Surety Bonds &Construction Risk

Transcription

1 What s New in Surety Presentation Government of Yukon & Yukon Construction Sector February 24, 2016 Surety Bonds &Construction Risk

2 Inscription found in the Temple of Apollo in Delphi Greece 03 March

3 I THE SURETY INDUSTRY Surety Companies SAC members write 95% + of all bonds in Canada There are hundreds of sureties listed on OSFI s website roster fewer than 20 are SAC members and they write almost all the bonds Surety Brokers Look for SAC member brokers they are dedicated to providing superior service 03 March

4 I Construction Risk

5 Construction Risk? Construction Risk = Risk of Contractor Failure Ongoing global economic uncertainty Surety Challenge: Uncertainty = more risk Economic factors now in a permanent state of flux (e.g.) resource development drives much of the economy but volatility in every resource sector is the new normal (potash; oil; gas; agribusiness) The number and severity of contractor failures continues to be a concern across the country

6 Gov ts Addressing Infrastructure Deficits Canada will have strong construction spending: Federal infrastructure commitment $48B over 10 yrs. + Federal Liberals additional commitments Western Provinces and Territories remain committed to infrastructure spending Larger and longer projects; infrastructure deficits Funding challenges for governments at all levels Many new procurement approaches in an effort to be more innovative, efficient and cost effective: o Construction Management and alternative financing (P3) o Integrated Project Delivery (IPD) New challenges for managing project (construction) risk

7 Why Contractors Fail Unqualified Contractors; the lowest irresponsible bidder Insolvency of Contractor Contractor default for non-financial reasons: Over Extension Inability to complete Incapacity of key people Unpaid subs and suppliers resulting in liens Warranty problems

8 Construction Risk Recent History From , the Surety industry paid out almost $800 million in claims; more than the previous 10 yrs a year to forget: Loss ratio; 52% - industry unprofitable Premiums flat after two years of decline Across all lines and all sectors of the country 2014 a record year: DWP $560 M. Loss ratio drops 32 points to 19%. 2015: first half continues the trend; slight increase in premium and loss ratio of 16%. Note: The industry hit new all-time highs for the value of contracts underwritten in 2014/15 ($75B+)

9 Other Changes Affecting the Construction Sector Continuing growth in Institutional Construction investment Challenges await: Regional Disparity: North & West Down, East up? Resource prices: Full impact yet to be felt Paradigm Shift: AFP s, P3 s, IPD, etc. Larger and longer projects Challenges to small and mid-sized firms

10 Evolving Political Environment Globalization of the construction industry with the continuing reduction of trade barriers (e.g.) Canada Europe Free Trade Agreement Trans-Pacific Partnership Participation of large multinationals will increase completion further. liquid balance sheets and demand for liquid security

11 Bigger, Longer & Tougher New Federal Government to fund ambitious infrastructure program; provinces following suit. New Models of Project Delivery & Procurement P3 s, AFP s Bundling Building Information Modeling (BIM) Integrated Project Delivery (IPD) Mega-Projects becoming the norm Small to mid-sized contractors are feeling the squeeze

12 and Faster Demand for instantaneous information and immediate satisfaction. Pressure for quicker, more expedient resolution to construction and other business problems. Challenges to the Surety Industry.

13 Options to Protect Against Construction Risk: Surety Bonds Performance Bonds Labour & Material Payment Bonds Liquid Security Irrevocable Letters of Credit Cash/Negotiable instruments on Deposit Subcontractor Default Insurance (SDI) Corporate (Parental) Guarantees

14 II Surety Bonds What are They? How do they Work?

15 Surety is not Insurance

16 Surety is not Insurance INSURANCE Losses anticipated 2 party agreement; Insured & Insurer Premiums actuarially determined No recourse against insured in the event of loss SURETY No losses anticipated 3 party agreement; Principal, Surety & Obligee Premiums only a service charge Recourse against the Principal via indemnity agreement

17 Surety Bonds: 3 Essential Services Prequalification: Assurance that the bonded contractor is qualified for the job for which they are contracted. Ongoing monitoring (and hidden services): Sureties monitor bonded contractors continuously and can provide assistance if needed ($, technical support, accounting, etc.) Security: Financial Protection in the event that the bonded contractor should default on its obligation.

18 Standard Construction Bonds Prequalification Prequalification Letter Bid Bond Consent of Surety Security Performance Bond Renewable Multi-Year Bonds Labour & Material Payment Bond

19 III Surety The Case for New Surety Products and Approaches

20 New Surety Products The Business Case Surety bonds have been around forever but they are being asked to respond to new procurement methods and changing needs of owners The surety industry has a well earned reputation as conservative and cautious Underwriting new and different risks requires new knowledge and data which is often lacking Remember the unique surety value proposition: it always strive to provide true performance security; i.e. providing owners with a completed project in the event of default. Also: payment protection for subs and suppliers.

