finance 431 surety bonds. surety will introduce some new concepts to you surety business contract...
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Finance 431
Surety Bonds
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Surety Will introduce some new concepts
to you Surety business Contract and commercial bonds Distinguish from and compare to
insurance Compare to banking
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Surety What is surety ?
Ancient process Biblical commentary Babylonian Roman times English history U.S. history
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Surety Personal surety Legal development Common law v statute Statute of frauds Development of corporate surety
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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
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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
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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
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Surety Classifications of bonds
Contract
Commercial
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Surety Contract
Bid Performance Payment
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Surety The bid process
Discussion Underwriting process
The three Cs of Credit extension An expensive and in-depth process
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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
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Surety Character
Example Contractor takes money out of company
w/o telling you … or invests in business unrelated to his construction business …
Bankruptcy… Other …
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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
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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
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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
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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
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Surety Commercial
Fiduciary License and permit Court Public official
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Surety Commercial
Fiduciary Executor or administrator of estate Guardianship of minor Trustees in bankruptcy
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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
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Surety Court Plaintiffs and defendants
Attachment bonds Plaintiffs Release of attachment
Appeal bonds High profile cases
Auto companies Oil companies
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Surety Public Official
Administrator Treasurer Tax Collector
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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
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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 ?
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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
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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
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Surety Legal remedies in case of loss Principal is primarily responsible
for the obligation In case of loss
Indemnification Subrogation
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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
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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
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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
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Surety
Questions?
Special thanks to Professor Vonnahme for the use of his materials.