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Overview Surety 101 State of the Industry

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Presentation on theme: "Overview Surety 101 State of the Industry"— Presentation transcript:

0 Surety Bonding Clint Diers & Hunter Bendall
February 12, 2015

1 Overview Surety 101 State of the Industry
Subcontractor Default Insurance Surety Bond vs Letter of Credit

2 Surety Bonds 101 The Basics of Bonding Surety Bonds 101

3 What is Surety Bonding? Principal Obligee Surety
A surety bond is a three-party agreement where the surety company assures the obligee (typically the project owner) that the principal (most often the contractor) will perform a construction contract. Surety bonds in construction are referred to as contract surety bonds. Surety bonding is a careful, rigorous, and professional process in which surety companies prequalify contractors and then assure project owners that these contractors are capable of performing the contract according to its terms and conditions and that they will pay certain laborers, subcontractors, and suppliers associated with the project.

4 Types of Surety Bonds Bid Bond Performance Bond Payment Bond
There are three basic types of contract surety bonds. The first is the bid bond which provides financial assurance that the bid has been submitted in good faith, that the contractor intends to enter into the contract at the price bid, and that the contractor will provide the required performance and payment bonds.

5 Types of Surety Bonds Bid Bond Performance Bond Payment Bond
Secondly is the performance bond. The performance bond protects the obligee from financial loss should the contractor fail to perform the contract in accordance with the terms and conditions of the contract document.

6 Types of Surety Bonds Bid Bond Performance Bond Payment Bond
And finally is the payment bond. The payment bond guarantees that the contractor will pay certain subcontractors, laborers, and material suppliers associated with the project.

7 Prequalification Capacity Financial Strength Company History
Organization Continuation Plans References How does a surety provide the assurance that a contractor can perform? Through the prequalification process. The surety company conducts a thorough prequalification review, also known as underwriting, carefully analyzing the contractor’s entire business operation and determine the contractor’s ability to meet current and future contract and financial obligations. Prequalification offers a complete analysis of the contractor’s: Capacity to perform; Financial strength; Track record & company history; Organizational structure & reporting; Business continuation plans; Trade references; and Analysis of all projects in progress. Work In progress

8 Surety Company Checklist
Good character Experience matching contract requirements Financial strength Excellent credit history Banking relationship Line of credit Necessary equipment A surety looks at specific criteria to determine if the contractor is qualified to perform the contract. A bond will not be issued until the surety is satisfied of a contractor’s: Good character; Experience matching contract requirements; Financial strength; Excellent credit history; Banking relationship; Line of credit; and If the contractors owns or has the ability to obtain the necessary equipment to carry out the contract. In short, the surety company’s prequalification provides assurances that the contractor runs a well-managed, profitable enterprise, deals fairly, and performs obligations as agreed.

9 Benefits of Bonds Financial Security Construction Assurance
The primary benefits of bonds can be summarized by detailing what surety bonds provide: financial security and construction assurance. Surety bonds are the most comprehensive risk management tool. Surety bonds assure the project owner that the contractor is capable and qualified to do the job. Should the unforeseen happen and the contractor defaults, the surety arranges for project completion. Payment bonds provide protection to subcontractors, suppliers, and laborers. Many subcontractors offer better prices when they know they’re protected by payment bond.

10 Functions of Bonds No liens
Smooth transition from construction to permanent financing Provide support to contractor Project completion Surety Bonds Surety bonds relieve the private project owner from risk of financial loss arising from liens filed by unpaid subs & suppliers and protect taxpayer dollars on public projects. In the absence of liens, the transition from construction to permanent financing is much smoother. If the contractor requests help, the surety may offer technical, managerial, or financial assistance. This may help the project move forward and significantly reduce the likelihood of default. Should the contractor default, the surety arranges for project completion.

11 Cost of Surety Bonds Bid Bond No charge Performance Bond
½ - 2% of contract price Payment Bond Price included with performance bond The charge for a surety bond is referred to as the bond premium. Generally, there is no charge for the bid bond. The performance bond premium is typically ½% to 2% of the contract amount. And, there is typically no charge for the payment bond when purchased in conjunction with the performance bond. The surety bond premium is a fee for the surety’s underwriting services. In theory, sound underwriting should result in no loss to the surety.