21 The case for new products cont d Traditionally, a surety bond will not provide: Cash-on-demand. There must be a default. Dispute resolution (that s covered in the contract) A magic lamp defaults must be investigated before being remedied However, there are new realities for owners and contractors (e.g.) Owners want more control in default situations (schedules, replacement contractors) Lenders need assurance that big projects won t be held up due to a default of a key trade or supplier Some contracts (like road maintenance) need to be much longer five years or more is common

22 The case for new products cont d As a result of these pressures, the surety industry has been innovating at an unprecedented pace in recent years, (e.g.) SAC s Enhanced Process Performance Bond SAC s Multi-Year Renewable Bonds: Performance Labour & Material Payment P3 bonds The new Headstart Bond

23 A Caution: Larger players and alternative procurement methods don t change one myth: We don t need a bond; our contractor is huge. Recent history has shown that construction firms are not too big to fail even though they may have annual revenues ranging from hundreds of millions to several billions of dollars. There are bonding safeguards to protect project owners and others when a contractor fails. Excerpt from Why Contractors Fail by Hugh Rice and Arthur Heimbach, FMI Corporation*, 2007 *Largest provider of management consulting and investment banking for engineering & construction industry in the U.S.

24 IV New & Improved What s the Latest in the World of Surety Bonds?

25 SAC Performance Bond 2012 SAC consultations with Owners & Contractors; More certainty in the claims process. More responsiveness to a claim More frequent and effective communication between sureties and owners. New enhanced performance bond provides construction buyers with more timely &responsive claim service. Provides more responsive services to owners by..

26 SAC Performance Bond 2012 Pre-Demand Conference to allow surety and owner to prevent problems from turning into a default. Timelines for Surety s Response: 5 days to acknowledge a statement of default & request information 21 days (from receipt of information) for surety to respond to owner with their response. Emergency Remedial Work: Allows Owner to address urgent issues (e.g. safety) under the bond. Post-Demand Conference: Mechanism to minimize or eliminate work stoppages while surety investigates. Contact Coordinates: Contact information for all parties to facilitate notices and communication.

27 Renewable Multi-Year Bonds First designed for service contracts; e.g. road maintenance, snow removal but with longer term contracts becoming more common renewable bonds are now common Initial Term is open 2-3 years seems to be the norm. Renewal Terms are typically 1-2 year periods The bond automatically renews each year Failure to renew the Bond is not a default under the Contract or the Bond 2-year suit limitation runs from earlier of expiry of latest bonded Term or date default declared

28 Surety Bonds & P3 Projects Comprehensive and adequate performance security against construction default on largep3 projects. Bonding capacity for big P3s now accepted by I.O. Broad and flexible protection packages which include: Professional surety prequalification Specialty P3 bonds designed by member sureties: Provide liquid / cash on demand protection. Built-in fast-track dispute resolution Early Response; surety involved pre-default. Protection for trades & suppliers via the payment bond. Renewable Multi-year bonds provide protection during long term operation/maintenance phase.

29 And Coming Soon. Enhanced Payment Bond: Prompt payment of undisputed amounts Timelines for response to claims Option to extend protection to the second tier subcontractors and suppliers. Protection for Liquidated Damages: Current Bond Language unclear as to treatment of LD s; jurisprudence inconsistent. Rider to add coverage for LD s up to 10% of contract amount. Owner required to notify surety when LD s arise.

30 Code of Best Practices Sets out standards of professionalism for a surety s response to a performance bond claim. Provides Obligees with a guide to what it can expect when claiming under a performance bond. Incorporates principles of Enhanced Bond: Prompt Resolution Pre-default meeting. Standards of professional conduct in claims handling

31 Headstart Performance Bond TM Created to protect GCs from sub default (competitive alternative to SDI) Flexibility: Obligee given two mitigation options: Traditional Option: Surety investigates and implements solution (as in standard bond); or, Headtstart Option: Obligee implements its own solution upon surety s acceptance of Obligee s completion proposal. Responsiveness: First dollar protection(no deductible or co-payment). Surety will respond in 3 days from receipt of Claims letter. Standard claims notice and mitigation agreement.

32 e-procurement &e-bonding Consult Consult Consult: Industry buy-in and engagement is critical; early in the process Don t Reinvent the Wheel: are you a software developer? Insist on Verifiability: a true ebond; responsive vendor Scanned pdf??? Take the Time to get it right: Not difficult just different; Lead time to allow industry to adjust; Mock Tenders, Phase-in Periods SAC can Assist: Vendor evaluations Visit SAC Website:

33 Prompt Payment Slow payment/non-payment; leading cause of insolvency and financial distress in construction industry. Prompt Payment legislation in U.K. and U.S.; none in Canada. Ontario leading the way Attorney General initiates review of Lien Act; prompt payment to be incorporated Report to be submitted by March 2016 Five other provinces exploring legislation

34 Where can I access: SAC s bond forms; and Information on current and developing trends in Surety?

35 SURETY ONLINE LEARNING CENTRE The Surety Online Learning Centre accessible from SAC website; Five learning modules that introduce the basics of surety bonds and the suretyship process Learn at your own pace. Ideal for review or for colleagues who can t attend a live information session. It s FREE

36 Contact Us Bob Sloat, Director Business Development Western Canada Phone: or or visit our website: