1. 20th Annual Willis Construction Risk Management Conference Plano, Texas
What’s Next for Surety? Adapting to changes in the Construction Economy…
C. Scott Hull, Head of Surety
Willis Global Surety

2. Today’s Topics Surety Market Underwriting Focus
How Sureties View Financial Information
Strategy – “Surety Game plan”

3. Surety Market Overview
Profitable trend continues for seventh consecutive year
Top line revenue showing moderate growth
U.S. industry direct loss ratio of only 16%
Significant capacity available

4. Surety Market Overview
Extremely competitive market
New players continue to enter product line
2014 forecast – moderate top line growth; potential for uptick in claim frequency as economy accelerates
Forecasts predict the industry will remain stable

5. 2013 Surety Industry Results
2013 GWP Rank
2013 Market Share
Entity Name
2013Y Direct Premiums Written ($000)
YOY DWP Change
2013Y Direct Premiums Earned ($000)
2013Y Direct Losses Incurred ($000)
YOY Direct Losses Incurred Change
2013Y Direct Incurred Loss Ratio (%) 1
14.87%
Travelers Ins Group Hldgs Inc.
778,689
24,447
779,834
-81,104
-62,494
-10.40 2
14.10%
Liberty Mutual Group Inc.
738,272
12,597
728,011
248,978
51,087
34.20 3
9.41%
Zurich American Insurance Co.
492,737
30,225
478,892
116,217
-36,005
24.27 4
7.80%
CNA Surety Co.
408,606
-2,554
403,674
73,482
43,383
18.20 5
4.01%
Chubb Corp.
210,243
11,645
214,184
5,152
-13,132
2.41 6
3.20%
International Fidelity Ins Co.
167,316
5,961
169,499
18,730
-2,935
11.05 7
3.18%
HCC Credit & Surety Group
166,419
5,851
165,165
8,149
-9,978
4.93 8
3.07%
Hartford Financial Services
160,694
990
160,353
38,280
-8,368
23.87 9
2.73%
ACE INA Group
143,062
13,948
136,108
26,292
9,171
19.32 10
2.11%
RLI Corp.
110,595
-25
110,566
12,573
2,406
11.37 11
Great American Insurance Co.
110,313
6,205
103,824
26,158
-22,113
25.19 12
1.84%
Lexon Surety Group LLC
96,285
-4,690
97,589
37,055
-18,437
37.97 13
1.53%
Swiss Re Ltd (NAS)
79,920
1,760
79,343
1,158
-22,811
1.46 14
1.48%
Hanover Insurance Group Inc.
77,266
-8,415
78,635
52,735
-21,891
67.06 15
1.46%
Merchants Bonding Co. (Mutual)
76,212
3,408
74,666
9,213
3,366
12.34 16
1.43%
Arch Insurance Group Inc.
74,743
9,420
68,560
4,571
-44,050
6.67 17
1.41%
Fairfax Holdings (ASI, Hudson, Seneca, Crum)
73,896
4,362
70,638
29,093
-10,497
41.19 18
1.23%
AIG Property Casualty Inc.
64,309
2,372
72,807
-6,145
-46,641
-8.44 19
Berkley Insurance Co.
64,216
6,334
62,375
17,507
1,064
28.07 20
1.13%
SureTec Financial Corp.
59,196
7,371
55,370
7,269
-6,383
13.13
Total
5,236,554
191,477
5,160,926
839,333
-263,552
16.26
Ex Travelers
4,457,864
167,030
4,381,092
920,437
-201,057
21.01
Ex Top 5
2,608,007
115,117
2,556,332
476,608
-246,391
18.64

6. Top 15 Writers of All U.S. Surety
Well, you certainly have seen this slide before, either at NAIS last month from me, or at NASBP last week from CNA, but you should know the real origin of the first version – Laura Shanahan, probably 12 years ago. There certainly have been progressions and changes in the slide since then!
There are more than 217 insurance groups writing surety bonds. Twelve of the Top 15 writers of all U.S. surety have merged or left the market since In 1990, the Top 10 wrote slightly less than half of total surety; by 2011 the Top 10 wrote 67% of all U.S. surety. In 2011, the Top 5 companies wrote 53% of all U.S. surety. In the surety industry’s case, consolidation has been positive. The sureties remaining are stronger and more disciplined.
A number of smaller surety markets have entered the business, and the more established smaller carriers have redefined their approach to the surety business. This is good news for small- to medium-sized contractors seeking bonding capacity.
Source: SFAA 6

7. Industry Market Share
Top 5 Market Share
32.3% %

8. Underwriting Focus
Underwriters are challenged with balancing increased risk environment with holding on to clients
Contractor’s debt levels
Increased interest in cash flow, profitability and overhead flexibility
Vigilance on credit risks
Verification and understanding of project funding – Financing terms
Subcontractors – prequalification practices, payment controls, performance security closely inspected
Increased interest in contractual terms, specifically, schedule, payment terms and damages clauses – Liquidated, consequential, etc.
Bond Forms
Warranties – type and duration

