Challenges to Improve the Design of Products:

Surety – Vanilla or Rock Star?

Bruce Cliff, ChubbComisión Nacional de Seguros y Fianzas ● October 25, 2018México City

Surety – Vanilla or Rock Star?

The challenge:

Analyze the importance of market research in the design and development of new insurance and surety products, as well as the use of innovative strategies focused on the understanding and needs of consumers (design thinking).

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Surety – Vanilla or Rock Star?

. . . The design and development of new surety products

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Surety – Vanilla or Rock Star?

Probably impossible to develop new surety products but not

new applications for surety.

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Surety – Vanilla or Rock Star?

To understand why, let’s take a quick look at the product and

its history by taking a brief course at . . .

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Surety University

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─ The state of being sure: such as a) sure knowledge -> certaintyb) confidence in manner or behavior -> assurance

─ A formal engagement (such as a pledge) given for the fulfillment of anundertaking -> guarantee

─ A basis of confidence or security …One who has become legally liable for the debt, default, or failure in duty of another…

Surety 101: Definition of Surety

Surety – Vanilla or Rock Star?

Surety University

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Surety University

2750 BC Mesopotamia1790 BC Code of Hammurabi, Babylon

600 – 1485 Medieval England1840 First corporate surety: Guarantee Society of London2018 Mexico – Largest Surety Market in Latin America

and 2nd largest in North America

Surety – Vanilla or Rock Star?

Surety 102: A Brief History of Surety

Now

Conditional or On Demand.

3 party or 2 party relationship.

There is no “insured”; the party who buys the surety bond

(Principal/Tomador) buys it for the benefit of a 3rd party

(Beneficiary/Obligee) although the 3rd party often pays the

premium

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Surety – Vanilla or Rock Star?

Surety 103: It really is a simple product

So it’s not the product that changes but, rather, the underlyingobligation that changes.

Regionally, economic conditions change – the construction market, forexample – driving surety companies to identify new risks that lendthemselves to the surety product.

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Surety 104: A simple product subject to new applications

Surety – Vanilla or Rock Star?

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Examples of market changes resulting in new suretyapplications IN. . .

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Surety 105: A new application in Brazil

Surety – Vanilla or Rock Star?

Up until 2014, approximately 70% of Brazil surety premium camefrom performance bonds, driven by large, governmentinfrastructure contracts

2014

Economic Crisis

Brazilian economic crisis that began in 2014 resulted, in among otherthings, significant reduction in government spending that wouldrequire surety bonds

Brazilian insurance companies lobbyed the Government to allowsurety bonds, in addition to bank guarantees, liens on assets andcash, in order to allow the appeal of tax claims to move forward

November 13th, 2014

Law 13,042/2014 was passed, allowing for the use of surety bonds in connection with tax appeal cases and, in effect, creating the tax appeal bond.

With government infrastructure spending still very low, thepremium associated with tax appeal bonds makes up nearly90% of the Brazilian surety market; keeping it the 2nd largestsurety market in Latin America behind Mexico.

Vanilla or Rock Star?

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Examples of market changes resulting in new suretyapplications IN. . .

During the early 2000’s, Britain enjoyed a budget surplus, allowingfor significant public infrastructure spending.

Many of these were achieved under the Private Finance Initiative or“PFI” scheme whereby private firms were contracted to completeand manage public contracts.

Many British surety companies issued PFI bonds in support ofthese contracts.

As a result of the Austerity program instituted in 2008 by theBritish Governement in response to the financial crisis, publicspending dramatically slowed, ending the need for PFI bonds.

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Surety 106: A new application in Britain

Surety – Vanilla or Rock Star?

This new application created a benefit to the client and anew revenue source for the surety.This new application created a benefit to the client and a newrevenue source for the surety.

With construction spending at a standstill, British surety companiesneeded a new source of revenue and alternate applications weresought.

One such new application was the use of surety bonds to guaranteea firm’s future pension payment obligations to the pension fundtrustee, allowing the client to deploy their capital elsewhere.

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Surety 106: A new application in Britain

Surety – Vanilla or Rock Star?

Vanilla or Rock Star?

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Understanding Customer needs

United States

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100%, conditional bonds, threeparty structure where the Suretyand Principal are jointly liableto the Beneficiary/Obligee.