12 Surety Information Office |
For More Information Surety Information Office 1828 L St. NW, Suite 720 Washington, DC 20036 | Fax | For more information on contract surety bonds, contact the Surety Information Office at or visit us on the Web at

13 State of the Industry In this section, take out qualifiers, be more affirmative and confident with tone (no we think, we might, we hope)

14 State of the Industry Surety Results

15 State of the Industry Surety Results 1995-2013 Total Direct Losses
$$ in millions Direct Written Premiums Direct Earned Direct Losses Incurred Direct Loss Ratio 1995 $2,472 $2,147 $525 24.5% 1996 $2,626 $2,262 $499 22.1% 1997 $2,769 $2,384 $540 22.7% 1998 $2,919 $2,528 $567 22.4% 1999 $3,401 $2,832 $675 23.8% 2000 $3,490 $3,411 $1,549 45.4% 2001 $3,473 $3,330 $2,748 82.5% 2002 $3,756 $3,514 $2,455 69.9% 2003 $3,727 $3,708 $1,833 49.4% 2004 $4,205 $4,006 $2,428 60.6% 2005 $4,410 $4,270 $1,755 41.1% 2006 $4,975 $4,696 $787 16.8% 2007 $5,433 $5,183 $979 18.9% 2008 $5,520 $5,426 $669 12.3% 2009 $5,103 $5,236 $967 18.5% 2010 $5,180 $5,273 $694 13.2% 2011 $5,172 $5,188 $696 13.4% 2012 $5,035 $5,137 $1,109 21.6% 2013 $5,245 $5,175 $841 16.3% Total Direct Losses $12,768

16 Surety Comparison Data
2003 SAA Results 2013 SAA Results* 1 Travelers $581,645,877 $778,689,161 2 St Paul $391,742,859 Liberty $738,271,612 3 C N A $341,835,008 Zurich $492,737,467 4 $275,289,480 $408,605,990 5 Safeco $212,456,655 Chubb $210,242,628 6 $197,422,175 IFIC $167,316,158 7 $151,492,862 HCC $166,419,402 8 Hartford $142,900,460 $160,693,912 9 AIG $84,458,207 ACE $143,061,872 10 $73,307,108 RLI $110,594,591 *Notes In 2013 the top 10 writers accounted for 64% of the Industry revenue. The top 20 accounted for 79% of revenue.

17 Subcontractor Default Insurance
In this section, take out qualifiers, be more affirmative and confident with tone (no we think, we might, we hope)

18 Subcontractor Default Insurance
What is Subcontractor Default Insurance? An insurance policy which indemnifies the Project Owner and General Contractor for costs associated with Subcontractor default and adds value to the project as a risk mitigation method. Typically these are rolling programs and cover multiple contract. High limits and High deductibles. Why was SDI created? Large General Contractors expressed concern with increasing risks of Subcontractor default, and their dissatisfaction with the structure and process involved with making claims against Subcontractor Surety Bonds. The idea is that the sophisticated GC can do a better job of prequalifying, selecting, and mitigating subcontractor risk and SDI aligns the incentive to do so with the lower cost of insurance coverage.

19 Subcontractor Default Insurance - Continued
Objectives of SDI: Control: puts control back in the hands of the GC project team. Coverage: provides consistent and efficient coverage. Cost: a cost-effective solution. Profit: by utilizing the GC’s ability to prequalify, select, and mitigate subcontractor risk. Why Would a Project Owner or Lender be Interested in SDI? Subcontractors will typically perform more than 75% or more of the work on a project. Subcontractors fail at a rate of over 90,000 firms per year. During the course of your project, including the maintenance period, the GC can anticipate that as many as 25% of their Subcontractors will experience financial or operational difficulties leading to potential default. SDI generally carries a longer term tail coverage for default.

