Casualty Actuarial Society 2002 Annual Meeting November 11, 2002 Surety Bonds – A General Overview By Richard Meyerholz Vice President Underwriting

2 What is “Suretyship”? Suretyship is essentially an extension of credit by the Surety on behalf of the Principal. Suretyship is designed to protect the Obligee from exposures to loss.

3 What are “Surety Bonds”? A surety bond is a written agreement providing for monetary compensation or satisfactory completion of an obligation by the surety. A surety bond is a three- party agreement whereby the surety is bound, with the principal to the Obligee.

4 There are two broad categories of Surety Contract Surety – a contract bond guarantees the performance of the principal under a written contract to build or supply goods and services. Commercial Surety (also known as non-contract or miscellaneous bonds) – a commercial surety bond guarantees the principal will honor obligations to pay a certain sum of money under a defined agreement or Gov’t. statute.

5 Experience (Contract & Commercial Surety) Contract Surety - Loss activity over the past 5 years has increased in both frequency and severity - Gross vs. Net Results - Reinsurers share of the industry losses disproportionate Commercial Surety - Historically very profitable, but recently reported losses may wipe out accumulated profits from the last 15 years. - Over the past 5 years: New product development Growing number of high risk obligations

Surety Top 10 Direct Loss Ratio43.9% Net Loss Ratio23.7% Ceded Loss Ratio233.0% Data from Surety Association of America and A.M. Best

7 Preliminary Surety Results 2001 DirectNetReinsurers Top 10 Loss Ratio103.4%68.0%330.9% Results Loss Ratio 43.3%32.7% 87.0% Top 100 Loss Ratio 82.7%56.4%225.8% Data from Surety Association of America

8 Reinsurance Market Changes from January 2000 – December Calendar year 1999-over 25 active reinsurers with a total market capacity exceeding $250,000,000 - December 2001 – 12 active reinsurers with a total market capacity at approximately $90,000,000 (excluding New Bermuda markets) - As of today – the jury is still out. Reinsurance Companies reviewing the market potential.

9 Recent Claim Activity - Contract Surety losses over $50 million are now common -Loss over $200 million is in the market - Freide Goldman Halter (three sureties involved) -IVI/Sade Vigesa $400,000,000 -Several others on the ropes - Commercial Surety losses are growing with the biggest claim ever produced now in litigation. The biggest potential loss is Enron Corp. Other potential large losses include Kmart, Consolidated Freightways, CMC, Pacific Financial

10 Enron US Surety Market & Exposures Market participants Primary companies: ChubbSafeco St. PaulAIG Liberty BondCNA Surety TravelersHartford Fireman’s FundF&D Surety KemperAtlantic Mutual Total = $2,488,000,000

11 Enron US Surety Market & Exposures Market participants Reinsurance companies: Transatlantic ReGerling Global Swiss ReAmerican Re Gen ReNac Re/XL Re Partner ReSt. Paul Re FolksamericaZurich Re C.N.A. ReHanover Re Employers ReEverest Re SCOR ReBerkley Group London Total = $750,000,000

12 Surety Involvement  ContractSurety - Performance Bond / Payment Bonds - Operations and Maintenance Bonds  Commercial Surety - Advance Payment Bond - Premium Payment Bond - Financial Guarantee Bond  Domestic Business Interests  International Business Interests

13 Where Are The Losses Contract- most likely from the international business - Argentina exposure most tenuous - estimate $25-$200 million Commercial - paid losses to date exceed $265,000,000 - A.P.E.A. Bond [American Public Energy Agency] - Winterthur Bond - NEPOOL Bonds [New England Power Pool] - Mahonia Bonds

14 Example of a Forward Sale Agreement A.P.E.A. Bond  Paid loss $250,000,000  Structure of the deal  Forward sale agreement  J.P. Morgan/Chase  A.P.E.A.  End Users  Enron A.P.E.A. Bond Holders Chase Enron Utility Benefit to Utility – Discounted oil price Tax credit Benefit to Enron – Use of money

15 Mahonia  Who/What is Mahonia  Six Open Bonds  Guarantee Advance Payment  Total Amount On Six Bond claims - $1.1 Billion  Current Litigation

16 Kmart  Commercial Surety Loss  Workers’ Compensation/Self Insurers Bond  Lease Bonds License and Permit Bonds

17 IVI/Sade Vigesa  Contract Surety Loss  Performance and Payment Bonds on two oil platform projects for Petrobias  Bonds written in 1995  Judgment against Sureties: $370,000.00

18 Things To Consider  Be sure to understand the product  Know the reinsurance coverage  Be aware of potential tail exposure  Are claims adequately reserved  Ask questions

19 QUESTIONS