Demystifying Insurance Guarantees: Trusting Beyond the Bank

June 6, 2024 / Insight / By Helgaard Müller

In the world of financial assurances, the distinction between an insurance and a bank guarantee looms large in the minds of many. In reality, the words on the guarantee itself carry equal weight – regardless of the institution issuing them; it’s the beneficiary who dictates the terms, not the guarantor.

So, where does (or should) your trust lie? Is it with the traditional, stalwart image of a bank? Or the protective embrace of an insurance company?

Both entities are regulated and mandated to uphold a minimum capital reserve to shield against insolvency; both have the ability to provide financial solutions in response to risk mitigation; both require some degree of security when issuing a guarantee.

Skepticism towards insurance guarantees persists; a lingering doubt that insurers might find reason to avoid claims payment; that an insurance guarantee lacks the solidity of cash backing; that their financial stability pales in comparison to the banks’.

Demystifying Insurance Guarantees

So is it all myth, or are the concerns justified?

Here’s why an insurance guarantee could be an advantage for your business over a banking guarantee. 

A notable advantage of insurance companies is their skin in the game approach.  Insurers often play a proactive role in ensuring contract completion – for everyone’s benefit – whereas banks may impose tangible security requirements, potentially heightening the contractor’s risk by tying up much needed working capital.

This doesn’t, however, mean claims avoidance.  Contrary to popular belief, reputable insurers are driven by a commitment to honour valid claims promptly. Take Lombard, for instance; our reputation has been built on our integrity – evading legitimate claims is simply not an option.

While insurance guarantees might not always be cash-backed, responsible insurers bolster their claims-paying ability through reinsurance with internationally acclaimed reinsurers (with A-ratings or better), ensuring robust protection for beneficiaries (who we see as important stakeholders in our business).  For an insurer there’s a critical reliance on this reinsurance.  Usually, the reinsurers who provide backing to the guarantor (insurer) will not cover claims arising in full; as a result, insurers are responsible, should a claim arise, to absorb a portion themselves – meaning a share in the risk on projects.  This incentivises rigorous due diligence on the contractors’ capabilities, generally surpassing the assessment typically undertaken by banks on the same risk.

Guarantee wordings are dictated by the beneficiaries, and while they may differ, responsible insurers strive for clarity and fairness in negotiations with contractors and beneficiaries, and as such, a reason for the demand (claim) must be clearly stated and justified.

Cautionary tales

History attests to the resilience of insurers, with fewer failures compared to banks, in recent decades. Even in the rare event of insurer insolvency, reinsurers typically step in to honour obligations, maintaining continuity for beneficiaries.

However, amidst the landscape of legitimate insurers, caution is warranted, particularly in South Africa, where non-compliant “NCR guarantee providers” operate outside the FSCA regulations. These entities lack adequate capitalisation and security, posing significant risks for those who rely on their guarantees and ability to truly mitigate risk.

The choice between insurance and bank guarantees transcends mere perception.

It’s based on understanding nuanced differences, assessing the reliability of guarantors, and prioritising the protection of beneficiaries’ interests.

As our financial landscape evolves, trust extends beyond traditional institutions, embracing the integrity and resilience of insurers as guarantee providers.

For Lombard, business is about more than just the numbers.  It’s about understanding the people behind and in the business and projects, knowing the industry and unique opportunities and challenges therein, and crafting a guarantee to meet specific project needs that ultimately delivers success for all the key stakeholders involved.  It’s about building trust through delivering on our guarantee expertise.

Talk to us if you’d like to see how our guarantees can help your business and projects.

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