The Surety Industry and Workers Compensation GuaranteesThe Surety Industry and Workers Compensation Guarantees

Casualty Actuarial Society

Presentation by:

Marsh Surety Practice

Drew Brach, Managing Director

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Three Things to Discuss

State of the Surety Industry

Workers Compensation Issue from a Surety Perspective

Workers Compensation Bond Forecast

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Surety Industry - 2001

Direct Written Premiums:– $3,473,100,578

Direct Earned Premiums:– $3,330,170,608

Direct Losses Incurred:– $2,748,411,932

Direct Loss Ratio:– 82.5%

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Surety Industry - 2001

Direct Written Premiums:– $3,473,100,578

Direct Loss Ratio:– 82.5%

Expense Ratio– 50%

Combined Ratio – 132.5%

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Surety Industry

What happened?

– Economy changed– Banks tightened credit policies– Bankruptcies increased– Enron– Kmart– Telecommunications Losses

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Surety Industry

Reduced capacity

Reinsurance problems - specific bonds

Industry Losses

Underwriting tightening

Sureties refocusing on core business

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Commercial Surety Risk ProfileBack to the Fundamentals

Capital Capacity Ongoing ManagementCharacter

Commercial Surety Risk Profile

• Financial Analysis

• Profitability

• Bank Line of Credit

• Working Capital

• Net Worth

• Financial Ratios Benchmarking

• Off Balance Sheet items

• Hidden Net Worth

• Rating Agency Reports

• Timely Payment of Bills

• Balance Sheet Strategy

• Operations

• Ability to perform

• Bond Form Terms

• Length of Obligation

• International

• Environmental

• True Risk of the guarantee

• Organization

• Management Team

• Integrity

• Honesty

• Trust

• Reputation

• Customer base

• Philosophy

• Continuity Plan

• Credit Report

• Business Plan

• References

• Supplier Relationships

• Single Bond and Total Aggregate Program

• Surety Rate

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Surety Industry

Problems our Clients face– Bond program cancellations– Rate increases up to 500% as

credit/capital market pricing driving surety rates

– Very conservative underwriting– No markets for risks with exposure

over 5 years– Primary Surety companies increasingly

asking for collateral to underwrite a bond

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Marsh Surety Business Survey Business that cannot be placed - 945

– 175 Risk Management

– 770 Middle Market accounts

Risk Management Accounts

– 35% reclamation/landfill closure

– 35% workers compensation and insurance premium bonds

– 15% energy supply bonds

– rest are all types of bonds for basically financially difficult companies

Middle Market Accounts

– 70% workers compensation, insurance premium and other long tail bonds

– remaining 30% are for financially difficult companies

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Workers Compensation Example

Old Reality– Triple B plus S&P rated company– $150 million in WC guarantees– no collateral requirement from Surety

Company– priced at 20 basis points

New Reality– $45 million capacity in marketplace– no collateral required by the Surety

Company– 100 basis points

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Workers Compensation Guarantees

Today’s Surety Market

– Underwriting and Rates based on: Credit Risk Workers Compensation Risk Reinsurance Costs Collateral provided

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Workers Compensation Guarantees

Underwriting - Workers Compensation Risk

– Type of Guarantee

– Bond Form / Cancellation provision

– Type of workers compensation claims

– Expected life of obligation

– Actuarial analysis of claims data

– Law requiring the bond

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Workers Compensation Guarantees

Acceptable Worker Compensation Risks

– Investment Grade Firms in acceptable sectors

Unacceptable Risks

– everyone else

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Workers Compensation Guarantees

Workers Compensation Surety Underwriting Issues

– long tail nature of obligation

– cancellation provision in bond

– understanding true risk exposure

– funding of workers compensation exposure

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Workers Compensation Bond Forecast

Sureties to provide guarantees for high investment grade companies in acceptable business sectors

No new capacity for these guarantees in the next several years

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Workers Compensation Bond Forecast

Sureties will continue to explore different types of collateral for these risks

– Letters of Credit

– Escrow account

– Bank of New York Trust

– Trusts

– Stocks

– Bonds

– Property

– Credit Default Swaps

– Accounts Receivable

– Equipment

– Other Assets

– Finite Risk

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Workers Compensation Bond Forecast

In order to get the Surety Industry to reconsider their stance on Workers Compensation Guarantees

– reduce the life of the obligation

– negotiate an acceptable bond form

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Workers Compensation Bond Forecast

Reduce the life of the obligation

– Surety covers the first 3 to 5 years of the credit risk

– Bank Letter of Credit covers the longer term credit risk

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Workers Compensation Bond Forecast

$10 million Deductible Guarantee

– Surety covers the first 3 to 5 years of the credit risk at $6,000,000

– Bank Letter of Credit covers the longer term credit risk at $4,000,000

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Workers Compensation Bonds

Questions