9. Rate Environment
Rate levels continue to be stable – Pressure for rate reductions
Pricing based on credit modeling
Driven by target return on capital rates
Middle market contractors may enjoy lower rates than larger firms
International pricing based on local country conditions – bank pricing, type of obligation and contract terms & conditions

10. Tomorrow…
Surety is still the most economical form of capital support for the construction industry.
Surety losses, historically, are lagging indicator. While loss severity has not yet been a major factor, loss frequency is increasing.
Ample surety capacity is available. For contractors with aggregate work programs of $500 million+, underwriting terms and pricing have been stable. Alternatives are growing.
International surety is growing. Reverse-Flow business within the US expected to grow from acquisition activity and a trend to PPP opportunities.
Leading US sureties now global, with significant premiums outside US, which will improve premium growth and profit picture.
Growing use of surety in place of bank guarantees. Pay on demand facilities for international work (e.g. Australia, South Africa, Brazil, Peru, Columbia, Venezuela, etc.).

11. Tomorrow…
Contractors with work programs of $50 million to $500 million are more vulnerable to current pressures on margin. Sureties are cautious that loss activity will develop further in this sector.
Increased interest in joint ventures by contractors seeking risk-sharing and access to capacity for larger work.
Continued focus, by sureties, on subcontractor selection and risk management practices, contract terms & conditions, bond forms and credit risk management.
Actions by rating agencies, the failure of sureties to meet internal capital return hurdles and the possibility of industry consolidation are among the uncertainties that might disrupt a contractor’s surety capacity with little or no warning.

12. How Sureties View Your Balance Sheet
Tangible Liquidity
Cash
Accounts Receivable
Retainage
Related Parties
Investments
Cost in Excess of Billings – “Underbillings”
Prepaid Expenses
Cash Value of Life Insurance
Future Cash

13. How Sureties View Your Balance Sheet
Tangible Equity
Accounts Receivable
Profits / Completed vs. Uncompleted
Notes Receivable and Payable
Cost in Excess of Billings – “Underbillings”
Billings in Excess of Cost – “Overbillings”
Deferred Income vs. Job Borrow
Goodwill and Intangibles

14. Work-in-Progress A Surety’s Focus
Unbilled Backlog
Cost in Excess of Billings – “Underbillings”
Billings in Excess of Cost – “Overbillings”
Net Cash Remaining
Pure Job Borrow
Gross Profit Margin Remaining
Completed vs. Uncompleted Margin Trends

15. Work-in-Progress A Surety’s Focus
Net Cash Remaining
Measures future cash flow available from a contractor’s unbilled backlog, based on the currently estimated cost-to-complete of all projects.
Formula:
(Total Contract Value) – (Total Billed to Date) – (Total Est. Cost to Complete) = Net Cash Remaining
Pure Job Borrow
Is the sum of all negative “Net Cash Remaining” balances that exist on individual projects. Pure Job Borrow represents the amount of cash that must go back into a given project at or prior to completion – at the project’s currently estimated cost-to-complete.

16. Surety Game Plan Business Plan: Budget
Revenue – Overhead – Profit – Overhead… OVERHEAD!
Continuity
Acquisitions territorial or niche expansion
Capital Expenditures (CapEx)
Future Expansion/Goals
Surety Needs to Support Business Plan
Increased single or aggregate need
New territories, type of work, etc.
Large Potential Projects
Safety Program
Job Watch List

17. Surety Game Plan Job Selection Process:
Hard Bid – Negotiated – Owners’ Credit Risk
Risk Management:
Subcontractor selection, on-site management
Collections
Contract review
Onerous provisions; i.e., liquidated or consequential damages, potential accelerated schedule
Cash:
Cash Management – Average balances
Pro-forma cash flow (unrealized backlog cash flow)
Receivables:
Status – Non Job – Status Over 90
WIP Information:
Underbillings/Overbillings Status

18. Be Prepared for the Unexpected
How does the surety analyze your company?
Review your surety’s financial analysis – it’s their scorecard for extending credit.
Communicate what you expect of your Surety and clearly understand the surety’s expectations of your company.
Any changes to your surety’s underwriting appetite?
Any recent personnel changes within your surety at the local and/or home office level?
How is your surety performing?
What are your surety’s financial ratings? Are there any pending events that might impact its or its parent company ratings?
What is the status of your “stand-by” surety?

19. Maximizing Your Surety Support
Communicate your business plan and seek your surety’s input. What are they seeing in the construction marketplace and your markets? Can they and your broker help align you with trading partners?
What pro-active steps have you taken to deal with current and forecasted market conditions?
Bad news.. OK / Surprises… NOT OK
Projections… realistic. Hit or exceed them.

20. Thank you…