Presentation to Insurance Regulatory. August 4, 2014

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1 A Primer on Surety Bonds Presentation to Insurance Regulatory Examiners Society August 4, 2014

2 State Legislative Issues: Surety Bonds Lenore S. Marema Vice President Government Affairs The Surety & Fidelity Association of America

3 Background A trade association of 450+ insurance companies that plays a leadership role in promoting and preserving use of surety and fidelity bonds to protect public and private interests SFAA members collectively l write vast majority of surety and fidelity bonds in United States

fidelity bonds to protect public and private interests SFAA members

4 Functions SFAA is a state-regulated entity for the following functions: Serves as advisory organization for surety & fidelity --rate/loss cost and form filing Serves as statistical agent for surety & fidelity data

for surety & fidelity --rate/loss cost and form

5 Introduction Surety Basics: The Number One Thing You Need to Know

6 A Primer on Surety Bonds Surety bonds are a unique form of insurance Surety is a three-party yproduct compared to traditional two-party insurance contract Sureties prequalify risks rather than spread losses A surety incurs a loss only if principal fails to perform its obligations and cannot reimburse surety Surety is generally a mandatory product not a voluntary purchase

rather than spread losses A surety incurs a loss only if principal fails to perform its

7 Surety as a 3-Party Contract Principal Obligee Surety

8 Surety as a 3-Party Contract Surety is a specialized form of insurance in which one party guarantees performance of an obligation of another party Principal/obligor is party that undertakes obligation Surety guarantees that Principal will perform Obligee is party that t receives benefit of performance In traditional insurance, risk is transferred to insurer In surety, risk remains with Principal (bond is for protection of obligee)

guarantees that Principal will perform Obligee is party that t receives benefit of performance In

9 Prequalification of Risks Surety underwriting is based on technical capability of surety to evaluate risks in order to avoid any losses Surety is more like a credit transaction (emphasis is on prequalification i and selection) If there is an appreciable likelihood of loss, surety will not write bond Traditional insurance underwriting is based on spreading risk of loss

(emphasis is on prequalification i and selection) If there is an appreciable likelihood of

10 Claims Under Surety Bonds A surety suffers a loss only if principal defaults on its obligation and cannot reimburse surety Surety theoretically is written to a zero loss ratio In traditional insurance, underwriter takes into consideration that a certain portion of premium will be paid out in losses In surety, premiums are charged for use of surety s financial backing and guarantee (cost of avoiding loss)

insurance, underwriter takes into consideration that a certain portion of premium will be paid out in

11 Surety Premium Volume Surety and fidelity premium volume is between 2% and 3% of property-casualty p y insurance industry

12 3 Types of Surety Bonds Contract surety These are bonds that contractors have to provide under state and federal law to assure that a construction project will get done on time and according to the contract and that everyone working on the job will be paid Most of surety premium is contract tsurety

project will get done on time and according to the contract and that

13 3 Types of Surety Bonds Commercial surety These are bonds that public entities require of individuals or entities as a condition for a license or a permit to engage in specified activities or to otherwise assure their compliance with hlaws and regulations

condition for a license or a permit to engage in specified

14 3 Types of Surety Bonds Fidelity Bonds These bonds provide indemnification for insured from losses caused by dishonest acts of employees

15 Bid Bonds Contract Surety Guarantee that contractor intends to enter into contract for bid amount and will provide required bonding for job Payment Bonds Guarantee that contractor will pay subcontractors, suppliers and laborers Performance Bonds Guarantee that contractor will complete job on time and according to specifications

that contractor will pay subcontractors, suppliers and laborers Performance Bonds

16 Contract Surety Amount of bond is usually 100% of contract price Premium is.5% to 2 % of the bond amount Public owner usually reimburses the bond principal for the premium in the first draw on the job so that it is a cost of public construction.

