This is how insurers advanced
A number of reasons can be given for insurers' 'advance' over banks:
- Banks fall under the so-called Basel III supervisory regime and insurers fall under the Solvency II supervisory framework (see also the explanation below this list).
- Banks' ratings are on average lower than those of insurers.
- The international branch network of banks has virtually disappeared since the banking crisis.
- In principle, guarantee facilities through an insurer are not deducted from the credit facility. With a bank, this does happen. With insurers, there is no restriction on working capital.
As a number of banks were in danger of collapsing during the banking crisis (2008-2011), new bank solvency requirements were imposed. The Basel standards governing this were tightened, resulting in more capital must be held for outstanding liabilities (including guarantees). Insurers are subject to the so-called Solvency legislation. In doing so, the requirements less stringent than Basel standards.
The insurance industry saw opportunities and so they entered the financial guarantee market. They did so with strides; in the Netherlands, the number of providers increased rapidly. In parallel with that development, recipients of guarantees went on to provide guarantees to insurers increasingly acceptable find. This was partly due to the ever-improving rating of insurers. An added advantage of insurers is that they often have a expanded office network abroad have. This allows them - in countries that require it - to issue guarantees locally.
Common forms of guarantees
There are different forms of guarantees. We list the most common forms for you below and explain them using practical examples.
- Offer/Inscription guarantees;
- Advance payment guarantees;
- Performance guarantees;
- Maintenance guarantees.
Furthermore, there are specific guarantees prevalent in the market, including:
5. Customs guarantees;
6. Rent guarantees.
This is how guarantees work in practice
- 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 The tender was withdrawn and re-launched, with the requirement that a offer/tender guarantee was issued of $ 250,000. The result: only four (high-quality) parties signed up.
- Prepayment guarantee
A contract for the delivery of capital goods, for example, generally includes a payment schedule. 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 advance payment guarantee. After all, he wants to make sure the money is used for that purpose. If not, the client will reclaim the money through the guarantee.
- Performance guarantee
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. Against this payment(s), the client will performance guarantee questions.
- Maintenance guarantee
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 requires a Maintenance guarantee,so that he can be sure this will happen 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.
- Customs guarantee
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 once the alcohol enters circulation. Until then, the owner has to pay a customs guarantee to the Inland Revenue worth the total amount of excise duty. This is to prevent the alcohol from circulating without excise duty.
- Rent guarantee
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.
Tips for working with guarantees
Besides explaining the market with regard to financial guarantees and outlining the different forms of guarantees, we would like to give you some more tips on how to work 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.
- The minimum facility issued by an insurer is approximately €2 million (whatever the need).
- Don't wait for the bank to refuse a guarantee facility/expansion. The insurer prefers not to be the 'last resort'.
Want more information on guarantee facilities through insurers? Then contact the specialists at Xolv or view our special page about Guarantees.
