Glossary of Surety Terms

PRINCIPAL

Companies from all activity sectors

BENEFICIARY

The different judicial institutions, courts and tribunals of a country

BOND AMOUNT

The amount is determined by the Court, aggregating sometimes 20% of attorney fees The suit is readjusted in accordance by the type of Court (Federal, Municipal, State). The sum insured should be readjusted accordingly

BOND TENOR

Duration: up to 20 years, policies issued with initial duration of 3-5years No automatic renewals, however, could be processed with policy endorsements after normal request of the parties

LOSS TRIGGER

Loss of trial and being unable to fulfil the obligations/payments

PARTICULARITIES

Could be used not only for new legal process, but also to replace other Court guarantees in existing process. Bonds are unconditional, on first request, and do not include the right to object and defence

UNDERWRITING RECOMMENDATIONS

Very strong financial position Legal assesment of the underlying process (possibility to win) Estimated duration of the case and previous experience in litigation

TERRITORIALITY

It is a product of the Brazilian market and due to the peculiar Legal System in the country (interpretation, very long process)

OTHER NAMES USED FOR THIS TYPE OF BOND

PRINCIPAL

Obligor of the project finance contract. The Principal usually is a Special Purpose Company (SPC) created specifically in order to implement and operate the project. It is a legally independent company, with its own capital and structure. The shareholders act like pure investors.

BENEFICIARY

Creditor of a project finance contract (usually a development bank).

BOND AMOUNT

The bond amount usually is equivalent to 100% of the project finance amount; therefore the bank does not retain any risk.

BOND TENOR

The overall project (e.g. concession) usually has a long-term period (between 10 and 20 years), however the bond will cover only the construction phase, which might vary depending on the complexity. Periods up to seven years are not unusual.

LOSS TRIGGER

Non completion of the construction of the project.

OTHER RISK DETAILS

Beneficiary: 100% cover, no retention (as standard); commercial interest in the loan exceeding the interest in the project (development banks are considered safe in this respect) credit cash outflow exceeding the real progress of the project. Principal: The SPCs are usually newly created. The Project:Typically high complexity; cost overrun and construction delay.

UNDERWRITING RECOMMENDATIONS

The Beneficiary should be a development bank or a financial institution whose main objective is to finish the project (and not to achieve a financial profit). The development bank should have expertise in project finance and pre-select projects on the basis of strict and adequate criteria. It should be clearly stipulated that the non-repayment of the loan does not constitute a reason to call the bond, but only the non-completion of the construction. The Beneficiary should have the technical skills to monitor the project as the construction progress must be the basis for the pay-out of the funds. Counter-guarantees of the shareholders who should have the technical expertise and sufficient experience plus a vital interest in the project’s success. They should be prepared to inject further equity if necessary (e.g. if cost overrun occurs). The underlying contract should represent the main economic activities of the principal. The company performing the construction works for the Principal should present a performance bond/guarantee to the Principal. Considering the progress of the construction works the Surety should have the option to either finish the project or pay out the amount of the claim (usually the payout represents the finance already released by the bank). The Surety should keep track of the project too. The wording of the Bond should be accessory / conditional and not on first demand. Force Majeure should be excluded in the underlying contract between Principal and sponsor of the project or at least in the Surety Bond.

TERRITORIALITY

OTHER NAMES USED FOR THIS TYPE OF BOND

COMMENTS

Completion Bonds typically relate to project finance. Thus the repayment only starts with the successful operation of the project. For this reason the financing bank requests a completion bond. The Completion Bond guarantees to the Beneficiary the good, faithful, timely (the agreements with the Beneficiary should include a grace period) and correct execution of the project, for which the loan has been granted, by using the committed resources, directly and specifically in the named project.

PRINCIPAL

The concessionaire, which usually (but not necessarily) is a Special Purpose Company (SPC) especially created in order to manage the concession. In case of a SPC, it is a separate company, with its own capital and corporate structure.

BENEFICIARY

Public entity, e.g. a State Government or a Federal Government, responsible for supplying certain infrastructure to the public and conceding the private use of the state assets for this purpose to a concessionaire.

BOND AMOUNT

The bond amount is either based on the investments to be done during the period covered by the surety bond or based on the contract value of the whole concession period.

