Guarantees vs. Insurance

Although they both provide levels of security or surety to contracting parties in the event of non-fulfilment, there are three key differences between a financial guarantee and any insurance product:

1. No insurance product constitutes a bank-related guarantee simply because of the issuer — an insurance company versus a bank (in the case of a Standby Letter of Credit, Bank Guarantee or similar).  If an insurance company were to involve their bank, then it would become a “financial” instrument, subject to banking rules, not merely the insurance company’s policy contractual terms.
   This matters for the sake of CAP funding security because it hinges on our family office partner’s funding banks’ ability to deliver private capital, per the rules imposed on them by the international banking system, such as the Uniform Rules for Demand Guarantees, ICC Pub. No 758.  more on URDG 758 or Security
2. That said, insurance can still be a wise purchase for other reasons. Our flagship capital partners accept either of these aforementioned instruments to fund projects at an early stage, beginning with any remaining pre-construction steps, then during construction as credit enhancement and to ensure completion and commissioning of the project.  Such financial guarantees are strictly focused on performance, or to be precise, a remedy for non-performance within established contracts (in this case, with a Loan Agreement that requires the developer to resolve issues and complete the project), whereas insurance products underwrite contracts to protect against possible loss in other areas.  The only exception is when a contractor offers a completion bond (type of insurance product), which overlaps in its purpose, but protects the developer in case of loss.  Here, our use of a “completion assurance” guarantee protects our bank, as the provider of this capital, effectively filtering out fraud/malfeasance (we cannot call the guarantee arbitrarily) no matter what party brings the bank-involved guarantee or cash security deposit on the developer’s behalf.
3. Guarantees are underpinned by an implied agreement between the guarantor(s), the issuing bank guaranteeing the completion of a project, and a beneficiary, which with CAP funding is the source of the capital. In this context, an investment agreement defines the client project developer’s obligations (“performance”) which includes keeping the guarantee in place until the project is delivered — marked by Commercial Operation Date (COD).  By contrast, insurance is a direct agreement between the insurance provider and the policy holder regarding the policy holder’s activities.  There is usually just an insurance company, not a bank, to uphold the agreement.  Less complicated, but also limited depth or value to those seeking to raise funding at the best available terms.  Insurance can be nonetheless helpful for other reasons.
4. Finally, whereas insurance can usually be cancelled by either the provider or the policy holder if enough notice is provided — a “pay as you go” product — financial guarantees cannot be cancelled.  Once they are operative and in use, these annual instruments are considered “irrevocable.” They automatically expire once the contract they apply to is fulfilled, which in our case is when the project construction and commission are completed (COD).  This is one of the main ways our use of a financial guarantee or other forms of security differ from a traditional loan guarantee (more) used by institutional lenders as credit enhancement.

For more on commercial, political or credit insurance coverage available through In3 and our partners, visit this overview or contact us.