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How Can Insurers, Reinsurers and Brokers in the CIMA Region Issue Surety Bonds?

30.01.2018Jean Olivier Anet, Manager/Technical Operations, Continental Re

This blog is a summary of a recent book in french by the author (janet[at] about the theoretical and practical aspects of the surety branch and its reinsurance.


The question may sound puzzling given that surety bonds fall within the broader portfolio of traditional insurance products.  Yet, it is a crucial question nonetheless as surety is a highly specialized niche within the insurance world. The issue is equally important if one is to take into consideration the growing interest from mainstream insurance sector players particularly in the CIMA (Conférence Interafricaine des Marchés d’Assurances) region, which includes 13 African francophone countries. However, despite surety bonds being a new phenomenon in the franc zone, a number of specialized companies have already had their licences withdrawn.

More importantly, the issuance of surety bonds is a crucial topic especially with regard to emerging development prospects and synergies between the banking and insurance sectors. This is thanks to financial insurances and bank guarantees. Take for instance the housing finance sector, mortgage guarantee is a case in point with regard to synergies between the housing and insurance sectors.

What is a surety bond and what exactly do insurers understand by the term?

A surety bond is a regulated product that is governed by an agreement that protects against financial loss. As such, there is not one specific definition of the term. If anything, a definition per se does not quite exist. The only explicit reference of the concept in the CIMA insurance code, is in article 328 on the classification of insurance classes. The term surety bond is listed under class 15 and split into two subsectors; direct bond 15A, and indirect bond 15B.

There is no further direct reference of the concept in the CIMA code, hence the recourse to doctrine, jurisprudence, legal references from other countries and professional practice.

What is a direct bond?

A direct bond or surety bond is an ordinary legal guarantee granted by an insurance company.

Stricto sensu, a guarantor is a person committing to guarantee the payment of a liability contracted by a person or company (the principal) with a third person (the obligee), in the event that the principal defaults. On a broader note, a surety bond is a security for the main contract agreement. The surety can be implemented free of charge or paid at a fee of between 0.1% and 3.5% of the contract amount. When the surety is issued by a professional credit and financial institution, a collective credit guarantee entity, or an insurance company, it is referred to as a professional or financial guarantee. A surety allows for the fulfilment of numerous conventional or legal operations.  Whenever there is need for a guarantee, a surety is a definite way of securing the operation.

The business of guaranteeing, also known as « surety » is a financial service. The French Association of Specialised Financial Companies (ASF) defines the concept as: « a commitment made by a surety company (guarantor/surety) on behalf of a person or a company (principal), enabling the principal to offer a guarantee to its financial or economic partners (the surety beneficiaries). If the principal defaults, the guarantor shall replace the former to execute their legal duty. The guarantor may later seek financial redress from the principal.»

Surety bonds apply to a wide variety of cases, for example market sureties, which is necessary for public and private sector procurement. There is also a regulated profession guarantee fund, to protect clients of such professionals, when the latter handle funds belonging to third parties e.g. travel agents, notaries, lawyers, insurance brokers, etc.

As defined above, a surety bond, generally involves three parties, resulting in a dual relationship; between the guarantor and the principal, and between the guarantor and the obligee; which by nature is a personal guarantee or surety (a concept that protects the obligee against financial loss, thanks to a third party commitment). As such, a surety, which is actually a financial service, is not limited to a guarantee. It also covers the independent guarantee, which in itself is a commitment separate from the main contract. The legal nature of a surety bond is similar to a bank loan rather than to an insurance contract. A good rule of thumb is that not all guarantees issued by an insurance company constitute an insurance policy.

To non-specialists, this difference between a surety bond and an insurance policy may not be obvious, and especially because service insurance companies that issue sureties use the same risk management techniques as those in mainstream insurance business. For instance, the risk pooling which includes spreading the risk across a large number of policy holders for risk mitigation, risk selection, premiums, risk reinsurance, provisioning collecting premium tax etc.

In actual sense, the difference between the two concepts is rather obvious. Unlike in insurance where the risk is linked to the occurrence of an unforeseeable/unavoidable event, such as a fire or an accident, surety applies when the damage is as a result of a person’s or a company’s inability to honour their commitment.  Yet, a principal’s failure to honour his engagement is seldom an accident. It is usually the result of either financial, technical, judicial, economic or political situations, which in some cases could have been avoided. The damage does not result from unforeseeable circumstances as would be the case with traditional insurance. Additionally, unlike an insurance contract, a surety bond gives an obligee, subrogatory or personal recourse in the event that a payment is made out on his behalf. Unlike bankers who control financial flows of the clients they guarantee, which enables them obtain a reimbursement for payments made out on their behalf, a guarantor does not have direct access to their clients’ bank accounts. It is for this reason that a surety has to build his business model around a sound risk management mechanism and a clear and innovative re-insurance structure.

In a nutshell, a bond is not an insurance product but rather a financial service. If an insurer were to issue such a product, he would be forced to adopt a banker's attitude, while managing the constraints of the insurance world.

What about suretyship (indirect), the second subsector of sureties?

