Adapting to changes in the Construction Economy

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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
Today’s Topics
• Surety Market
• Underwriting Focus
• How Sureties View Financial Information
• Strategy – “Surety Game plan”
2
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
3
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
4
2013 Surety Industry Results
2013Y
2013Y
2013Y
2013Y
Direct
Direct
Direct YOY Direct Direct
Premiums
Premiums Losses
Losses Incurred
Written YOY DWP Earned
Incurred Incurred
Loss
($000)
Change
($000)
($000)
Change Ratio (%)
778,689
24,447
779,834
-81,104
-62,494 -10.40
738,272
12,597
728,011
248,978
51,087 34.20
492,737
478,892
116,217
30,225
-36,005 24.27
408,606
-2,554
403,674
73,482
43,383 18.20
210,243
11,645
214,184
5,152
-13,132
2.41
167,316
5,961
169,499
18,730
-2,935 11.05
166,419
5,851
165,165
8,149
-9,978
4.93
160,694
990
160,353
38,280
-8,368 23.87
143,062
13,948
136,108
26,292
9,171 19.32
110,595
-25
110,566
12,573
2,406 11.37
110,313
6,205
103,824
26,158
-22,113 25.19
96,285
-4,690
97,589
37,055
-18,437 37.97
79,920
1,760
79,343
1,158
-22,811
1.46
77,266
-8,415
78,635
52,735
-21,891 67.06
76,212
3,408
74,666
9,213
3,366 12.34
74,743
9,420
68,560
4,571
-44,050
6.67
2013
2013
GWP Market
Rank Share
Entity Name
1
14.87% Travelers Ins Group Hldgs Inc.
2
14.10% Liberty Mutual Group Inc.
3
9.41% Zurich American Insurance Co.
4
7.80% CNA Surety Co.
5
4.01% Chubb Corp.
6
3.20% International Fidelity Ins Co.
7
3.18% HCC Credit & Surety Group
8
3.07% Hartford Financial Services
9
2.73% ACE INA Group
10
2.11% RLI Corp.
11
2.11% Great American Insurance Co.
12
1.84% Lexon Surety Group LLC
13
1.53% Swiss Re Ltd (NAS)
14
1.48% Hanover Insurance Group Inc.
15
1.46% Merchants Bonding Co. (Mutual)
16
1.43% Arch Insurance Group Inc.
17
18
19
20
1.41%
1.23%
1.23%
1.13%
Fairfax Holdings (ASI, Hudson, Seneca, Crum)
AIG Property Casualty Inc.
Berkley Insurance Co.
SureTec Financial Corp.
Total
Ex Travelers
Ex Top 5
73,896
64,309
64,216
59,196
4,362
2,372
6,334
7,371
70,638
72,807
62,375
55,370
29,093
-6,145
17,507
7,269
-10,497
-46,641
1,064
-6,383
41.19
-8.44
28.07
13.13
5,236,554 191,477 5,160,926 839,333 -263,552 16.26
4,457,864 167,030 4,381,092 920,437 -201,057 21.01
2,608,007 115,117 2,556,332 476,608 -246,391 18.64
5
Top 15 Writers of All U.S. Surety
Surety & Fidelity Association of America
Top 15 Surety Writers
1994 vs 2013
1994
2013
($millions)
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
Surety
Premium
Reliance
Travelers
USF&G
St. Paul
Travelers
F&D
Zurich
St Paul Group
Travelers
AIG
AIU Holdings
Chartis
Aetna
Travelers
Continental
CNA
Fireman's Fund
Out of surety
CNA Insurance Companies
Safeco
Liberty Mutual
Chubb
Hartford
Amwest
Gone
Capsure
CNA
CIGNA Group
ACE
147.1
144.1
142.5
140.9
111.5
106.6
100.7
97.3
92.8
88.9
77.7
74.0
70.2
55.3
49.7
($millions)
Surety
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
TRAVELERS BOND
LIBERTY MUTUAL GRP
ZURICH INSURANCE GRP
CNA INSURANCE GRP
CHUBB & SON INC GRP
INTERNATIONAL FIDELITY INS CO
HCC CREDIT & SURETY GROUP
HARTFORD FINANCIAL SERVICES
ACE LTD GROUP
RLI INSURANCE GRP
GREAT AMERICAN
LEXON/BONDSAFEGUARD
NAS SURETY GRP
HANOVER INSURANCE GROUP
MERCHANTS BONDING
Premium
778.6
738.2
492.7
408.6
210.2
167.3
166.4
160.7
143.1
110.6
110.3
96.3
79.9
77.2
76.2
Companies that are gone in RED
Companies that merged or were sold are in BLUE
Companies that merger or were sold a second time are in GREEN
Source: SFAA
6
Industry Market Share
Top 5 Market Share
1999
32.3%
2013
50.19%
7
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
8
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
9
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.).
10
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 risksharing 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.
11
How Sureties View Your Balance
Sheet
• Tangible Liquidity
o Cash
o Accounts Receivable
 Retainage
 Related Parties
o Investments
o Cost in Excess of Billings – “Underbillings”
o Prepaid Expenses
o Cash Value of Life Insurance
o Future Cash
12
How Sureties View Your Balance
Sheet
• Tangible Equity
o
o
o
o
o
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
o Goodwill and Intangibles
13
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
14
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.
15
Surety Game Plan
• Business Plan:
o Budget
o Revenue – Overhead – Profit – Overhead… OVERHEAD!
o Continuity
o Acquisitions territorial or niche expansion
o Capital Expenditures (CapEx)
o Future Expansion/Goals
• Surety Needs to Support Business Plan
o Increased single or aggregate need
o New territories, type of work, etc.
• Large Potential Projects
• Safety Program
• Job Watch List
16
Surety Game Plan
•
Job Selection Process:
o Hard Bid – Negotiated – Owners’ Credit Risk
•
Risk Management:
o Subcontractor selection, on-site management
o Collections
o Contract review
 Onerous provisions; i.e., liquidated or consequential damages, potential
accelerated schedule
• Cash:
o Cash Management – Average balances
o Pro-forma cash flow (unrealized backlog cash flow)
• Receivables:
o Status – Non Job – Status Over 90
• WIP Information:
o Underbillings/Overbillings Status
17
Be Prepared for the Unexpected
• How does the surety analyze your company?
o Review your surety’s financial analysis – it’s their scorecard for
extending credit.
o 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?
18
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.
19
Thank you…
20
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