Casualty Actuarial Society2002 Annual MeetingNovember 11, 2002

Surety Bonds – A General Overview

By Richard Meyerholz

Vice President Underwriting

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What is “Suretyship”?Suretyship is essentially an extension of credit by the Surety on behalf of the Principal. Suretyship is designed to protect the Obligee from exposures to loss.

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What are “Surety Bonds”?A surety bond is a written agreement providing for monetary compensation or satisfactory completion of an obligation by the surety. A surety bond is a three-party agreement whereby the surety is bound, with the principal to the Obligee.

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There are two broad categories of Surety

Contract Surety – a contract bond guarantees the performance of the principal under a written contract to build or supply goods and services.

Commercial Surety (also known as non-contract or miscellaneous bonds) – a commercial surety bond guarantees the principal will honor obligations to pay a certain sum of money under a defined agreement or Gov’t. statute.

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Experience (Contract & Commercial Surety)

Contract Surety- Loss activity over the past 5 years has increased in both frequency and severity- Gross vs. Net Results- Reinsurers share of the industry losses disproportionateCommercial Surety- Historically very profitable, but recently reported losses may wipe out accumulated profits from the last 15 years.- Over the past 5 years:

• New product development • Growing number of high risk obligations

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2000 Surety Top 10

Direct Loss Ratio 43.9%

Net Loss Ratio 23.7%

Ceded Loss Ratio 233.0%

Data from Surety Association of America and A.M. Best

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Preliminary Surety Results2001

Direct Net Reinsurers

Top 10

Loss Ratio 103.4% 68.0% 330.9%Results 11-100

Loss Ratio 43.3% 32.7% 87.0%

Top 100

Loss Ratio 82.7% 56.4% 225.8%

Data from Surety Association of America

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Reinsurance MarketChanges from January 2000 – December 2001

- Calendar year 1999-over 25 active reinsurers with a total market capacity exceeding $250,000,000- December 2001 – 12 active reinsurers with a total market capacity at approximately $90,000,000 (excluding New Bermuda markets)- As of today – the jury is still out. Reinsurance Companies reviewing the market potential.

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Recent Claim Activity

- Contract Surety losses over $50 million are now common- Loss over $200 million is in the market - Freide Goldman Halter (three sureties involved)- IVI/Sade Vigesa $400,000,000- Several others on the ropes

- Commercial Surety losses are growing with the biggestclaim ever produced now in litigation.

• The biggest potential loss is Enron Corp.• Other potential large losses include Kmart,

Consolidated Freightways, CMC, Pacific Financial

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EnronUS Surety Market & Exposures Market participants Primary companies: Chubb Safeco St. Paul AIG Liberty Bond CNA Surety Travelers Hartford Fireman’s Fund F&D Surety Kemper Atlantic Mutual

Total = $2,488,000,000

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EnronUS Surety Market & Exposures Market participants Reinsurance companies: Transatlantic Re Gerling Global Swiss Re American Re Gen Re Nac Re/XL Re Partner Re St. Paul Re Folksamerica Zurich Re C.N.A. Re Hanover Re Employers Re Everest Re SCOR Re Berkley Group London

Total = $750,000,000

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Surety Involvement

Contract Surety - Performance Bond / Payment Bonds - Operations and Maintenance Bonds

Commercial Surety - Advance Payment Bond - Premium Payment Bond - Financial Guarantee Bond

Domestic Business Interests

International Business Interests

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Where Are The LossesContract - most likely from the international business

- Argentina exposure most tenuous

- estimate $25-$200 million

Commercial - paid losses to date exceed $265,000,000

- A.P.E.A. Bond [American Public Energy Agency]

- Winterthur Bond

- NEPOOL Bonds [New England Power Pool]

- Mahonia Bonds

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Example of a Forward Sale AgreementA.P.E.A. Bond

Paid loss $250,000,000

Structure of the deal Forward sale agreement J.P. Morgan/Chase A.P.E.A. End Users Enron

A.P.E.A.Bond Holders

Chase

Enron

Utility

Benefit to Utility – Discounted oil price

Tax credit

Benefit to Enron – Use of money

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Mahonia

Who/What is Mahonia

Six Open Bonds Guarantee Advance Payment

Total Amount On Six Bond claims - $1.1 Billion

Current Litigation

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Kmart

Commercial Surety Loss Workers’ Compensation/Self Insurers Bond Lease Bonds

License and Permit Bonds

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IVI/Sade Vigesa

Contract Surety Loss Performance and Payment Bonds on two oil platform

projects for Petrobias Bonds written in 1995 Judgment against Sureties: $370,000.00

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Things To Consider

Be sure to understand the product

Know the reinsurance coverage

Be aware of potential tail exposure

Are claims adequately reserved

Ask questions

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QUESTIONS