Suretyship (indirect), also known as surety insurance by legal advisors is a type of insurance that provides a cover to sureties such as banks and financial institutions or entities other than surety companies. Surety insurers mainly target banks, financial institutions, surety funds, or even individuals. It is crucial to note that indirect bonds have the same judicial connotation as insurance contracts. As such, they can only be issued by insurance companies. That is the particularity of such bonds.

What is the purpose of this book and more precisely, who does it target?

Success in any given insurance sector can only happen if one fully understands and masters the parameters that govern the sector. The book "La branche caution et sa reassurance: Théorie et Pratique" (Surety and Reinsurance: Theory and Practice) allows the reader to have a better understanding of the reinsurance sector. It is a contribution to the sector as it scientifically examines the business of surety bonds in a neutral and practical manner.

The book covers topics such as; risk and claims management, the financial selection of risks, information systems etc. It is a guide book to be used as a strategic tool for decision-makers in the industry.


About the Author

Jean Olivier Anet is currently the Technical Operations Manager at the Continental Re-insurance in the Abidjan Regional Office. Prior to joining the organization, he worked for ten years as a Senior Underwriting Assistant in charge of claims management and underwriting of surety and credit insurances.  In 2012, Jean Olivier received the FANAF’s Jean CODJOVI Award in recognition of his work in surety. The Jean CODJOVI award aims to promote research in the Insurance and Reinsurance field. Jean Olivier holds a Master’s degree (Msc) in Management and another in Insurance.

Message from the MFW4A Partnership Coordinator

12.01.2018David Ashiagbor

Dear Reader,

As we begin 2018, I would like to wish you all a happy and prosperous New Year on behalf of all of us at MFW4A.

2017 was a pivotal year for us. We began our transition to a more inclusive Partnership with the integration of African financial sector stakeholders into all levels of our platform.  This new phase also includes a revamped value proposition designed to deliver sharper outcomes.

Our work in 2017 strengthened MFW4A’s position as a leading and independent voice on financial sector development in Africa. Mobilising domestic capital for long term investment was a focus for us. We brought together African pension funds, regulators and development finance experts in Abidjan in November, to identify options and instruments to leverage Africa’s growing pension assets for investment in infrastructure, agriculture and affordable housing. A task force was established to follow up on the meeting’s recommendations, which will continue to guide our work in this area. 

A notable outcome in 2017, was the approval of a $3 million Line of Credit to the Union Trust Bank in Sierra Leone, by the African Development Bank (AfDB) in September 2017, following the Conference on Financial Sector Development in African States Facing Fragile Situations co-hosted by MFW4A in June 2016. Another was the resolution taken by Governors of African central banks and Senior officials of international financial institutions, to strengthen supervision and solution plans for Pan-African banks at the ‘’Cross-Border Banking and Regulatory Reforms in Africa‘’ conference, jointly organized with the International Monetary Fund (IMF) and the Basel Committee for Banking Supervision (BCBS) in Mauritius.

Our work in support of a strong and stable African financial sector will continue this year, with national and regional Financial Sector Dialogues in selected regions. These high-level events will provide a platform for African financial sector stakeholders to assess the progress of ongoing reforms in their respective regions and identify future priorities. We will also launch a new programme on Trade Finance to help fill existing knowledge and skills gaps through research, capacity building and advocacy efforts. A Long-term Finance initiative expected to lead to the establishment of a scoreboard that provides comparative indicators of the level of development of long-term finance markets in Africa, will also be launched, in collaboration with AfDB and GIZ.

We will continue to support efforts to develop and implement financial risk management solutions in the agricultural sector while promoting an enabling environment for digital finance. Other activities include research to support diaspora investments and remittances as well as capacity building programmes in our SME Finance and Housing Finance workstreams.

We look forward to your continued support and collaboration.

With our best wishes for a happy and prosperous 2018.

David Ashiagbor
MFW4A Partnership Coordinator

Natural Disaster Risk Pooling to Enhance Financial Access

08.01.2018Johannes Wissel, Financial Consultant

This blog is a summary of Johannes Wissel's Master's thesis on "International Economics and Development".

Limited financial access in times of natural disasters

In her blog of 5 June 2017 Sonja Kelly ascertains the low success of weather-indexed insurance and depicts the reasons why it is not working. She regrets that although these problems are not new, the industry has not managed to solve them.

In addition to insurance, Elodie Gouillat, Rodrigo Deiana and Arthur Minsat and Bella Bird in their blogs of 29 June 2017, 24 October 2017 and 19 December 2017 point out the limited access to finance particularly for low-income households and small enterprises.

Microfinance institutions (MFIs) fail to meet the demand of their clients, especially in times of a natural disaster. Despite the debate on the advantages and disadvantages of microfinance, financial access helps to strengthen the natural disaster resiliency of affected communities. MFIs are constrained in providing their services because in times of natural disasters they themselves lack financial access. They are generally not well diversified around the globe. A natural disaster leads to a widespread defaulting on credits in one region and consequently many credits of one MFI have to be written off. Without the access to external financial resources, this will hamper the MFI's capital ratio which is a key indicator of an MFI's solvency and subject to financial supervision. To avoid further risks, MFIs restrict their lending activities.

