Transcript Document

Understanding the
Importance of Surety
Ray Batistoni, Hertz Global Holdings
Stephen Haney, ACE Professional Risk
Robert McDonough, AON Risk Solutions
Presenters
The Broker:
Robert McDonough, Surety Regional Managing Director
Aon Risk Solutions’ Construction Services Group
The Underwriter:
Stephen Haney, Executive Vice President
ACE Professional Risk - Surety
The Risk Manager:
Ray Batistoni, Risk Manager
Hertz Global Holdings
Underwriting
The Underwriter:
Stephen Haney, Executive Vice President
ACE Professional Risk - Surety
Any positions or opinions expressed are the presenter’s own and not necessarily
those of any ACE company.
Surety is NOT Insurance
1. Three Parties
•
Obligee
•
Principal
•
Surety
2. Indemnity
3. No Losses
4. Pricing
Characteristics of Surety
Surety Bond
• Independent instrument
• Conditioned on an underlying contract, ordinance or obligation
Risk of loss in bonding
• Failure to perform assumed obligations
Surety bond is not a risk transfer mechanism for the principal
If Surety sustains loss due to default on part of principal, loss
is recovered from principal and/or any Indemnitor(s)
Classes of Bonds
Construction
• Bid
• Performance & Supply
• Maintenance
Commercial
•
•
•
•
•
Court Bond
Customs
License & Permit
Public Official
Miscellaneous
Examples of Surety Obligations
Fiduciary Bonds:
Be an honest employee (e.g., Tax Collectors)
Customs Bonds:
Allow importation of goods without the
immediate need to pay taxes
Performance Bonds: Comply with contract’s terms and conditions
Payment Bonds:
Pay those supplying goods and services in
performance of a bonded contract
Meet all conditions of an ordinance or statute in
License and Permit: the performance of licensed trade or business
Alternatives To Surety Bonds
Letters of credit
• Ties up borrowing facility
• Can trip covenants
• Not conditional
Cash
• Reduces balance sheet liquidity
• Cost of capital
Treasury securities
• Cost of capital
Sometimes, there are no alternatives
• Public funds typically require surety
• Certain federal court obligations mandate surety
Underwriting Considerations:
Non-Financial
Identification and
Evaluation of Obligation
• Cancelable
• Demand vs. conditional forms
Pricing
• Market driven
• Credit sensitive
• Obligation sensitive
Indemnity
• Ultimate parent vs. subsidiary
• Captive arrangements
Underwriting Considerations:
Financial Underwriting
Balance Sheet
• Liquidity
• Leverage
• Debt maturity
Income Statement
• Earnings predictability
• Interest coverage
Cash Flow Analysis
• Free cash flow vs. no cash flow
• Capital expenditure needs
Broker
The Broker:
Robert McDonough, Surety Regional Managing
Director
Aon Risk Solutions’ Construction Services Group
U.S. Surety Industry: Strong Profitability,
Default Concerns Continue
2009
2010
YTD 9-30-10 YTD 9-30-11
Earned Premiums
Loss Ratio
$5.24B
19.5%
$5.27B
13.2%
$3.96B
16.7%
$3.87B
12%
Paid Losses
$1.0B
$694M
$654.5M
$465M
Through 9/30/11 top 20 surety companies accounted for:
• 82.6% industry-earned premiums
• 85.9% losses
Industry results were profitable, but:
• Largest surety provider results are inconsistent
• Industry fears greater contract default experience
Source: The Fidelity & Surety Association of America
Surety History Premium / Loss Results
6
80.00%
70.00%
5
60.00%
4
3
40.00%
30.00%
2
20.00%
1
10.00%
0
0.00%
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Direct Written Premium
Direct Losses
Loss Ratio
Loss Ratio
Dollars in Billions
50.00%
Adapting to New Market Realities
Underwriters expected increased loss activity in 2011.
Fortunately, companies made rapid changes to adapt.
Reduced overhead: Many contractors implemented financial
model with lower backlog and smaller margins
Increased liquidity:
– Slowing down capital expenditures
– Negotiating new contracts with better payment terms
– More modest M&A activity
– Replacing letters of credit with surety bonds
Result: Stronger balance sheets collectively improved credit
risk portfolios of the underwriting companies
Six Years Consecutive Commercial Surety
Profitability Leads to New Capacity
2010 premium placements:
• Approx. $1.5B:
• 28.3% of $5.3B total industry
premium
New capacity developed through:
• Hiring new commercial surety
leadership
• Current writers expanding capacity
• New capital entering the sector
Excess capacity and increased
competition provided:
• Better credits/improved pricing
• Lower credits access to
previously unavailable credit
2011 New Commercial Surety Capacity ($M)
Company
Aspen Re
Single
Aggregate
$5
$50
$25
$50
$200
$200
Hanover
$10
$25
Argo
$15
$35
Main Street America
$25
$25
Philadelphia Insurance
$10
$30
Arch
XL
TOTAL
$290
$415
Aggregate expansions for established markets:
ACE $100M; Chubb $250M; Liberty $1B
Source: The Fidelity & Surety Association of America
Market Discipline Challenged by Premium
Growth Plans
Given finite universe of statutory risks, Sureties expanding writings
through financial guarantee obligations (e.g., insurance program bonds)
2012: A record year for bankruptcies?
– On pace for 60: 5 U.S. and 6 global companies currently in default
– S&P: 39 US defaults in 2011 vs. 58 in 2010
Companies that refinanced maturities instead of reducing debt and those
faced with refinancing significant debt maturities in 2012 may risk default
Bankruptcy isn’t sole barometer for commercial surety losses – the
confluence of soft market and potential increased defaults may reverse
trends in the space in 2012
Expect continued “flight to quality” within the commercial surety segment
Construction Surety Sector Slow to Increase
New Capacity – Despite Profitable Results
Contract Surety Earned
Premium Placements
• Approximately $3.8B in 2010
• 21.7% of $5.3B total industry earned premium
Underwriting Concerns
• Weak construction spending & margins
• Increased subcontractor payment claims
• General contractors managing sub contractor default
issues
Underlying Sector Risk
• Continues to grow
• Must navigate industry issues to avoid far-reaching
impact of contractor default
In extending credit,
underwriters continue
to consider:
•
•
•
•
•
Health of existing backlog
Timing of payment from owners
Rising subcontractor failures/impact on profitability
Require more frequent financial updates
Onerous bond forms/contracts shifting risk to customer
Higher Loss Activity = More Questions for
Project Approval
Greater financial reporting requirements
More stringent capital and liquidity retention requirements
Heightened discussions around surety indemnity language
and credit facility documents
Rate increases for higher-risk clients and projects
Contractor default insurance may become a less viable option
due to risk and cost
Varied Impact of Current Industry Trends
Clients consider alternate collateral structures to support
unique transactions
Surety bonds can serve as viable alternatives to letters of
credit
Holistic view of client internal cost of capital driving more
opportunities to surety
Larger capacity available for investment grade type companies
Surety capacity a critically important credit tool for
construction companies
A Risk Manager’s View of Surety
The Risk Manager:
Ray Batistoni, Risk Manager
Hertz Global Holdings
Keys to a Successful Surety Program
Price
Reputation of the backer
Working relationship
Administrative efficiency
– Ease of application
– Turn-around time
Questions?