Construction Risk Management Presentation. Government of Yukon & Yukon Construction Sector February 24, 2016 Surety Bonds &Construction Risk

Transcription

1 Construction Risk Management Presentation Government of Yukon & Yukon Construction Sector February 24, 2016 Surety Bonds &Construction Risk

2 He that is surety for a stranger shall smart for it: he that acts not as surety is sure. Proverbs 11:15

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: What we Mean 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 (oil; gas; minerals and metals; agribusiness) The number and severity of contractor failures continues to be a concern across the country

6 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

7 Construction in Canada 2016 Canada will still have strong construction spending: Federal infrastructure commitment $48B over 10 yrs. Western provinces and territories remain committed to infrastructure spending Canada was to go to 5 th from 9 th largest construction market how times change! foreign investment was the key; going elsewhere now Larger and longer projects are a lasting legacy, though: Challenges to small and mid-sized contractors Challenges regionally (Priority Saskatchewan)

8 Construction Risk 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 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)

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

11 Surety is not Insurance

12 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

13 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.

14 Prequalification Intensive Ongoing Comprehensive Value Added

15 Capital Capacity Character

16 Information a Surety Needs Organization Structure Key Employee Resumes Business Plan Backlog Report Financial Statements References Contractors Profile (Underwriting Requirements) Bank Information

17 Surety prequalification isn t superficial (Site visit) 03 March

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

19 Prequalification Letter Not a bond but a letter from a bonding company to the project owner confirming bondability. Used during the pre-tender phase; (i.e.) before contract terms, scope or pricing details are known. Non-binding surety and principal reserve the right to review the details before firm commitment. Typically refer to the project at hand. SAC standard form available on SAC website.

20 Bid Bonds protection from the lowest irresponsible bidder provide assurance that contractor will: enter into the contract provide the required security Typically required in the amount of 10% of tender if contractor defaults, surety pays the difference between successful bid and second bidder Tender must be accepted within time frame set out in tender documents seven months to file suit

21 Consent of Surety Not a bond at all; a letter of commitment from the Surety to the Obligee to execute performance and/or payment bonds No penal sum set out; payment not an option Typically, bonds must be required within 30 days following award No standard (CCDC) form in existence, many variations in wording

22 Performance Bonds Guarantees Contractor will perform contract in accordance with its terms & conditions. Contractor must be in default and the default must be declared Owner must perform their obligations In the event of default: Surety has4 options: Remedy the default Complete the Contract Arrange for new contractor to complete Tender Payment Two years to file suit

23 Labour &Material Payment Bonds Guarantee that the contractor will pay all direct subcontractors, suppliers for materials and services provided to bonded project. Obligee is trustee on behalf of the claimants Claimant must have a direct contract with the Principal Claimants may only claim for goods and services supplied to the bonded job Claim must be filed within 120 days of the last day worked or the date material shipped One year to file suit

24 Make sure to ask for the L&M Payment Bond! It s better when trades and suppliers are paid especially on publicly funded jobs 03 March

25 III Surety Myths & Misconceptions

26 Myths & Misconceptions Myth #1: Sureties Don t Pay Claims. A surety bond will provide: Professional prequalification to weed out unqualified contractors. True performance security; i.e. provides owners with a completed project in the event of default. Payment protection to subs and suppliers. 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 don t expect the impossible Protection beyond the scope of the contract

27 Myths & Misconceptions Myth #1: Sureties Don t Pay Claims. Also. Owner must have fulfilled its contract obligations L & M Claimants must comply with the terms of the bond and be prepared to document claim SAC wants to hear about bad or problems claims: Contact the Surety Association of Canada Phone: bsloat@surety-canada.com

28 Myth #2: A 50% Bonds only provide 50% Protection In fact: a 50 % bond gives you 100 % protection up to the bond amount Example: Myths & Misconceptions Contract Price = $ 1 million 50 % Performance bond ($500,000) Contract is 50% complete Surety arranges completion for $ 700,000 Surety s loss is???

29 Myths & Misconceptions Myth #3: Bonds are a Barrier (especially to small contractors). Barrier? Bonding companies need to write bonds. Sometimes a time problem for contractors without a surety it takes time to establish a facility. Some sureties will ONLY bond small contractors, others have small contractor divisions Small firms will be able to secure bonding for jobs within their realm of expertise Bonds are only a barrier to unqualified contractors

30 Myths & Misconceptions Myth #4: Payment Bonds Don t Help Owners Ensures that subs working on your jobs will be paid. Many are local rate payers. Ease the Administrative burden in the event of default. Reduces the Owner s legal exposure. More competitive prices from subs who are now certain of being paid Speedier resolution of a default; continuity of team.

