surety bonds had been received, including 20 for performance security and 144 for bid securities.
June 2024: In June 2024, TATA AIG General Insurance issued India's largest performance surety bond, valued at over INR100Cr/$12m.
So, more than 2 years since the framework was implemented and 1 and a half since the first product was officially launched, only a minimal fraction of the market has been covered. It's obvious that market adoption has been slow, or at least not up to expectations.
But is it really a problem of market adoption, or of the underwriters' ability to service the market?
Bottlenecks to date
Surety bonds currently present several challenges for insurance companies that lack expertise in risk assessment for this type of business. As of today, there is no clear guidance on pricing, recourse against defaulting contractors, or reinsurance options. These issues are critical and may hinder the development of surety-related expertise and capacity, ultimately deterring insurers from offering these bonds.
First, reinsurance support is crucial for surety bonds - no primary insurer can issue a policy without adequate reinsurance backing. Issuers of surety bonds in India must be able to legally enforce tripartite contracts that ensure compliance, payment, and performance. However, the Indian Contract Act and the Insolvency and Bankruptcy Code do not recognize insurers' rights on par with financial creditors, limiting insurers' recourse in the event of default. Currently, many insurers issuing surety bonds do so without sufficient reinsurance support, restricting their capacity to issue bonds of significant value. Loss mitigation tools in surety contracts are also not clearly defined, raising concerns about insurers' risk-bearing capacity. The lack of a robust regulatory framework to address defaults leaves insurers exposed and hampers their ability to recover losses. Additionally, the absence of a vibrant reinsurance market limits insurers' ability to diversify and distribute risk. Insurance providers therefore need to find alternative recovery mechanisms (as per IRDAI Guidelines), such as finding alternate contractors, re-bidding the job for completion, or even providing assistance to the existing contractor.
Leading reinsurers involved in designing these products for the Indian market note that buyers are reluctant to pay adequate premiums: it appears that the expectation is that surety bonds should be cheaper than bank guarantees, unsustainable for insurers. Perhaps this is due to market education. The basic idea is that the opportunity cost saved by freeing up margin or collateral (either reducing what banks require or not needing any at all) should exceed the premium that insurers charge for surety bonds. This opportunity cost can be calculated by considering how the freed-up margin is used to generate operational profit or how the freed-up collateral can secure a higher fund-based limit, which again contributes to operational profit. The increase in profit represents the opportunity cost that insurers need to consider. If insurers charge more than this opportunity cost, contractors will have no incentive to opt for surety bonds. Conversely, if the charges are lower, contractors will see the benefit of choosing surety bonds over bank guarantees.
Last, effective pricing of surety bonds requires actuarial analysis based on historical data, which is currently lacking. Without an extensive database of product issuances, developing a pricing model is challenging, contributing to reluctance among insurers to offer these bonds. Furthermore, insurance companies struggle to access historical data on bank guarantee issuance and defaults, typically held by the banking sector, which also lacks a consolidated central database. This data gap makes it difficult for insurers to assess risk and price their products accurately.
Where does the business opportunity lie, then?
My thesis
If we look at the different stakeholders within this particular value chain, there is a tangible opportunity to tap into as a value-adding (and therefore value-extracting) player. This player should not (and could not) be a fully-fledged insurer, though. Rather, in my opinion, there is a sizable opportunity for a startup to operate as an "integrated broker" and capture a large share of the market. Let me explain.
An "integrated broker" is not a licensed insurer itself, nor a simple broker - rather, it is a company that develops its own proprietary underwriting algorithms and leverages existing insurance companies to front the bond, which is then “passed upon” to reinsurers.
Why? Surety bond underwriting involves a pre-approval assessment carried out by the surety (the insurer). This process includes evaluating the bond performance requirements set by the obligee, as well as the principal's financial condition, to gauge the risk associated with the performance criteria and the principal's capacity to repay the surety if a claim arises. Therefore, underwriting is a critical function of an insurer, with the underwriter's goal being to accurately evaluate a particular risk, determine whether the insurer should accept it, and, if so, establish the appropriate pricing. We've already established that insurance companies lack strong underwriting capabilities.
Hence, there is a strong case to be made for a company that can solve the underwriting problem. This company will effectively be a broker registered with insurers and receive a commission from them for selling insurance products that are issued in their name, but powered using its own underwriting mechanism.
Therefore, the underwriting technology becomes key. Traditionally, obtaining a surety bond is a cumbersome and time-consuming process, laden with paperwork and manual assessments. A fully digital approach is possible, so long that the company is capable of fetching the required data (e.g. through integration with governmental agencies, etc.) which feeds the underwriting algorithm and generates automated reports recommending the premium, as well as the surety bond limit. Effectively shortening a days-long process into a minute-long process.
Another key thing to nail will be partnerships, both with insurers and re-insurers. The latter partnership is particularly crucial, as reinsurance allows to transfer the risk associated with surety bonds to the reinsurer, reducing the overall exposure of the insurer (the integrated broker bears no risk) - solving another pain point preventing insurers from issuing surety bonds.
Raison d'etre
The question arises: why is there a need for such a player to begin with? I'll be short.
It's very simple: that's how the industry already operates. Insurance companies will always rely on brokers because brokers serve as a critical distribution channel, providing insurers with access to a broader market without the need for extensive direct sales efforts. Brokers handle the client acquisition process, policy administration, and customer service, which can be resource-intensive for insurers to manage directly.
However, an integrated broker addresses other critical inefficiencies and gaps in the current system, as it combines the traditional role of a broker with advanced underwriting capabilities, creating a powerful intermediary that adds significant value to both insurers and clients. Indeed, the integrated broker model can accelerate the underwriting process by pre-screening clients and gathering detailed risk information upfront, which can reduce the workload for insurers and speed up policy approvals. Moreover, it helps also to offload risks to reinsurers.
Additionally, in a market where trust and relationships still play a significant role in business transactions, an integrated broker can act as a trusted advisor, balancing the impersonal efficiency of technology with a human touch. This hybrid approach can be particularly effective in India, where personal relationships often underpin business dealings, especially in sectors like construction and infrastructure.
If you are a founder looking to build in the space, reach out to me - I would love to be a sparring partner. If you know a strong profile interested in the opportunity, don't hesitate to connect them with me - I'd love to chat
Well, that's it. Feel free to reach out if you want to share thoughts, or leave a comment - I'll be happy to get your perspective.
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