Typically, one surety issues allbonds for a single contractorclient.

Surety – Vanilla or Rock Star?

Understanding Customer needs

James Cape & Sons Co., a Wisconsin-based contractor specializing in highwaysand bridges.

Suffered financial distress resulting in its defaulting on 120 different bondedcontracts in 2005.

One Surety faced 120 performance bond claims and over 1,500 payment bondclaims.

Surety settled and paid all performance bond and payment bond claims,incurring a Net Loss of $87 million.

The State of Wisconsin was the beneficiary on many of the contracts and hadpreviously considered no longer accepting surety bonds based on bad experienceswith sureties.

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Surety – Vanilla or Rock Star?

Understanding Customer needsUnited States – Case Study

Here, the State changed it view and invited the Surety to a ribbon cuttingceremony on one project. Why?

The surety sold a promise and kept it, understanding Custumer needs!

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Surety – Vanilla or Rock Star?

Promisemade.Promisekept.

Understanding Customer needsUnited States – Case Study

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Germany

Surety – Vanilla or Rock Star?

Understanding Customer needs

Percentage, typically conditional bonds, two party structure where the Surety is independently liable to the Beneficiary/Obligee

Typically, several or multiple sureties and banks issue surety bonds and guarantees on behalf of the same client. Bonds often subject to fast or immediate payment obligations.

SURETY OBLIGEE

PRINCIPAL

Bond

Walter Bau AG was a German engineering and construction firmoperating in Germany and Australia.

Suffered financial distress resulting in its defaulting on numerouscontracts.

One Surety faced 24 performance bond claims in Germany and 12 inAustralia, the largest being a contract for the renovation of the OlympicStadium in anticipation of the 2005 World Cup.

The Surety promptly negotiated mutually acceptable settlements on allclaims.

The German beneficiaries were happy. Why?

Again, we sold a promise and we kept it!

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Surety – Vanilla or Rock Star?

Understanding Customer needsGermany – Case Study

Promisemade.Promisekept.

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Peru

Surety – Vanilla or Rock Star?

Understanding Customer needs

Percentage, on demand bonds, two party structure where the Surety is independently liable to the Beneficiary/Obligee.

Multiple sureties and banks issue surety bonds and guarantees on behalf of the same client.

Peru regulations require payment to government beneficiaries within 3 days or be subject to interest.

SURETY OBLIGEE

PRINCIPAL

Bond

A large government contract, Gasoducto, was being performed in jointventure by two contractors.

The contract contained a clause requiring the contractors to securefinancing.

The surety issued two on demand bonds, one for $144 million and thesecond for $52 million.

The contractors were unable to secure financing and were terminated fordefault by the government which made a claim on the two bonds.

The surety paid the total amount, $196 million, within 3 days.

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Surety – Vanilla or Rock Star?

Understanding Customer needsPeru – Case Study

One year later, a different contractor suffered financial problems oncontracts with the same government agency.

The sureties and banks offered to “finance” the contractor in order tomitigate the loss and deliver the completed contracts on time. Thegovernment agreed. Why?

The Sureties sold a promise and kept it, understandingCustomer needs!

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Surety – Vanilla or Rock Star?

Understanding Customer needsPeru – Case Study

Promisemade.Promisekept.

Surety is a relatively simple product; it is essentially a promise topay or complete in the event the Principal/Tomador fails to meetits underlying contractual obligation(s).

The way in which a Surety company can differentiate itself and demonstrate its importance to the end user, the Beneficiary/Obligee, is to:

Identify new uses and applications that lend themselves to be secured witha surety bond; and

To understand and satisfy the needs of the end user in order to maintainrelevancy and provide a benefit – generally in the form of prompt paymentwhen payment is due.

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Surety – Vanilla or Rock Star?

In summary . . .

Finally, with among the lowest loss ratios and combined ratios of all lines,I’d call that a….

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Surety – Vanilla or Rock Star?

In summary . . .

2019 PASA events

General Assembly:

Llao Llao Hotel, Bariloche, Argentina (May 5 – 8)

Technical Seminar:

México City, México (October 1 - 4)

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Muchísimas Gracias