31 Myths & Misconceptions Myth #5: We don t need a bond; our contractor is huge. Excerpt from Why Contractors Fail by Hugh Rice and Arthur Heimbach, FMI Corporation*, 2007 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. *Largest provider of management consulting and investment banking for engineering & construction industry in the U.S.

32 IV Surety Bonds What Happens when a Contractor Defaults?

33 Before a Default is Declared Surety has extensive experience with contracts and solving construction problems. Surety has intimate knowledge of contractor and its operation Can provide informal assistance to solve problems that can lead to a default Will convene meeting or teleconference among the parties to address problems. Can assist in formalizing solutions.

34 Keep the Surety informed! 03 March

35 Claims When A Contractor Defaults: Surety will promptly acknowledge notice of default and being to gather information. Surety will begin an investigation as soon as possible. Surety will conclude the investigation as soon as possible. If requested by the owner, surety will provide periodic written updates on investigation status and best estimates as to completion date.

36 Claims During and After the Investigation: Surety will cooperate with the owner to protect work from damage or deterioration. Surety will work with the owner to: Identify and implement a solution. Minimize delays, keep the job going and protect the rights of all parties. Pay valid labour and material payment bond claims as promptly as possible to ensure continuity of subs and suppliers.

37 How the Project Owner can help Comply with bond & contract terms! (e.g. proper notifications, payments and certifications) Communicate: keep surety appraised of problems and provide default notice promptly. Cooperate: Ensure surety has access to knowledgeable staff and relevant documents. Keep expectations realistic.

38 V Surety Bonds Unseen Services to Owners & Lenders (and Contractors)

39 Unseen Services of Surety Bonds A surety can provide assistance and default prevention services by: Facilitating the resolution of construction performance issues that could lead to default Providing management and business assistance to assist contractors with administrative issues. Providing financial assistance to financially distressed contractors Providing technical/engineering expertise if required

40 VI - Other Forms of Contract Security

41 Liquid Security (LoC s) Yield cash; not performance Provide no prequalification assurance Available in smaller; perhaps insufficient amounts (5% to 10%) Typical default: 43% not unusual Deplete a contractor s borrowing power and can bring on the very problem they seek to avoid Provide no dedicated protection for subs or suppliers You own the problem upon default no support from the surety to complete the contract

42 Subcontractor Default Insurance Introduced in the U.S., in 1996, to protect very large general contractors from subcontractor default. Indemnity product compensates for loss incurred Significant deductibles and co-payment Only the largest GCs ( insured ) can get it requires in-house construction administration experience and strong cash flow; even they are new to underwriting Designed to protect large G.C. s against subcontractor default. NOT designed to protect owners from risks associated with default of prime contractor

43 Waiving Final Bonds Call for bid bond so get the benefit of surety prequalification (only qualified bidders can bid) Then, save the bond premium by waiving requirements for final bonds. Smart, eh? NOT! This can risk millions to save a few dollars. Contractor failures on the rise as the economy continues to struggle. History shows that NO contractor, large or small, is immune to financial and economic forces and the risk of default

44 VII e-bonding Did someone mention paperless??!!!

45 Electronic Delivery of Bonds Issues and Challenges Commercial Legal Technological SAC s Efforts to Address the Issues & Challenges

46 SAC & e-bonding Publications on SAC website: Designing Electronic Pathways Together. Vendors Guideline. Criteria checklist. Position Paper: Surety Bonds in a Digital World. Working with owners and vendors: Mock Tender big owners incl. DCC, AI Development of template language for inclusion in tender documents.

47 VIII New & Improved What s the Latest in the World of Surety Bonds?

48 New bond wordings; new forms of contracts are now bondable 03 March

49 Here are some of SAC s New Bond Forms SAC Enhanced Process Performance Bond More responsive; more control for owners P3 Bond forms Broad and flexible protection packages Tailored to the P3 project at hand Renewable Multi-Year Bonds Performance Labour & Material Payment Headstart Bond not ready to go yet, but will be soon If you d like to learn more about where the surety industry is going, and about our new bond forms, make sure to come to this afternoon s breakout session

50 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

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