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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

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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

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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 Contractor -- ObligorSurety -- Secondary Obligor Owner -- Obligee

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Surety Bonds - What are they? And what do they do? (Contd) 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: 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 InsuredInsurer

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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 contractors specific obligation (including contract terms), financial status, work program, and experience, among other factors Performance bonds address one partys responsibilities they do not address the project goals

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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

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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

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

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

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

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Top 15 Writers of All U.S. Surety

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Surety Market Todays Top 10 Sureties CompaniesDirect Premium Written (Millions $) 1. Travelers Bond867.8 2. Liberty Mutual Insurance Group751.2 3. Zurich Insurance Group512.3 4. CNA Insurance Group406.5 5. Chubb & Son Inc. Group256.9 6. Hartford Fire & Casualty Group177.2 7. HCC Surety Group176.1 8. International Fidelity Ins. Co.143.3 9. ACE Ltd. Group109.5 10. NAS Surety Group104.8 *Includes contract and commercial surety Source: The Surety & Fidelity Association of America (SFAA), Top 100 Writers of Surety BondsUnited States & Territories, Canada & Aggregate Other Alien, 2010 (Preliminary). Additional information and reports are available for purchase from the SFAA website at www.surety.org. See Statistical Services, then List of Statistical Repts.

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

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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

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No Surprise s! RTFCRTFC

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

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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

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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

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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

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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

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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

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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.

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

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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!

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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

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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 Obligees Guide SFAA http://www.surety.org/resource/resmgr/pubs- public/bondobligeeguide2011.pdf

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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 Federal HR 3534 Security in Bonding Act of 2011

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

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