To improve an MFI's financial access, its natural disaster-related high unsystemic risks need to be transferred out of the region it mainly operates in. Financial investors follow the same principle by diversifying their wealth. However, the only existing opportunity for microfinancial actors to transfer their disaster risks, is looking for reinsurance or reinsurance-like solutions individually. The comparatively unknown market and a non-perfect competition in reinsurance induce an inefficient and costly risk transfer. MFIs usually do not make use of these possibilities.

Introducing a risk transfer innovation

Alternatively, MFIs can mitigate the unsystemic disaster risks by bearing them collectively. A certain extent of risks can be transferred out of a region by pooling the risks among microfinancial actors. Only a minimised remaining risk of the pool itself needs to be transferred to the global capital market, which is expected to save costs. Two decisive prerequisites are fulfilled that allow for a pooling of these risks among microfinancial actors. Firstly, natural disasters do not occur in every region of the world simultaneously. For example, the risk of El Niño floods in Peru is high between January and March and Vietnam might be affected in June and July. Secondly, the distribution of microfinancial actors among the world regions is relatively balanced.

GlobalAgRisk, a U.S.-based research and development company with linkages to the University of Kentucky, intends to implement such a risk pool in 2018. In one hypothetical example, they envisioned a 31%-reduction in funding needs to cover the risks of two microfinance networks by pooling their risks. The impact of a natural disaster on an MFI's portfolio has been modelled for different disaster types and severities based on historic data, in order to determine the extent of contributions that a pool-participating-MFI has to make and the required payouts it potentially receives. This facilitates an index-based risk pooling which enables a quick disaster response and eliminates potential mistrust problems between different participants. In GlobalAgRisk's concept, an affected MFI is projected to receive a credit payout in order to meet the rising demand for credit of its clients and a capital payout that the respective regulatory authorities classify as equity in order to restore the MFI's capital ratio.

In my thesis titled, “Natural Disaster Risk Management in Microfinance”, I evaluated GlobalAgRisk's concept and portrayed potential improvements to increase the concept's likelihood in achieving its aims and depicted certain constraints for the implementation of potential improvements. The full thesis can be found here.

Recommendations: Inclusion of insurance risks in the concept

One potential improvement is the inclusion of insurance risks in the concept. High costs are a common explanation why weather-indexed insurance does not reach scale (see e.g. Sonja Kelly's blog). Microinsurers make use of the outlined costly reinsurance possibilities. Thus, weather-indexed insurance can benefit from the cost advantages risk pooling offers.

If the risk pool contains both credit and insurance risks, its size and diversification are expected to grow and therefore realize additional cost advantages; for example, through lower fixed costs per participant and better prices for reinsuring the pool's remaining risk externally. Moreover, a higher market penetration of weather-indexed insurance improves credit access, because insured clients benefit from a higher creditworthiness.

Even reinsurers can benefit from pooling both risk types among microfinancial actors, by covering the remaining risks that the pool cannot bear by itself. As such, the extent of covered insurance risks decreases for the reinsurers in comparison to insuring full risks. However, the total reinsurance business might grow because reinsurers can incorporate credit risks in addition to insurance risks.

The consolidation of both risk types appears feasible because the pool's payout patterns are similar to those of microinsurers reinsurance. The contribution payment into the pool is equivalent to a reinsurance premium and a payout is triggered if an insurance taker suffers from a damage. The modelled impact of a natural disaster on an MFI's credit portfolio fits in the already prevalent weather-indexed insurance.

Further success factors

For a successful risk pooling, the basis risk that comes along with an index-based risk pooling should be minimised as much as possible. To achieve this, a compartmentalised model that considers the pivotal risk types (e.g. floods, storms, drought, earthquakes) is crucial.

If the risk pool operates as a for-profit company, the benefits of the concept might be endangered. In order to be attractive, the pool only needs to be slightly cheaper than the existing risk transfer possibilities and could charge much higher contributions from the participants than the payouts amount. Establishing the pool as a mutual or cooperative company eliminates these potential profit extractions. In case of profits, they can be returned to the participants. Insuring the pool's remaining risks minimises the danger of suffering from losses as a co-owner. If certain microfinancial actors are restricted because of their co-ownership possibilities, they can participate in the performance of the pool without being a formal co-owner.

Finally, some countries' legal frameworks might require that the pool acquires insurance licences in order to provide the capital payouts. To avoid the acquisition of numerous licences, fronting might be a way out. Insurance companies that already possess licences in the respective countries can insure the participants and pass the risks on to the pool.


About the Author

Johannes Wissel recently graduated from Hochschule für Technik und Wirtschaft Berlin - University of Applied Sciences, with a Master's in International and Development Economics. He worked in sales management for Hannoversche Volksbank, a German Cooperative Bank. Prior to this, he worked with two international Christian organisations; Forum Wiedenest in Germany and Diguna in Kenya. Johannes is a licenced Corporate Bank Customer Consultant.


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