Finance 431 Surety Bonds

Surety Will introduce some new concepts to you Surety business Contract and commercial bonds Distinguish from and compare to insurance Compare to banking

Surety What is surety ? Ancient process Biblical commentary Babylonian Roman times English history U.S. history

Surety Personal surety Legal development Common law v statute Statute of frauds Development of corporate surety

Surety Essence of the surety relationship Three party arrangement Surety guarantees the obligation of a primary obligor(principal) to a third party ( the obligee) Surety -- Principal -- Obligee

Surety Industry highlights $ 5 billion business-approximately 1% of annual p/c revenues 135 or so groups of companies write bonds Multiline and specialty companies Top ten write approx. 70% of business

Surety Bonds support both public and private transactions Bonds are typically statutory in nature 85 to 90% of contract industry premium relates to public works projects 99% plus of commercial premium relates to statutory obligations

Surety Classifications of bonds  Contract  Commercial

Surety Contract  Bid  Performance  Payment

Surety The bid process Discussion Underwriting process The three Cs of Credit extension An expensive and in-depth process

Surety Character Too often a given, but essential Stature in community/reputation Relationship with other business partners Experience says watch out if an underwriter is aware of character issues

Surety Character Example Contractor takes money out of company w/o telling you … or invests in business unrelated to his construction business … Bankruptcy… Other …

Surety Capacity Proven track record on similar size,scope and location of work Organization Comprehensive business plan Performance record plus the ability to meet obligations on current and future work load, bonded and unbonded Continuity plan

Surety Capacity-common issues Contractor’s experience is on $ 5 million highway project Wants to bid on $ 25 million highway job Highway contractor wants to build a $ 25 million commercial building

Surety Capital CPA certified audited f/s for 3 to 5 years Work in process for bonded and un bonded work Cost control systems Investment strategy Perform complete analysis  Trends over time in profitability and liquidity  Credit history  Bank relationships  Accounting system  CFO/financial staff  Reputation of CPA performing audits and other services

Surety Capital-common issues Poor accounting system Lack of accounting and finance personnel  Contractor lost money in three of the past four years  Bank debt and overall debt is growing  Disputes on projects leading to slow A/R  A number of jobs are losing money – drain on company’s financial resources

Surety Commercial Fiduciary License and permit Court Public official

Surety Commercial Fiduciary Executor or administrator of estate Guardianship of minor Trustees in bankruptcy

Surety License and permit Virtually all businesses will have some license bonds Compulsory obligations Agents/brokers Real estate broker Permit when signs extend over a public walkway Truckers on road with overweight load Contractors license Tax bonds Reclamation bonds

Surety Court Plaintiffs and defendants Attachment bonds Plaintiffs Release of attachment Appeal bonds High profile cases Auto companies Oil companies

Surety Public Official Administrator Treasurer Tax Collector

Surety Underwriting process Very similar to contract but different too… Complex due to many types of obligations Industry analysis Many obligations are long term Many obligations are non- cancelable

Surety Two phases in underwriting Assessment What is the obligation ? Can the principal do it? Protective How can/will the underwriter protect themselves ? What indemnity and what form ?

Surety Factors of significance Reputation and standing Ability to complete obligation Financial condition Quality of financial data prep and presentation Indemnity provided General agreement of indemnity Collateral

Surety Surety’s Responsibility Fulfill the commitments to various stakeholders Principal’s responsibility to surety Complete the obligation Indemnify against loss May be asked to provide collateral

Surety Legal remedies in case of loss Principal is primarily responsible for the obligation In case of loss  Indemnification  Subrogation

Surety Insurance v surety bonds Comparisons  Both regulated by statutes/reqs at state level  Transfer of risk/assumption of risk  Premium paid  Protection against financial loss  Contract defining the risk

Surety Some key distinctions Two party (insurance) vs. three party (surety) Third parties receive protection Principal is not protected by bond Law of large numbers does not apply Loss expectation v no loss anticipated Principal is always primarily responsible for completion of the obligation Most surety obligations are not cancelable Premium non payment is not valid reason to cancel the obligation

Surety Surety and banking Surety like banking is an extension of credit; monetary v non-monetary obligations Analysis of business very similar Repayment of credit or obligation Banks and sureties expect repayment Banks and sureties do not expect a loss Rights to pursue defaulting principal Collateral Indemnity

Surety Questions? Special thanks to Professor Vonnahme for the use of his materials.