17 Prequalification Capital Capacity Financial Resumes statements Contingency plan Working capital Business plan Work-in-progress (short & long-term) Indemnity Equipment Character Reputation Relationships References

plan Work-in-progress (short & long-term) Indemnity

18 Surety Basics Why prequalify contractors on public projects?

26 Contract Surety The cost of surety bonds Bid Bond (No charge) Performance Bond (0.5% to 2% of contract price) Payment Bond (Price included with performance bond) In contract surety, obligee ultimately pays for bond Amount of bond is usually 100% of contract price

27 Example Surety Bond Rates Project Amount $1 million $5 million $10 million $20 million Bond Premium $7,700-$13,500, $33,200-$47,250 $56,950-$81,000 $, $101,950-$146,000 Premiums may vary depending on size, type and contractor s bonding capacity

28 Commercial Surety License and permit bonds Guarantee compliance with laws and regulations Judicial bonds Appeals; attachments; injunctions Fiduciary bonds Probate; bankruptcy trustee; executor; guardian

29 Commercial Surety Public official bonds Sometimes are fidelity bonds Miscellaneous bonds Endless garden variety workers comp self-insurance; income tax bond; lost securities

30 Commercial Surety Underwriting Statutory obligation being bonded Bond form terms and conditions Evaluation of principal Role of bond amount

31 Commercial Surety Underwriting Bond premium generally is a fixed percentage of bond amount For many commercial bonds, there is an annual premium Bond principal pays the premium for most bonds

32 Fidelity Bonds These bonds protect against loss from employee dishonesty There are few, if any, state legislative or other issues related to fidelity bonds because most of requirements to obtain fidelity bonds are federal for federally regulated entities

33 Commercial Surety Why prequalify those applying for state licenses?

38 Market Conduct Issues in Surety Availability: I cannot get a bond Not everyone is supposed to get a bond prequalification

39 Market Conduct Issues Cancellation of Bonds Contract surety bonds cannot be cancelled Cancellation of a commercial surety bond often is a good thing

40 Market Conduct Issues Form Filing Compliance The public entity that requires the bond promulgates the form Form filing requirements would result in multiple filings of the same bond form

41 Market Conduct Issues Claims Issues Surety bonds are exempt from the unfair claims settlement practices laws and regulations in most states just like other three-party coverages health; workers comp

42 Market Conduct Issues Rates All SFAA s loss cost filings are countrywide data Companies file deviations SFAA as an advisory organization is examined once every five years

43 Market Conduct Issues Fraud --Individual sureties --fraudulent bonds

44 Developing Issues in Surety

45 Bail Bonds A Unique Surety Bond Contract between surety and bail bond agent requires the agent to indemnify the surety for all losses paid The surety underwrites the bail bond agent not not the criminal defendants

46 Bail Bonds The relationship between the surety and agent is the guaranty The risk of loss primarily is on the bail bond agent The bail bond agent retains a large part of the premium The surety is left with a premium minus commission i that reflects its actual risk

47 Rates and Claims Rates generally are statutory The claim is made on the bail bond agent who has taken collateral The agent looks to the criminal defendant and third party indemnitors to recover if the defendant fails to comply with terms of bail If that is insufficent, then the Build Up Fund pays and dlastly, l the surety

48 Bail Bonds Agency Agreements are the Key --How bail bonds are Underwritten -- Reporting of bail bonds --How the bonds are Secured

49 Agency Agreements Indemnity Agreement requires a Build Up Fund Surety holds 1% or more of the premiums of each bond to assure that the agent will be able to pay all losses Sureties have segregated accounts for each agent or agency that agents cannot access

50 Agency Agreements Power of Attorney(POA) grants the agents the authority to execute a bond Sureties commonly control the highest penal sum and create a fixed aggregate authority A POA must be attached to each bail bond

51 Agency Agreements Sureties placed identifying numbers on each POA given to an agent and give agents POAs in different denominations When the POAs are attached to the bonds and reported to the surety, the surety can assess its overall liability by calculating the penal sums associated with each number

52 Agency Agreements Sureties can calculate and control the stock of unused POAs Sureties require an accounting when the agent asks for a new stock of POAs. The agent must remit premium to the Back Up Fund when issuing a double another double check for the surety

53 Agency Agreements Other Controls Sureties Put in Place --How agents takes and holds collateral and when it must be returned --Sureties require periodic reporting of bonds executed and payment of premiums to the surety and the Build Up Fund

54 Signs of Trouble Missing POA in a numbered sequenceassumed attached to a bond Courts send notices of default to the surety Failure to report a bond issued is a warning sign The surety s experience of percentage of defaults vs the agents records

55 Bail Bond Examinations Based on SFAA s experience: Examinations of sureties largely are financial exams to determine the controls in place with the agents Market conduct exams most often are of agents/agencies

56 A Primer on Surety Parting Shots and Questions

A Primer on Surety Bonds

A Primer on Surety Bonds Mark J. Browne, Ph.D. Robert Clements Distinguished Chair School of Risk Management Tobin College of Business St. John s University New York, New York A Primer on Surety Bonds