Bank Guarantees vs Insurance Guarantees

Somthemba Makinana, Guarantees and Credit specialist at Apio, looks at bank guarantees versus insurance guarantees in the current climate.

Industries, especially construction, mining, fuel, logistics and renewable energy, functioned differently when it came to risk when we had not only a stable economy but also a growing economy. Previously, the commonly assumed norm for guarantees were sourcing them through the bank, and that was the traditional norm for the longest of time. This was also because companies had strong financials and smoother cash flows. Problems such as retrenchment, unemployment and being “over-staffed” hadn’t been a factor in those times. However, these commonly occur based on the performance of the economy and aren’t activities that are a once-off occurrence.

Fundamentally, banks have never focused on guarantees because that has never been their core functionality but because it was an important requirement when it came to projects, banks catered for this need and made room for it. They also created the product in such a way that they ensured that the process of acquiring a bank guarantee wasn’t complex. Basically, if you had the required funds, which is the value of your requested guarantee, then you were guaranteed cover. This came in different forms in the sense that your bigger companies didn’t necessarily have to put up collateral upon request of a guarantee but could be sourced through their lending facility. The bank made sure that they created supply for the demanded product by keeping the risk away from themselves.

Some companies still prefer this method because some have been in the industry for quite some time and have become comfortable with using this method. Many have moved away from it because of the impact of a poorer economy and not having the capacity as a business to sustain these means of obtaining guarantees. It’s no shock that this has occurred because of the transition we have gone through with regards to the state of the country, however this comes with any other fluctuating economy which is common with any country.

However, a better and efficient way of acquiring a guarantee was introduced decades ago and have only managed to gain popularity. This hope was restored by insurance companies by introducing insurance guarantees that have a much different approach to how guarantees are administered and the benefit it had brought to companies within various industries. Due to insurers introducing guarantees, more types of guarantees were formed and allowed other industries (construction, mining, logistics and fuel) to benefit from this because this transition provided the opportunity of more projects to be made available to companies with much more ease with the idea that methods had been put in place to mitigate the risk or not completing the task at hand.

Insurers have gained popularity because:

  • Consequences on the company’s cash flow of having huge amounts of cash collateral tied up in the bank had immense impact on operations;
  • Banks not specializing in guarantees and therefore having slow turnaround times;
  • The increasing need for guarantees from entities wishing to mitigate their risk exposures;
  • The “softer” (the ability for insurers to work around the type of securities companies can put up as opposed to the initially required ones) security requirements from insurance companies compared to banks;
  • Cost-effectiveness of using insurance companies as opposed to banks;
  • Experience that insurers have based on the type of industry the guarantee is required for and ensuring all parties are protected;

The major impact the above has had on entities is the relief of having a more efficient cash flow, so that they can have capacity to take on new projects. As opposed to cash, insurers took a different approach of expecting companies to prove they have the funds by providing financials where the insurer can assess various criteria based on the strength of their balance sheet and income statement. Collateral and securities have played a critical part in this process, based on the strength of a company’s financials. The amount of collateral required, if any, is also influenced by the size and type of guarantee required.

The benefits of guarantees through an insurer are as follows:

  • The company automatically saves capital that can be used for the completion of the project or pursue other projects;
  • The company has a much more efficient cash flow;
  • Entities can avoid borrowing funds from financial institutions to strengthen their cash flow to be able to complete projects;
  • Entities can have their premium rate reviewed and possibly decreased for other future projects should payments be made on time and adherence to other underwriting factors;
  • Some guarantees that are renewed annually creates the ease of allowing companies to focus on projects with the knowledge that risk is taken care of.

Evidently, insurance guarantees are much more logical and beneficial to entities much more than bank guarantees, especially in these current times. However, even though insurers have made life easier to acquire guarantees, the pressure of the survival of the construction industry and claims that have hammered insurance companies have caused immense amounts of reluctance and has tighten the process of being approved for one. This is obviously understandable, given the times that we are in given the current state of things. More importantly, it’s of great importance that a company gets a broker with relevant expertise to help facilitate this need. The process to acquire a guarantee using insurers may not always be as smooth but with the right expertise, it can be an efficient process.