Guarantee Policies: how do they differ from the normal Insurance policy

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Understanding when to take out a Guarantee Policy

Most short term insurance policies, while insuring different risks have a similar legal format. In return for the payment of a premium, the insurer agrees to accept a certain risk that the insured client has. The risk is not a certain one and in almost all cases the contracting parties are the Insurance Company and their insured client and if the uncertain risks insured against takes place, the insured client is paid out the limit of the Indemnity provided.

This format applies to property insurance, motor insurance and even liability insurance, where the insured’s claim is paid out based on the conditions of the policy up to the limit provided. With liability insurance, it maybe that the insurer agrees to pay the settlement directly to a third party to whom the insured owes the liability but there is still only one insured who enjoyed liability cover to a limit and a claim will be laid out if the insured is found liable in terms of the condition of the policy to a third party unknown at the time the cover is taken out.

A Guarantee Policy works differently and unless one understands these differences it becomes difficult to understand the dynamics of such a policy. The policy benefit or cover is not taken out for the sole benefit of the insured client who would pay a premium and then claim the benefit of an insured peril occurs. This policy acts as a surety or security in favour of a particular third party where the insured client is being requested to provide security. This security may for example be required in terms of a construction agreement where a construction company is required to provide security to an employer that they will not go bankrupt or leave the construction site but in fact complete the project. These construction companies request large deposits up front and an employer wants security that the project will be completed. This security is provided either in terms of a bank guarantee or by means of an insurance policy which has the insured client mentioned (who pays the premium) but it contains a surety or security that is drafted in favour of the third party beneficiary. The wording will say if a particular event takes place, the beneficiary will be able to make a claim on the insurer in terms of the guarantee contained in the policy. It is irrelevant whether the insured client chooses to claim or not or even goes bankrupt. He third party beneficiary will be paid out if the even mentioned in the policy occurs.

Another example would be where a company wishes to take a loan from a finance company or a bank and security from a credible insurer is required to stand good for the loan. If the client defaults on the loan, the insurance Guarantee would be called up and the insurers would pay out the sum stated in the guarantees.

A further exception is that the insurer, once they have paid out can then go after the insured client to recover their money. This is totally unlike any other cover where the whole point of taking the insurance is to lay off the risk to the insurer. This is different. The point of this policy is to provide comfort and security to the third party that is all. It is commons after a claim for the insurer then to sue the client for the money they paid out or to take collateral up front to mitigate their loss. It’s a very important type of policy as it enables business transactions to take place but one needs to understand how it works before taking out such a policy. Klapton has the strong technical staff to be able to underwrite and provide such guarantees to assist your business in getting transactions done.

by Danny Joffe : Chairman of Klapton’s Ethics, Nominations & Remuneration Committee