Surety Bonds &Construction Risk

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Surety Bonds &Construction Risk

What’s New in Surety

Presentation

Government of Yukon & Yukon Construction Sector

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03 March 2016 2

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03 March 2016 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

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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)

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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)

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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

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 From 2010-15, the Surety industry paid out almost

$800 million in claims; more than the previous 10 yrs.  2013 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+)

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Continuing growth in Institutional Construction

investment

Challenges await:

 Regional Disparity: North & West Down,

East up?

 Resource prices: Full impact yet to be felt

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Paradigm Shift: AFP’s, P3’s, IPD, etc.

 Larger and longer projects

 Challenges to small and mid-sized firms

Other Changes Affecting the

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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.

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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

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…and Faster

Demand for instantaneous information and

immediate satisfaction.

Pressure for quicker, more expedient resolution

to construction and other business problems.

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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

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II – Surety Bonds

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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

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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:

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Standard Construction Bonds

Prequalification

Prequalification Letter

Bid Bond

Consent of Surety

Security

Performance Bond

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III – Surety

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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.

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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

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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’

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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

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IV – New & Improved…

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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.

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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.

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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

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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

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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.

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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.

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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).

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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

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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

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Where can I access:

SAC’s bond forms; and

Information on current and

developing trends in

Surety?

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SURETY ONLINE LEARNING CENTRE

 The Surety Online Learning Centre accessible from

SAC website; www.suretycanada.com.

 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”

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