The Surety Industry: The Surety Industry: Changes and ChallengesChanges and Challenges

AASHTO Meeting August 5, 2008

San Antonio, TX

Howard CowanHoward Cowan Bond Agency, Inc.

Lubbock, TX

Surety Industry 2008Surety Industry 2008

5.4 Billion Industry5.4 Billion IndustryMost surety companies are divisions of large Most surety companies are divisions of large insurance carriers.insurance carriers.Typically surety companies divide their business Typically surety companies divide their business into two segments.into two segments.

3030--35% Commercial 35% Commercial 6565--70% Contract 70% Contract

Surety In the Early 1990sSurety In the Early 1990s

Strong economyStrong economy

Excess capacity in surety marketExcess capacity in surety market

Low premiumsLow premiums

Relaxed underwritingRelaxed underwriting

Commercial surety expansionCommercial surety expansion

Surety in the Early 2000sSurety in the Early 2000s

Sagging economySagging economy

Significant commercial lossesSignificant commercial losses

Heavy contract surety lossesHeavy contract surety losses

Increased failure ratesIncreased failure rates

Contract Surety Premiums & LossesContract Surety Premiums & Losses

0

0.5

1

1.5

2

2.5

3

3.5

4

Billi

ons

of D

olla

rs

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Direct Premiums Written

Direct Losses Incurred

Source: The Surety & Fidelity Association of America www.surety.org

Surety Losses & ProfitabilitySurety Losses & ProfitabilityContract Surety Industry Loss Ratios

CY 1958 - 2006Source: The Surety & Fidelity Association of America

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%

110.0%

1958

1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

Calendar Year

LossRatio

Average Contract Surety Loss Ratio for 1958 - 2006 = 43.8%

Surety Challenges Surety Challenges –– Beyond 2008Beyond 2008

““Credit CrisisCredit Crisis””GlobalizationGlobalizationPrice Escalations on CommoditiesPrice Escalations on CommoditiesFalling DollarFalling Dollar

Top Ten Sureties Top Ten Sureties -- 19921992Top Ten Writers of Surety Bonds in 1992

Company Name Direct Premiums Written

St. Paul/Seaboard Group $148,894,821Fidelity & Deposit $137,305,805Reliance Insurance Group $128,056,603United States F&G Group $119,502,476Aetna Life & Casualty Group $102,973,652American International Group $98,210,281Continental Insurance Companies $93,303,961Fireman’s Fund Companies $83,943,008CNA Insurance Companies $81,472,867 Safeco Insurance Companies $77,857,712

Source: The Surety & Fidelity Association of America (SFAA)“Top 100 Writers of Surety Bonds”

www.surety.org

Top Ten Sureties Top Ten Sureties -- 19971997

Top Ten Writers of Surety Bonds in 1997

Company Name Direct Premiums Written

CNA Insurance Companies $218,470,641 Reliance Insurance Companies $193,621,757U.S. Fidelity & Guaranty Group $151,278,874Fidelity & Deposit Group $151,278,874Travelers Property Casualty Corp. $147,479,769St. Paul/Seaboard Group $138,973,440American International Group $126,974,037New Hampshire Group $106,948,282Fireman’s Fund Insurance Companies $102,408,696Safeco Insurance Companies $96,670,164

Source: The Surety & Fidelity Association of America (SFAA)“Top 100 Writers of Surety Bonds”

www.surety.org

Top Ten Sureties Top Ten Sureties -- 20022002

Top Ten Writers of Surety Bonds in 2002

Company Name Direct Premiums Written

Travelers Property Casualty Corporation $522,288,148 The St. Paul Companies $450,448,789 CNA Insurance Companies $360,372,339 Zurich Group $260,158,209 ACE USA Group $202,140,844 Chubb Group of Insurance Companies $172,651,420 Safeco Insurance Companies $164,611,345Liberty Mutual Group $150,209,449 Kemper Insurance Companies $122,815,820The Hartford Insurance Group $122,075,060

Source: The Surety & Fidelity Association of America (SFAA) “Top 100 Writers of Surety Bonds” June 4, 2003

www.surety.org

Top Ten Sureties Top Ten Sureties -- 20072007

Top Ten Writers of Surety Bonds in 2007

Company Name Direct Premiums Written(Preliminary)

Travelers Bond $1,017,180,430Zurich Insurance Group $448,819,392CNA Insurance Group $436,119,894Safeco Insurance Group $423,274,038Liberty Mutual Insurance Group $341,250,237Chubb & Son Inc. Group $303,639,444Hartford Fire & Casualty Group $223,298,098HCC Surety Group $163,368,470Arch Capital Group $126,995,347ACE Ltd. Group $118,743,836

Source: The Surety & Fidelity Association of America (SFAA) “Top 100 Writers of Surety Bonds—United States & Territories & Canada,” (Preliminary); www.surety.org

Surety Consolidation ContinuesSurety Consolidation ContinuesAnnounced Purchase of Safeco by Liberty MutualAnnounced Purchase of Safeco by Liberty Mutual

ReinsuranceReinsurance

Availability of Reinsurance is an Availability of Reinsurance is an Important Factor to Most Important Factor to Most

Surety Companies! Surety Companies!

