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.