Finance 431

1. Finance 431 Surety Bonds

2. Surety • Will introduce some new concepts to you • Surety business • Contract and commercial bonds • Distinguish from and compare to insurance • Compare to banking

3. Surety • What is surety ? • Ancient process • Biblical commentary • Babylonian • Roman times • English history • U.S. history

4. Surety • Personal surety • Legal development • Common law v statute • Statute of frauds • Development of corporate surety

5. 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

6. 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

7. 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

8. Surety • Classifications of bonds • Contract • Commercial

9. Surety • Contract • Bid • Performance • Payment

10. Surety • The bid process • Discussion • Underwriting process • The three Cs of Credit extension • An expensive and in-depth process

11. 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

12. Surety • Character • Example • Contractor takes money out of company w/o telling you … or invests in business unrelated to his construction business … • Bankruptcy… • Other …

13. 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

14. 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

15. 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

16. 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

17. Surety • Commercial • Fiduciary • License and permit • Court • Public official

18. Surety • Commercial • Fiduciary • Executor or administrator of estate • Guardianship of minor • Trustees in bankruptcy

19. 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

20. Surety • Court • Plaintiffs and defendants • Attachment bonds • Plaintiffs • Release of attachment • Appeal bonds • High profile cases • Auto companies • Oil companies

21. Surety • Public Official • Administrator • Treasurer • Tax Collector

22. 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

23. 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 ?

24. 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

25. 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

26. Surety • Legal remedies in case of loss • Principal is primarily responsible for the obligation • In case of loss • Indemnification • Subrogation

27. 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

28. 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

29. 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

30. Surety Questions? Special thanks to Professor Vonnahme for the use of his materials.