20 How can SDI help a GC? Subcontractor Default Insurance - Continued
How can SDI help a GC? SDI provides protection against DIRECT LOSS including but not limited to costs: Supplement sub’s work to stay on schedule. Terminate and replace defaulting sub. Replace any non-conforming work. Pay for any unpaid suppliers or sub/subs. Any expenses or defense of disputes with subs (attorney’s, consultants, etc.). SDI provides protection against INDIRECT LOSS including but not limited to costs: Accelerate the work (extra payments to other subs to catch up after delay by defaulting sub). Extended overhead of GC to oversee additional workforces. GC of any liquidated damages directly related to a defaulted sub. - A well managed program with a low loss ratio can give the GC an opportunity to earn additional profits over time.

21 Subcontractor Default Insurance - Continued
Other Value To the Project Owner and GC: SDI provides expert consultant at the jobsite to assist in evaluation and resolution of default. (Insurance Company Risk Engineer) Enhanced schedule security - helps ensure on-time project. More capability to use MBE/DBE/WBE. Reduces potential litigation and property liens. Provides long tail years of completed operations coverage

22 Subcontractor Default Insurance - Continued
Project Cost Comparison – This is influenced by several factors • Is the GC bonded? What is the GC’s policy on requiring sub bonds? • Bonding both would typically cost 1.5% to 2.5% of the contact value. • SDI can help project contingency funds. • SDI, on average, is 50% - 75% the cost of sub bonds. • SDI covers all subs, not just the largest. Coverage: • Surety bond will pay up to the penal sum of the bond • SDI covers all subs and union benefits funds. • Bond provides limited or no coverage for Indirect Loss. • In the event of loss SDI can provide cash flow to the project if needed to keep on schedule. • SDI provides a long tail to report claims after project completion. SDI can have a more efficient claims Process: When your GC notifies a Surety of a problem with a sub, an investigation occurs. • The investigation uses valuable time and prevents the project from moving forward. • The Surety will pay for the resolution the Surety decides is correct, sometimes this is not the best resolution for the GC or the owner’s project.

23 Subcontractor Insurance
Procedures the GC Implements to Prevent and Mitigate Risk of Subcontractor Default:  • Pre-Qualification of Subs - financial, credit, performance, quality, safety, experience, personnel. • Selects Qualified Low Bid Subs who add value to your project. • Aggressive management / monitoring of subs: scrutinize schedules of values with pay submittals; 1st and 2nd tier partial and final lien releases; periodic supplier validations of payment; quality checks. • SDI procedures are reviewed by the insurance company Risk Engineers. What are the procedures when defaults do occur? • SDI allows the GC to take immediate action to remedy the default: - Hire a replacement subcontractor. - Supplement defaulting subcontractor’s workforce. - Assist the subcontractor with financial/payroll or other means to help complete the work. Complete the work ourselves. • SDI provides the GC with coverage to: - Replace non-conforming work. - Fund additional costs to hire replacement subcontractors. - Indemnify 2nd tier subs, suppliers or employees who may not have been paid. - Accelerate the schedule if default results in delay. - Fund costs of any necessary litigation or legal fees associated with subcontractor default.

24 Surety Bond vs. Letter of Credit
In this section, take out qualifiers, be more affirmative and confident with tone (no we think, we might, we hope)

25 Surety Bond vs. Letter of Credit
Apartment Project: 126 Units Surety Bond: 1% of construction value Total Development Cost w/ 1% Bond: $17,500,000 Construction Costs:     $15,000,000 Term/Rate: 40 years; 3.5% Bond Cost: $150,000 Monthly Payment, less taxes and insurance: $67,793 LOC 10% of construction value LOC Cost (50 Basis Points for 2 years) $15,000 Warranty Period 2.5% for 1 year LOC Cost (50 Basis Points 1 year) $1,875 Total LOC Hard Costs: $16,875 Cash Set Aside: $1,500,000 Interest Not Received on Escrowed Funds: (2.5% APR) $75,937 Real Cost of LOC w/ Opportunity Cost:  $92,812 Total Hard Development Costs w/ LOC: $17,366,875 Monthly Payment, less taxes and insurance: $67,277* Monthly Payment Delta (Bonds vs LOC): $516 or .007%

26 Clint Diers Hunter Bendall

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