1. Understanding the Importance of Surety
Ray Batistoni, Hertz Global Holdings
Stephen Haney, ACE Professional Risk
Robert McDonough, AON Risk Solutions

2. Presenters The Broker:
Robert McDonough, Surety Regional Managing Director
Aon Risk Solutions’ Construction Services Group
The Underwriter:
Stephen Haney, Executive Vice President
ACE Professional Risk - Surety
The Risk Manager:
Ray Batistoni, Risk Manager
Hertz Global Holdings

3. Underwriting The Underwriter: Stephen Haney, Executive Vice President
ACE Professional Risk - Surety
Any positions or opinions expressed are the presenter’s own and not necessarily those of any ACE company.

4. Surety is NOT Insurance
Three Parties
Obligee
Principal
Surety
2. Indemnity
3. No Losses
4. Pricing
OBLIGEE
PRINCIPAL
SURETY

5. Characteristics of Surety
Surety Bond
Independent instrument
Conditioned on an underlying contract, ordinance or obligation
Risk of loss in bonding
Failure to perform assumed obligations
Surety bond is not a risk transfer mechanism for the principal
If Surety sustains loss due to default on part of principal, loss is recovered from principal and/or any Indemnitor(s)

6. Classes of Bonds Construction Commercial Bid Performance & Supply
Maintenance
Court Bond
Customs
License & Permit
Public Official
Miscellaneous

7. Examples of Surety Obligations
Fiduciary Bonds:
Be an honest employee (e.g., Tax Collectors)
Allow importation of goods without the immediate need to pay taxes
Customs Bonds:
Performance Bonds:
Comply with contract’s terms and conditions
Pay those supplying goods and services in performance of a bonded contract
Payment Bonds:
Meet all conditions of an ordinance or statute in the performance of licensed trade or business
License and Permit:

8. Alternatives To Surety Bonds
Letters of credit
Ties up borrowing facility
Can trip covenants
Not conditional
Cash
Reduces balance sheet liquidity
Cost of capital
Treasury securities
Sometimes, there are no alternatives
Public funds typically require surety
Certain federal court obligations mandate surety

9. Underwriting Considerations: Non-Financial
Identification and Evaluation of Obligation
Cancelable
Demand vs. conditional forms
Market driven
Credit sensitive
Obligation sensitive
Pricing
Ultimate parent vs. subsidiary
Captive arrangements
Indemnity

10. Underwriting Considerations: Financial Underwriting
Liquidity
Leverage
Debt maturity
Balance Sheet
Earnings predictability
Interest coverage
Income Statement
Free cash flow vs. no cash flow
Capital expenditure needs
Cash Flow Analysis

11. Broker The Broker: Robert McDonough, Surety Regional Managing Director
Aon Risk Solutions’ Construction Services Group

12. U.S. Surety Industry: Strong Profitability, Default Concerns Continue
2010
YTD
YTD
Earned Premiums
Loss Ratio
2009
$5.24B
$5.27B
19.5%
13.2%
Paid Losses
$1.0B
$694M
$3.96B
$3.87B
16.7%
12%
$654.5M
$465M
Through 9/30/11 top 20 surety companies accounted for:
82.6% industry-earned premiums
85.9% losses
Industry results were profitable, but:
Largest surety provider results are inconsistent
Industry fears greater contract default experience
Source: The Fidelity & Surety Association of America

13. Surety History Premium / Loss Results

14. Adapting to New Market Realities
Underwriters expected increased loss activity in Fortunately, companies made rapid changes to adapt.
Reduced overhead: Many contractors implemented financial model with lower backlog and smaller margins
Increased liquidity:
Slowing down capital expenditures
Negotiating new contracts with better payment terms
More modest M&A activity
Replacing letters of credit with surety bonds
Result: Stronger balance sheets collectively improved credit risk portfolios of the underwriting companies

15. Six Years Consecutive Commercial Surety Profitability Leads to New Capacity
2010 premium placements:
Approx. $1.5B:
28.3% of $5.3B total industry premium
New capacity developed through:
Hiring new commercial surety leadership
Current writers expanding capacity
New capital entering the sector
Excess capacity and increased competition provided:
Better credits/improved pricing
Lower credits access to previously unavailable credit
2011 New Commercial Surety Capacity ($M)
Company
Single
Aggregate
Aspen Re $5
$50
Arch
$25 XL
$200
Hanover
$10
Argo
$15
$35
Main Street America
Philadelphia Insurance
$30
TOTAL
$290
$415
Aggregate expansions for established markets:
ACE $100M; Chubb $250M; Liberty $1B
Source: The Fidelity & Surety Association of America

16. Market Discipline Challenged by Premium Growth Plans
Given finite universe of statutory risks, Sureties expanding writings through financial guarantee obligations (e.g., insurance program bonds)
2012: A record year for bankruptcies?
On pace for 60: 5 U.S. and 6 global companies currently in default
S&P: 39 US defaults in 2011 vs. 58 in 2010
Companies that refinanced maturities instead of reducing debt and those faced with refinancing significant debt maturities in 2012 may risk default
Bankruptcy isn’t sole barometer for commercial surety losses – the confluence of soft market and potential increased defaults may reverse trends in the space in 2012
Expect continued “flight to quality” within the commercial surety segment

17. Construction Surety Sector Slow to Increase New Capacity – Despite Profitable Results
Contract Surety Earned Premium Placements
Approximately $3.8B in 2010
21.7% of $5.3B total industry earned premium
Weak construction spending & margins
Increased subcontractor payment claims
General contractors managing sub contractor default issues
Underwriting Concerns
Continues to grow
Must navigate industry issues to avoid far-reaching impact of contractor default
Underlying Sector Risk
Health of existing backlog
Timing of payment from owners
Rising subcontractor failures/impact on profitability
Require more frequent financial updates
Onerous bond forms/contracts shifting risk to customer
In extending credit, underwriters continue to consider:

18. Higher Loss Activity = More Questions for Project Approval
Greater financial reporting requirements
More stringent capital and liquidity retention requirements
Heightened discussions around surety indemnity language and credit facility documents
Rate increases for higher-risk clients and projects
Contractor default insurance may become a less viable option due to risk and cost

19. Varied Impact of Current Industry Trends
Clients consider alternate collateral structures to support unique transactions
Surety bonds can serve as viable alternatives to letters of credit
Holistic view of client internal cost of capital driving more opportunities to surety
Larger capacity available for investment grade type companies
Surety capacity a critically important credit tool for construction companies

20. A Risk Manager’s View of Surety
The Risk Manager:
Ray Batistoni, Risk Manager
Hertz Global Holdings

21. Keys to a Successful Surety Program
Price
Reputation of the backer
Working relationship
Administrative efficiency
Ease of application
Turn-around time

22. Questions?