Surety Bonding Basics

1. Surety Bonding Basics by Eduardo José Paternoster Vice President – Director St Paul Reinsurance

2. Better known “Bond” types:

3. Surety Bonding in the US Market Key Characteristics: • World Premium Volume: US$ 4.60 billion (gross) • USA Premium volume: US$ 3.10 billion (gross) US$ 460 million (ceded)

4. Surety Bonding The “Simple” Definition: • A promise by which one person (the SURETY) becomes accountable to another person (the OBLIGEE) for the debt obligation or conduct of a third person (the PRINCIPAL).

5. Surety Bonding The “Complex” Definition: • A contractual Agreement whereby a SURETY joins with the PRINCIPAL in order to guarantee to the OBLIGEE the fulfillment of the principal’s contractual obligation.

6. Surety Bonding Parties to the Agreement: “Simple” Definition • The PRINCIPAL is the party that undertakes the obligation. • The OBLIGEE is the party who receives the benefit of the bond. • The SURETY guarantees the obligation will be performed.

7. Surety Bonding Parties to the Agreement:“Complex” Definition • The PRINCIPAL is the party primarily responsible for the fulfillment of the obligation set forth in the bond. The principal must perform some act under certain conditions or respond in damages. • The OBLIGEE is the beneficiary under the terms of the bond. Either the obligation is fulfilled or the amount of the bond responds for any shortfall. • The SURETY joins with the PRINCIPAL in order to guarantee to the OBLIGEE the fulfillment of the principal’s obligation.

8. The 1st Rule of Surety Bonding: The Rule: • “Surety Bonding is NOT Insurance.”

9. Surety Bonding Similarities to Insurance: • Both are subject to insurance law and regulatory requirements. • The OBLIGEE’s interest is to protect against loss. • Suretyship is based on the insurance concept whereby the many pay for the losses of the few.

10. Surety Bonding Differences from Insurance: • There is no transfer of risk between the PRINCIPAL and the SURETY. The PRINCIPAL retains all responsibilities in respect of the OBLIGEE. • The premium charged is a “service fee”. The assumption is that there will be no loss. • Suretyship underwriting principles more closely resemble banking than insurance. The surety assesses the principal’s (financial) Capacity, Capabilities, and Character to perform its obligation under the agreement.

11. Surety Bond Underwriting Fundamentals The “3 C’s”: • Capital – Financial Condition (strength / wherewithal) • Capacity – Skill and Ability to perform • Character – Good Character

12. Types of Surety Bonds • Contract Surety Bonds • Non-Contract (or Commercial) Surety Bonds

13. Types of Contract Surety Bonds • Bid Bonds • Performance Bonds • Advance Payment Bonds • Payment Bonds (or Labor & Material Bonds) • Maintenance Bonds

14. Types of Non-Contract (or Commercial) Surety Bonds • Taxes Bonds including Customs and V.A.T. Bonds • Judicial Bonds • Supply Bonds  • Other Miscellaneous Bonds

15. Non-USA Surety Market Characteristics: • Competition from Bank Guarantees. • Legally required 1st Demand Bonds. • Other legal requirements for Public Works. • Smaller Percent (Penalty) bond amounts. • Bond Insurance as an alternative. • Lack of “Work-In-Progress” reports. • Inconsistent Indemnity and / or Collateral Requirements.

16. Surety Bonding in the USA Market Key historical factors affecting the development of the US Surety Bond Market: • Corporate Suretyship • Uniform Laws governing bonds for Public Works.

17. Factors which influence general Surety Bond Market performance: • Changes in economic and political environments • Technological changes • Changes in bankruptcy laws • Changes in banking regulations • Changes in bond penalties

18. Worldwide Surety Trends: • Uniform bond forms • Higher bond penalties • Stronger, more uniform Indemnity Agreements • Concession bonds • New bond types: Payment bonds, tax bonds, judicial bonds, etc… • E-Commerce