Surety Bonding Clint Diers Hunter Bendall February 12

Surety Bonding Clint Diers & Hunter Bendall February 12, 2015

Overview • Surety 101 • State of the Industry • Subcontractor Default Insurance • Surety Bond vs Letter of Credit

Surety Bonds 101 The Basics of Bonding

What is Surety Bonding? Principal Obligee Surety

Types of Surety Bonds • Bid Bond • Performance Bond • Payment Bond

Prequalification Capacity Financial Strength Organization Company History Continuation Plans References Work In progress

Surety Company Checklist ü Good character ü Experience matching contract requirements ü Financial strength ü Excellent credit history ü Banking relationship ü Line of credit ü Necessary equipment

Benefits of Bonds Financial Security Construction Assurance

Functions of Bonds Surety Bonds • No liens • Smooth transition from construction to permanent financing • Provide support to contractor • Project completion

Cost of Surety Bonds Bid Bond No charge Performance Bond ½ - 2% of contract price Payment Bond Price included with performance bond

For More Information Surety Information Office 1828 L St. NW, Suite 720 Washington, DC 20036 202 -686 -7463 | Fax 202 -686 -3656 www. sio. org | sio@sio. org

State of the Industry

State of the Industry Surety Results 1995 -2013 $6, 000 $5, 000 $4, 000 $3, 000 $2, 000 $1, 000 $0 1995 Direct Written Premiums $2, 472 Direct Earned Premiums $2, 147 Direct Losses Incurred $525 1996 $2, 626 $2, 262 $499 1997 $2, 769 $2, 384 $540 1998 $2, 919 $2, 528 $567 1999 $3, 401 $2, 832 $675 2000 $3, 490 $3, 411 $1, 549 2001 $3, 473 $3, 330 $2, 748 2002 $3, 756 $3, 514 $2, 455 2003 $3, 727 $3, 708 $1, 833 2004 $4, 205 $4, 006 $2, 428 2005 $4, 410 $4, 270 $1, 755 2006 $4, 975 $4, 696 $787 2007 $5, 433 $5, 183 $979 2008 $5, 520 $5, 426 $669 2009 $5, 103 $5, 236 $967 2010 $5, 180 $5, 273 $694 2011 $5, 172 $5, 188 $696 2012 $5, 035 $5, 137 $1, 109 2013 $5, 245 $5, 175 $841

State of the Industry Surety Results 1995 -2013 Direct Written $$ in millions Premiums 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 $2, 472 $2, 626 $2, 769 $2, 919 $3, 401 $3, 490 $3, 473 $3, 756 $3, 727 $4, 205 $4, 410 $4, 975 $5, 433 $5, 520 $5, 103 $5, 180 $5, 172 $5, 035 $5, 245 Direct Earned Premiums Direct Losses Incurred Direct Loss Ratio $2, 147 $2, 262 $2, 384 $2, 528 $2, 832 $3, 411 $3, 330 $3, 514 $3, 708 $4, 006 $4, 270 $4, 696 $5, 183 $5, 426 $5, 236 $5, 273 $5, 188 $5, 137 $5, 175 $525 $499 $540 $567 $675 $1, 549 $2, 748 $2, 455 $1, 833 $2, 428 $1, 755 $787 $979 $669 $967 $694 $696 $1, 109 $841 24. 5% 22. 1% 22. 7% 22. 4% 23. 8% 45. 4% 82. 5% 69. 9% 49. 4% 60. 6% 41. 1% 16. 8% 18. 9% 12. 3% 18. 5% 13. 2% 13. 4% 21. 6% 16. 3% Total Direct Losses 2000 -2005 $12, 768 15

Surety Comparison Data 2003 SAA Results 2013 SAA Results* 1 Travelers $581, 645, 877 Travelers $778, 689, 161 2 St Paul $391, 742, 859 Liberty $738, 271, 612 3 C N A $341, 835, 008 Zurich $492, 737, 467 4 Zurich $275, 289, 480 C N A $408, 605, 990 5 Safeco $212, 456, 655 Chubb $210, 242, 628 6 Chubb $197, 422, 175 IFIC $167, 316, 158 7 Liberty $151, 492, 862 HCC $166, 419, 402 8 Hartford $142, 900, 460 Hartford $160, 693, 912 9 AIG $84, 458, 207 ACE $143, 061, 872 10 IFIC $73, 307, 108 RLI $110, 594, 591 *Notes In 2013 the top 10 writers accounted for 64% of the Industry revenue. The top 20 accounted for 79% of revenue. 16

Subcontractor Default Insurance

Subcontractor Default Insurance • What is Subcontractor Default Insurance? An insurance policy which indemnifies the Project Owner and General Contractor for costs associated with Subcontractor default and adds value to the project as a risk mitigation method. Typically these are rolling programs and cover multiple contract. High limits and High deductibles. • Why was SDI created? Large General Contractors expressed concern with increasing risks of Subcontractor default, and their dissatisfaction with the structure and process involved with making claims against Subcontractor Surety Bonds. The idea is that the sophisticated GC can do a better job of prequalifying, selecting, and mitigating subcontractor risk and SDI aligns the incentive to do so with the lower cost of insurance coverage. 18