The Three CThe Three C’’s of s of SuretyshipSuretyship

Do They Still Matter?Do They Still Matter?

Yes, They Do!Yes, They Do!

From Biblical Times From Biblical Times to Enron, to Enron,

You Had Better Know You Had Better Know With Whom You Are With Whom You Are

Dealing!Dealing!

Construction Construction Contracting Is Risky Contracting Is Risky

Business!Business!

Contractor Failure RisksContractor Failure Risks

RISK

Low profitmargins

Slow collections

Insufficient Capital

Onerouscontracts

Unreasonableowners

HighMaterials

prices

Shortage of qualified,skilled workers

Contractor Failure RisksContractor Failure Risks

RISK

Inadequate Management

Change inScope of

Work

SubFailure

Inclement Weather

NewOwner

OverExpansion

MaterialsShortages

CapitalCapital

CapacityCapacity

CharacterCharacter

CapitalCapitalFinancial Financial

statements statements

Working capitalWorking capital

WorkWork--inin--progressprogress

IndemnityIndemnity

CapacityCapacityResumesResumes

Contingency Contingency planplan

Business planBusiness plan--short & short &

long termlong term

EquipmentEquipment

CharacterCharacterReputationReputation

RelationshipsRelationships

ReferencesReferences

Surety Surety –– Does It Add Value?Does It Add Value?

Meets Statutory RequirementsMeets Statutory RequirementsRepresents Good Business PracticeRepresents Good Business PracticePrequalificationPrequalificationWhat if Prequalification is Wrong?What if Prequalification is Wrong?

Backed by BondBacked by BondCounsel & Capital Counsel & Capital

Surety Surety –– Does It Add Value?Does It Add Value?

ClaimsClaimsA lossA loss--free business?free business?

Losses from 2001Losses from 2001--2005 2005 (approximately $5 billion of direct losses)(approximately $5 billion of direct losses)The Big DigThe Big DigMidwest Highway ContractorMidwest Highway ContractorEnronEnronA Simple Claim is the Best Claim A Simple Claim is the Best Claim

Highway Construction Highway Construction and and

The Surety IndustryThe Surety Industry

Are We Traveling Are We Traveling

the Same Road?the Same Road?

Common GoalsCommon Goals

LetLet’’s Keep America Moving!s Keep America Moving!Aging InfrastructureAging InfrastructurePolitics of TransportationPolitics of TransportationAdequacy of FundingAdequacy of Funding

Not A ProblemNot A Problem

Routine DOT ProjectsRoutine DOT ProjectsDifferent Delivery MethodsDifferent Delivery Methods

The Critical IssuesThe Critical Issues

Capacity on Jumbo JobsCapacity on Jumbo JobsProbably More Than 750MM, Less Than 1BProbably More Than 750MM, Less Than 1B

TimeTimeLength of ProjectLength of ProjectLength of WarrantyLength of WarrantyLength of Total CommitmentLength of Total Commitment

Legal RestraintsLegal RestraintsStatutory Requirements for 100% BondsStatutory Requirements for 100% Bonds

How to Handle?How to Handle?Treasury and Aggregation Limits on SuretyTreasury and Aggregation Limits on Surety

The Critical IssuesThe Critical IssuesCompetitionCompetition

ContractorsContractorsPossibly Less than 10 Consortiums at Upper EndPossibly Less than 10 Consortiums at Upper EndShutting Out of MBEShutting Out of MBE’’s and Small Businesss and Small Business

SuretiesSuretiesLimited Number of Participants Limited Number of Participants (In 2007, Top 5 Sureties Wrote 49%; Top 10 Sureties Wrote 66(In 2007, Top 5 Sureties Wrote 49%; Top 10 Sureties Wrote 66% % of Total.)of Total.)

Joint and Several LiabilityJoint and Several Liability

PeoplePeopleContractorsContractorsDepartment of TreasuryDepartment of TreasurySuretiesSureties

What Makes a Jumbo What Makes a Jumbo Project Doable?Project Doable?

