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TRANSCRIPT
Surety Bonds &Construction Risk
Construction Risk Management
Presentation
Government of Yukon & Yukon
Construction Sector
February 24, 2016
“He that is surety for a stranger shall smart
for it: he that acts not as surety is sure.” Proverbs 11:15
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
dedicated to providing superior service
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
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
Why Contractors Fail
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
2015 - Canada was to go to 5th from 9th 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)
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 ($75B+)
Construction Risk 2010-2015
Options to Protect Against
Construction Risk: Surety Bonds
Performance Bonds
Labour & Material Payment Bonds
Liquid Security
Irrevocable Letters of Credit
Cash/Negotiable instruments on Deposit
Subcontractor Default Insurance (SDI)
Surety is not Insurance INSURANCE
Losses anticipated
2 party agreement;
Insured & Insurer
Premiums actuarially
determined
No recourse against
insured in the event of
loss
SURETY
No losses anticipated
3 party agreement;
Principal, Surety &
Obligee
Premiums only a service
charge
Recourse against the
Principal via indemnity
agreement
Surety Bonds: 3 Essential Services Prequalification:
Assurance that the bonded contractor is
qualified for the job for which they are
contracted.
Ongoing monitoring (and hidden services):
Sureties monitor bonded contractors
continuously and can provide assistance if
needed ($, technical support, accounting, etc.)
Security:
Financial Protection in the event that the
bonded contractor should default on its
obligation.
Information a Surety Needs
Organization Structure
Key Employee Resumes
Business Plan
Backlog Report
Financial Statements References
Contractors Profile
Bank Information
(Underwriting Requirements)
Standard Construction Bonds Prequalification
Prequalification Letter
Bid Bond
Consent of Surety
Security
Performance Bond
• Renewable Multi-Year Bonds
Labour & Material Payment Bond
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.
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
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
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
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
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 2016
24
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
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: 778-995-6585
email: [email protected]
Myths & Misconceptions
Myth #2: A 50% Bonds only provide 50% Protection
In fact: a 50 % bond gives you 100 % protection up to
the bond amount
Example:
Contract Price = $ 1 million
50 % Performance bond ($500,000)
Contract is 50% complete
Surety arranges completion for $ 700,000
Surety’s loss is ???
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
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.
Myths & Misconceptions
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.
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.
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.
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.
Claims
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.
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
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
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 sub-
contractor default.
NOT designed to protect owners from risks
associated with default of prime contractor
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
Issues and Challenges
Commercial
Legal
Technological
SAC’s Efforts to Address the Issues &
Challenges
Electronic Delivery of Bonds
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.
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
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” information session.
It’s FREE
Contact Us
Bob Sloat, Director Business Development –
Western Canada
Phone: 403-612-4070 or 778-995-6585
email: [email protected]
or visit our www.suretycanada.com
website: