Understanding performance bond in insurance

CHUKWUMA ONONIWU

Chukwuma Ononiwu (FCILRM, Nig; FICRMP, U.K.), an alumnus of Abia State University and Lagos Business School Pan Atlantic University, is a consummate insurance broker, seasoned insurance consultant and digital insurance advocate. He can be reached on: riskswisepro@gmail.com and +234-903-596-8732 (text only).

BOND INSURANCE: A bond insurance is a type of insurance that a contracting firm, as requested by its principal, purchases, and which guarantees the repayment of an agreed percentage of the total contract sum or the total contract sum and all associated interest payments, in the event of a DEFAULT. The types of Bond Insurance include, but are not limited to, Bid bond, Performance bond, Advance Payment bond, Supply bond, Labour and material payment bond, Retention bond, etc. 

The most requested type of bond is Performance bond. Performance bond is a type of contract construction bond that guarantees  that a contractor will complete a project according to the timeline/specifications/terms/conditions/clauses, etc, outlined in the contract by the principal. If the contractor cannot complete the obligations to the principal, the bond value is paid to the principal to compensate for losses and consequential liabilities.

Performance bonds are either ON DEMAND BONDS or CONDITIONAL BONDS. There is also a hybrid.      

The essential difference between a bank guarantee and a performance bond: The obligation in a bank guarantee is secondary and it is dependent on the existence of the primary debtor’s liability to the creditor. On the other hand, the obligation in a performance bond is to make payment upon demand and the obligation exists, irrespective of the underlying position between the creditor and the debtor. The duration of a performance bond is usually 12 months from the date of issuance of the performance bond. 

The premium for performance bond insurance is between one percent to five percent of the entire contract value, depending on the pedigree/financial standing/regulatory compliance status of the contracting firm. 

The prerequisites for the issuance of a bond by an insurance company include, but not limited to, the following: 

The letter of award of contract issued by the principal; the pedigree of the principal; the pedigree of the contracting firm; the financial health status of the contracting firm  evidenced by bank statements of the immediate past six months to 18 months; the evidence of successful execution of similar contracts in the immediate past 6 months to 18 months by the contracting firm; the evidence on past jobs completed in the immediate past six months to 18 months; the C.A.C. certificate of incorporation of the contracting firm; the names of directors of the contracting firm; the three-years tax clearance certificate of the contracting firm; the corporate profile of the contracting firm; the list of equipments/machineries/plants/Vehicles of the contracting firm for which the contracting firm will take an insurance policy to avoid selection against the insurer; the financial report/the auditors report of the contracting firm; the evidence of a public liability insurance policy; the evidence of past payments received in the immediate past six months to 18 months for works successfully completed; letter of indemnity undertaken by the directors of the company; the copies of the valid international passport of the directors/NIN/identical passport pictures; the names/qualification/experience of the key staff of the contracting firm, the policy document evidence of bond insurance taken in the past; and the evidence of no default in the bond insurance taken in the past. 

The critical reason for the plethora of documentation is the nature of bond insurance, which is between three parties, namely: the principal, the contractor and the insurance firm, which if not diligently and professionally put together by sticking  to due diligence, by the insured/the insurance firm/the reinsurance firm, will lead to LAW SUITS, which will be colossal in liabilities, especially in very large ticket bonds. 

Thus, the key elements of a bond are: Surety, Principal, Obligee, Premium and Claim. Going further, the other class of insurable risk placements are  between two parties, namely the insured and the insurance firm.

Summary: A performance bond is a subset of contract bonds, which guarantees that a contractor will fulfil the terms/timeline/clauses/conditions/specifications, etc, of a contract, failure of which the surety company (the insurance firm) will be  and is responsible for completing the contractual obligations, either by securing a new contractor to complete the contract or by paying the financial compensation. 

Taking into cognisance the peculiarities of a bond insurance, the insurance policy document must be signed by the chief executive officer (CEO), by the executive director (ED), technical; and by the company secretary/ED, legal. 

Going further, the processing of the bond document must pass through the technical department, the bond underwriting unit usually populated by engineering graduates, the legal department and the reinsurance department. All hands are on the deck to ensure compliance with risk management at the project sites in addition to regular inspections by the engineering unit staff of the insurance firm, backed up with videos, pictures and site visitation log books. To further secure their risk exposure, the insurance, depending on the type of bond and on the amount of the bond, will request for a counter bond, which will be issued by another insurance firm and premium paid both ways. 

It is best to do BOND INSURANCE with an insurance firm that has the technical capacity, the reinsurance capacity and the financial capacity to underwrite a bond risk. As in all insurance it is most appropriate to get bond insurance through a bond experienced professional practising insurance broker/professional risk manager. 

The value of a bond must be stated in the letter of award of the contract issued by the principal to the contractor. This is usually a percentage of the total contract value. The premium is usually between one percent and five percent of the bond value, for either performance bond or counter bond, in a situation where a counter bond must be submitted.

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