Everything you ever wanted to know about surety bonds

1. Everything you ever wanted to know about surety bonds WCOE, USA Annual Congressional and Leadership Conference February 4, 2012 Mark McCallum, National Association of Surety Bond Producers (NASBP), CEO Susan Hecker, NASBP Board Director and Area Executive Vice President of Gallagher Construction Services

2. National Association of Surety Bond Producers (NASBP) • NASBP serves insurance agencies employing bond producers • NASBP membership includes about 500 companies • NASBP producers engage in construction contract surety production throughout the US, Puerto Rico, Guam, and a number of other countries

3. Surety Bonds - What are they? And what do they do? A performance bond is a three-party contract that guarantees to the Owner that the Contractor will perform in accordance with the contract documents, including the plans and specifications Owner -- Obligee Contractor -- Obligor Surety -- Secondary Obligor

4. Surety Bonds - What are they? And what do they do? (Cont’d) • Admitted Insurance Companies are the main issuers of surety bonds, but bonds and traditional insurance policies are not the same • Traditional two-party insurance presumes the possibility of a loss, insuring against unknown or fortuitous events: Insured Insurer • A performance bond is a three-party instrument - presumes no loss • because the bond is provided to those entities determined by the • surety to be capable and qualified to perform the contract obligation • Performance bonds - prequalification of the contractor and financial • protection of the owner

5. Surety Bonds - What do they do? Zero-Loss Goal • Surety companies expect zero loss – rigorous underwriting and general indemnity agreement from the contractor -- corporate and individual indemnity • Performance bonds are underwritten for a specific entity, not for the project or for all the project stakeholders • Surety company analyzes the contractor’s specific obligation (including contract terms), financial status, work program, and experience, among other factors • Performance bonds address one party’s responsibilities —they do not address the project goals

6. Surety Bonds: Myth v. Reality • A performance bond on a construction contract does not guarantee completion of the project • A performance bond is not a default recovery mechanism for failure of the project to achieve a sustainability goal • A performance bond surety is not the insurer of the project

7. Surety Underwriting Concerns –What Makes Sureties Anxious • Contractual shifting of risks to party not in best position to control the risk • Potential guarantee of a sustainable objective that is the collective responsibility of multiple parties, including those outside the bonded relationship • Tying contractor payments to achievement of third-party certification • Consequential damages (failure to achieve third-party certification, energy savings) • Lengthened warranty period • Poor operations/maintenance causing lack of compliance

8. Surety in the Early 1990s • Strong economy • Excess capacity in surety market • Low premiums • Relaxed underwriting • Commercial surety expansion

9. Surety in the Early 2000s • Sagging economy • Significant commercial losses • Heavy contract surety losses • Increased failure rates

10. Contract Surety Premiums & Losses Source: The Surety & Fidelity Association of America “Twelve-Year Experience Summaries (1999-2010) Surety Countrywide (Preliminary)”

11. Top 15 Writers of All U.S. Surety

12. Surety Market – Today’s Top 10 Sureties

13. Present Market & Beyond • Increased risk for owners, contractors & sureties caused by current economy • Continued disciplined underwriting, exposure management & project analysis • Stabilized capacity & restored profitability

14. Present Market & Beyond • Optimism about surety capacity & demand • Surety available for contractors at all levels • Marginal contractors will have difficulty obtaining bonding • More competition, fewer projects • Tightened operations for contractors • Increase in contractor failures

20. RT FC No Surprises!

23. NASBP

24. Surety Industry Issues • Bond Threshold Increases • Bond Waivers • Public/Private Partnerships • Alternative Project Delivery • Individual Surety • Bond Verification

25. Bond Threshold Increases • Introduced often as an alleged “aid” to small and minority business or a cost-savings measure • State bond thresholds vary in amount; most are equal to or less than $100,000 • Most bill sponsors do not understand how increasing the bond threshold impacts downstream parties – subcontractors, suppliers

26. Bond Waivers • Bond waiver legislation typically arises in two contexts: • Belief that bonding is an obstacle to small or minority contractor participation • Belief that bonding capacity does not exist for larger projects • Bond waiver legislation may: • Vest procuring officials with discretion to require performance and payment bonds, or • Exempt small or minority contractors from having to furnish payment and performance bonds

27. Public/Private Partnerships • Legislature introduces measure to authorize private developer to construct project • Sometimes payment bond requirement is omitted or is made discretionary in authorizing legislation • Need to ensure that authorizing legislation references state “Little Miller Act” or contains its own payment bond requirement

28. Alternative Project Delivery • States and localities wish to expand project delivery options, moving away from design-bid-build to design-build and CM at risk methods • Authorizing legislation is not clear on bonding requirements – i.e., no clear reference or link to “Little Miller Act”

29. Individual Surety • Misperception that corporate sureties will not write small and minority contractors • Legislature seeks alternative market, introducing measure that permits an unlicensed natural person to write surety bonds on public or private construction contracts

30. Individual Surety • As unregulated surety, certain state protections do not apply, such as market conduct investigations, recovery funds etc. • Case example – MD HB 1071/SB 782 (2011) Presumably as an aid to minority businesses, a bill is introduced to exempt individual sureties from obtaining a certificate of authority from insurance commissioner to write on private contracts. Bill never leaves committee.

31. Other Threats - Integrity Challenges • Current economic environment ripe for fraud • Unauthorized bonds • Unlicensed surety companies • Unlicensed individuals acting as sureties

32. Other Threats - Integrity Challenges • Subcontractors and suppliers should not rely on contracting officials to exercise sufficient due diligence • If an insurer is not subject to governmental oversight – i.e., under the control of the state insurance commissioner - watch out!

33. Bond Verification • Caution and due diligence are needed in this economic climate • Obtain a copy of the bond • On federal construction projects, see FAR 28.106-6(b), (c) & (d) • Verify both the surety and the bond

34. Bond Verification – Corporate Sureties • State Insurance Departments • http://www.naic.org/state_web_map.htm • US Department of Treasury, Circular 570 • http://www.fms.treas.gov/c570/c570_a-z.html • Private rating organizations – e.g., A.M. Best • http://www3.ambest.com/ratings/default.asp • Bond Obligee’s Guide – SFAA • http://www.surety.org/resource/resmgr/pubs-public/bondobligeeguide2011.pdf

35. Federal HR 3534 – Security in Bonding Act of 2011 • Bill would change how the federal government treats the assets of individual sureties ensuring that such assets are real and in the care and custody of the federal government

36. Mark McCallum CEO NASBP Washington, DC mmcallum@nasbp.org Susan Hecker Area Executive VP Gallagher Construction Services San Francisco, CA Susan_hecker@ajg.com Contact Information

37. For More Information National Association of Surety Bond Producers 1140 19th Street NW Suite 800 Washington, DC 20036 Phone: 202-686-3700 Fax: 202-686-3656 www.nasbp.org