Subcontractor Default Insurance - Continued • Objectives of SDI: - Control: puts control back in the hands of the GC project team. Coverage: provides consistent and efficient coverage. Cost: a cost-effective solution. Profit: by utilizing the GC’s ability to prequalify, select, and mitigate subcontractor risk. • Why Would a Project Owner or Lender be Interested in SDI? - Subcontractors will typically perform more than 75% or more of the work on a project. - Subcontractors fail at a rate of over 90, 000 firms per year. - During the course of your project, including the maintenance period, the GC can anticipate that as many as 25% of their Subcontractors will experience financial or operational difficulties leading to potential default. - SDI generally carries a longer term tail coverage for default. 19

Subcontractor Default Insurance - Continued • How can SDI help a GC? SDI provides protection against DIRECT LOSS including but not limited to costs: - Supplement sub’s work to stay on schedule. Terminate and replace defaulting sub. Replace any non-conforming work. Pay for any unpaid suppliers or sub/subs. Any expenses or defense of disputes with subs (attorney’s, consultants, etc. ). SDI provides protection against INDIRECT LOSS including but not limited to costs: - Accelerate the work (extra payments to other subs to catch up after delay by defaulting sub). - Extended overhead of GC to oversee additional workforces. - GC of any liquidated damages directly related to a defaulted sub. - A well managed program with a low loss ratio can give the GC an opportunity to earn additional profits over time.

Subcontractor Default Insurance - Continued • Other Value To the Project Owner and GC: • SDI provides expert consultant at the jobsite to assist in evaluation and resolution of default. (Insurance Company Risk Engineer) • Enhanced schedule security - helps ensure on-time project. • More capability to use MBE/DBE/WBE. • Reduces potential litigation and property liens. • Provides long tail years of completed operations coverage 21

Subcontractor Default Insurance - Continued Project Cost Comparison – This is influenced by several factors • Is the GC bonded? What is the GC’s policy on requiring sub bonds? • Bonding both would typically cost 1. 5% to 2. 5% of the contact value. • SDI can help project contingency funds. • SDI, on average, is 50% - 75% the cost of sub bonds. • SDI covers all subs, not just the largest. Coverage: • Surety bond will pay up to the penal sum of the bond • SDI covers all subs and union benefits funds. • Bond provides limited or no coverage for Indirect Loss. • In the event of loss SDI can provide cash flow to the project if needed to keep on schedule. • SDI provides a long tail to report claims after project completion. SDI can have a more efficient claims Process: • When your GC notifies a Surety of a problem with a sub, an investigation occurs. • The investigation uses valuable time and prevents the project from moving forward. • The Surety will pay for the resolution the Surety decides is correct, sometimes this is not the best resolution for the GC or the owner’s project.

Subcontractor Insurance Procedures the GC Implements to Prevent and Mitigate Risk of Subcontractor Default: • Pre-Qualification of Subs - financial, credit, performance, quality, safety, experience, personnel. • Selects Qualified Low Bid Subs who add value to your project. • Aggressive management / monitoring of subs: scrutinize schedules of values with pay submittals; 1 st and 2 nd tier partial and final lien releases; periodic supplier validations of payment; quality checks. • SDI procedures are reviewed by the insurance company Risk Engineers. What are the procedures when defaults do occur? • SDI allows the GC to take immediate action to remedy the default: - Hire a replacement subcontractor. - Supplement defaulting subcontractor’s workforce. - Assist the subcontractor with financial/payroll or other means to help complete the work. -Complete the work ourselves. • SDI provides the GC with coverage to: - Replace non-conforming work. - Fund additional costs to hire replacement subcontractors. - Indemnify 2 nd tier subs, suppliers or employees who may not have been paid. - Accelerate the schedule if default results in delay. - Fund costs of any necessary litigation or legal fees associated with subcontractor default.

Surety Bond vs. Letter of Credit

Surety Bond vs. Letter of Credit Apartment Project: 126 Units Surety Bond: 1% of construction value Total Development Cost w/ 1% Bond: $17, 500, 000 Construction Costs: $15, 000 Term/Rate: 40 years; 3. 5% Bond Cost: $150, 000 Monthly Payment, less taxes and insurance: $67, 793 LOC 10% of construction value LOC Cost (50 Basis Points for 2 years) $15, 000 Warranty Period 2. 5% for 1 year LOC Cost (50 Basis Points 1 year) $1, 875 Total LOC Hard Costs: $16, 875 Cash Set Aside: $1, 500, 000 Interest Not Received on Escrowed Funds: (2. 5% APR) $75, 937 Real Cost of LOC w/ Opportunity Cost: $92, 812 Total Hard Development Costs w/ LOC: $17, 366, 875 Monthly Payment, less taxes and insurance: $67, 277* Monthly Payment Delta (Bonds vs LOC): $516 or. 007%

Clint Diers +1 804 915 5624 clint. diers@rutherfoord. com Hunter Bendall +1 703 813 6515 hunter. bendall@rutherfoord. com