It Must Have It Must Have ““The Right StuffThe Right Stuff””

““The Right StuffThe Right Stuff””

Project TeamProject TeamContract Terms and ConditionsContract Terms and ConditionsOwnerOwnerFinancingFinancingSharing of Risk Sharing of Risk

ContractorContractorSuretySuretyOwner Owner

Avoiding Problematic Avoiding Problematic Language in Your Language in Your

Bond Forms!Bond Forms!

Problematic LanguageProblematic Language

Terms that make it easier to invoke the suretyTerms that make it easier to invoke the surety’’s s liability (e.g., liability (e.g., ““any breach will doany breach will do””))Terms that increase the suretyTerms that increase the surety’’s monetary s monetary liability beyond that originally stated in the bond liability beyond that originally stated in the bond (e.g., contract changes automatically increase (e.g., contract changes automatically increase penal sum)penal sum)Terms that vary the burden of proof (e.g., Terms that vary the burden of proof (e.g., determination of default is at sole discretion of determination of default is at sole discretion of obligee; surety waives any notice of default)obligee; surety waives any notice of default)

Problematic LanguageProblematic Language

Terms that limit the suretyTerms that limit the surety’’s options (e.g., no s options (e.g., no optionsoptions----forfeiture of entire penal sum)forfeiture of entire penal sum)Terms that broaden the obligations covered Terms that broaden the obligations covered (e.g., copyright infringement; obligee is intended (e.g., copyright infringement; obligee is intended beneficiary of payment bond)beneficiary of payment bond)Terms that lengthen the time the surety remains Terms that lengthen the time the surety remains liable (e.g., claims period in bond tied to liable (e.g., claims period in bond tied to expiration of any warranty period in contract, expiration of any warranty period in contract, such as 20 yr. roofing warranty)such as 20 yr. roofing warranty)

Know What Surety Bonds Know What Surety Bonds Are and Are Not!Are and Are Not!

DonDon’’t Place New and Unquantifiable Risks Into t Place New and Unquantifiable Risks Into the Bond Productthe Bond ProductSurety Bonds Are Surety Bonds Are NotNot ––

Insurance PoliciesInsurance PoliciesFinancial GuaranteesFinancial GuaranteesGuarantees of Output or ResultGuarantees of Output or Result

Qualifying the SuretyQualifying the Surety

Is the surety admitted in the jurisdiction of the Is the surety admitted in the jurisdiction of the project?project?Is surety financially sound?Is surety financially sound?Is the surety established and reputable?Is the surety established and reputable?

Qualifying the Surety Qualifying the Surety -- ResourcesResources

Information resources:Information resources:State Insurance DepartmentsState Insurance Departments

www.naic.org/state_web_map.htmwww.naic.org/state_web_map.htmUS Treasury DepartmentUS Treasury Department

www.fms.treas.gov/c570/c570.htmlwww.fms.treas.gov/c570/c570.htmlA.M. Best Company A.M. Best Company www.ambest.comwww.ambest.comDun & Bradstreet Dun & Bradstreet www.dnb.com/uswww.dnb.com/usStandard & Poors Standard & Poors www.standardandpoors.comwww.standardandpoors.comMoodyMoody’’s s wwww.moodys.comww.moodys.com

For More Information For More Information On SuretyshipOn Suretyship

National Association of Surety Bond Producers (NASBP)National Association of Surety Bond Producers (NASBP)202202--686686--3700 3700 www.nasbp.orgwww.nasbp.org

Surety Information Office (SIO)Surety Information Office (SIO)202202--686686--7463 7463 www.sio.orgwww.sio.org

The Surety & Fidelity Association of America (SFAA)The Surety & Fidelity Association of America (SFAA)202202--463463--0600 0600 www.surety.orgwww.surety.org

Thank You for Your Thank You for Your Time and Attention.Time and Attention.

Howard Cowan, Pres. Howard Cowan Bond Agency, Inc.

Phone: (806) 722-2663Fax: (806) 722-2662

E-mail: howardcowan@sbcglobal.net

Howard Cowan, Pres. Howard Cowan Bond Agency, Inc.

Phone: (806) 722-2663Fax: (806) 722-2662

E-mail: howardcowan@sbcglobal.net

My thanks to the following organizations which contributed

ideas and information to this presentation: Chubb, CNA, Great

American, Liberty Mutual, NASBP, Safeco, SFAA, SureTec, Travelers, General Re, Westfield & Zurich.

My thanks to the following organizations which contributed

ideas and information to this presentation: Chubb, CNA, Great

American, Liberty Mutual, NASBP, Safeco, SFAA, SureTec, Travelers, General Re, Westfield & Zurich.