Surety Bonds 101

September 20, 2012

Presented by:Troy CarlsonTroy.carlson@willis.com

What is a Surety Bond

An instrument where one party (Surety) guarantees the obligations of a second party (Principal) to a third party (Obligee)

Obligee

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to a third party (Obligee)

A three party contract between the Surety, Principal, and Obligee

PrincipalSurety

Parties to a Surety Bond

Obligee

(Owner) – Requires and receives

protection of bond

Parties to a Surety Bond

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PrincipalSurety

(Contractor) undertakes

obligation and provides bond

Issues bond and provides

guarantee

Surety Bonds Vs. Traditional Insurance

Surety Bonds Insurance3-party 2-party

Indemnification/surety doesn’t pay

claims unless your organization fails

Claims are expected & paid

Risk transfer Risk transfer

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Duty to obligee Duty to insured

Regulated by State Insurance

Departments

Regulated by State Insurance

Departments

Premium fee for prequalification

services

Premium actuarially determined

Project specific Usually term specific

Penal sum Policy limits

Who Requires Bonds?

Public Sector

• Federal Government

• State & Local

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• State & Local Governments

Who Requires Bonds?

Private Sector

• Private Owners

• Lending Institutions

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• Lending Institutions

• General Contractors

Contract Surety Bonds

• Bid bonds

• Performance bonds

• Maintenance bonds

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• Payment bonds

• Supply bonds

A surety bond offers assurances to the owner of a construction project that

the contractor will perform the work specified in the contract and pay

certain subcontractors and suppliers.

Types of Bonds

1. Bid Bond

- Covers bid security

- Assures contractor, if

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- Assures contractor, if awarded a contract, will enter into the contract and provide the required Performance and Payment bonds.

Types of Bonds

2. Performance

Bond- Guarantees owner the contractor will perform the obligations contained in the

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obligations contained in the contract documents.

- If the contractor defaults, the Surety has the obligations to fulfill the contractor’s obligations.

Types of Bonds

3. Payment Bond

- Guarantees the payment of defined subcontractors and material suppliers.

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material suppliers.

Types of Bonds

4. Maintenance Bond

- Guarantees workmanship and

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- Guarantees workmanship and material for a period of time after project completion and acceptance of the work.

Functions of Bonds

- Ensure project completion

- Relieves owner from risk of financial loss due to Mechanic’s Liens

- Smooth transition from construction to permanent financing

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financing

- Provides payment protection for subcontractors and suppliers

- Protects public funds on public projects

Prequalification

Surety Bonds

• Capital

• Capacity

Letters of Credit

• Single focus

• Quality &

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• Capacity

• Character

• Quality &

liquidity of

collateral

What Are Bank Letters of Credit?

• Cash guarantee to owner

• Called on demand

• Payment to owner & loan for

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• Payment to owner & loan for contractor

• No guarantee of project completion

• Irrevocable

Borrowing Capacity

Surety Bonds

• Issued on unsecured basis

Letters of Credit

• Assets used as collateral

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• Does not diminish borrowing capacity

• Credit enhancement

• Diminish existing line of credit

• Can affect cash flow

Duration

Surety Bonds

• Duration of contract

Letters of Credit

• Date specific

• “Evergreen”

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contract

• Maintenance period

• “Evergreen” clauses

Claims

Surety Bonds

• Surety investigates claim of default

Letters of Credit

• Payable on demand

• Owner determines

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claim of default

• Surety’s options

• Surety pays rightful claims of certain parties

• Owner determines validity of claims by subs & suppliers

Benefits of Surety Bonds

• Protects the interest of labor & vendors on construction projectsSurety Bonds

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construction projects

• Surety company assumes the responsibility of investigating & validating claims

Surety Bonds

Performance Bond Protection

• Re-bid the job for completion

• Arrange for replacement

Surety

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replacement contractor

• Retain original contractor

• Reimburse owner as required by the bond

Surety

Payment Bond Protection

• Surety pays eligible subs & suppliers

• Protects owner from Surety

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• Protects owner from mechanics’ liens

• Protects subcontractors from nonpayment

Surety

Benefits of Surety Bonds

• Qualified bidders

• Reduced risk of liensOwner

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• Reduced risk of liens

• Timely project completion

• Defect protection

Owner

• Contract reviews

• Continuity plans

• Expertise

• Project qualificationContractor

Benefits of Surety Bonds

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• Project qualification

• Private construction

• Lending institutions

• Subcontractor protection

• Technical, managerial, financial assistance

Contractor

Cost of Surety Bonds

Bid Bonds Usually no cost

Performance Bonds ½ to 2% of contract price

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Payment Bonds Price included in cost of

Performance Bond

Maintenance Bonds Price for1 year included;

additional for longer term

Qualifying the Surety

A.M. Best Company

• Rating agency for all insurance and surety

companies. A+++ rating is best

• Anything B+ or lower is a red flag

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Treasury Dept. Circular 570

• Also know as the “Treasury List”, this publication lists the

sureties that are approved for Federal projects and the

maximum single bond that the government will accept

from that surety

Thank You

Questions ??

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Questions ??