BOND TENOR

As concession contracts usually have a term between 15 to 30 years, the bond can only be reinsured if the applicable law/regulation clearly allows for shorter bond periods – usually annually however periods up to 3 years are possible. The Concession Bond should not be automatically renewable; non-renewal should not provide a reason either to call the bond or to require prolongation of the current bond after its expiry. If this is not possible, concession bonds may be written with cash collateral which cover the guaranteed amount after maximum period acceptable (based on the development of the credit quality of the Principal).

LOSS TRIGGER

Non-performance of the obligations fixed in the concession contract.

OTHER RISK DETAILS

Long-term nature of the concession contract; overestimation of toll income to cover the ongoing costs of the concessionaire (risk of change); complexity of the concession contract; newly created Principals still have to prove their capacity (ability to perform under the contract) and capital strength.

UNDERWRITING RECOMMENDATIONS

Underwriting recommended only in regulatory environments where the term of the bond can be detached from the term of the concession contract with all consequences (i.e. non-renewal of the bond does not justify a call) - alternatively with sufficient collateral; only with Principals having the relevant technical expertise, experience and commitment (esp. the shareholders of the SPC). By law the Surety has recourse against the Principal which is the SPC but not necessarily against its shareholders. Therefore especially in the case of newly established SPCs which usually will not have the financial strength for compensation of the Surety, there should be a counter-guarantee in place signed by all shareholders. Further counter-guarantees signed by other companies of a shareholder’s group can enhance the financial strength to the project if needed. The Concessionaire itself should always sign a corresponding indemnity agreement. The underlying Concession Contract should clearly address all obligations of the concessionaire with a corresponding timetable. The underlying contract should refer to the main economic activities of the principal.

PRINCIPAL

The seller (not necessarily the producer / manufacturer) of the respective "machinery".

BENEFICIARY

The acquirer of the respective "machinery". The bond may be a requirement agreed among the parties involved only or a mandatory e.g. to obtain public subsidies.

MAXIMUM AMOUNT OF RISK

Established as a percentage of the underlying purchase contract.

BOND TENOR

2 to 5 years

LOSS TRIGGER

Final default of the "machinery" to provide the technical output agreed.

OTHER RISK DETAILS

Instead of being the object of an individual bond, efficiency risk components can be included in performance bonds (as a reduced tail running post-acceptance) or maintenance bonds. Bond titles like "liquidation bonds" or "maintenance and operation bonds" are indicative of such combined risks. If included in a performance or maintenance bond wording the capiton "liquidated damages" may relate to efficiency provisions.

UNDERWRITING RECOMMENDATIONS

The bond constitutes a warranty with regard to technical output of machinery while operating. Cover kicks in after production / completion and subsequent acceptance of the "machinery". Ideally, the performance risk for building the respective "machinery" should be covered first. To take the subsequent efficiency risk a thorough understanding how technical performance is assessed (benchmark data, measurement method and operating conditions) is key for risk assessment. Should the bond relate to a financial / monetary output (yield) its character likely covers an entrepreneurial risk.

TERRITORIALITY

EU, South American countries,

OTHER NAMES USED FOR THIS TYPE OF BOND

What information does the reinsurer need?

In facultative reinsurance, the reinsurer carries out his analysis in a similar depth like the surety based on the Zero Loss Underwriting principle. To be able to analyse and decide on a facultative commitment the reinsurer therefore needs all the information necessary for a thorough analysis of the individual bond transaction / project It is recommended to use the facultative reinsurance questionnaire from ICISA / PASA.

PRINCIPAL

Fiduciary such as Administrator, Executor, Guardian, Liquidator, Insolvency Practitioner, administrator of funds for construction projects, insurance broker etc. Fiduciary Definition in this context: An individual, corporation or association holding assets as trustee for another party, often with the legal authority and duty to make decisions regarding financial matters on behalf of the other party. Fiduciaries are often required by statute, courts (or wills).

BENEFICIARY

A court of jurisdiction, the owner of the estate /money given in trust

BOND AMOUNT

100% up to 300%

BOND TENOR

Depends on the type of fiduciary bonds. Open term in the case of Administrator, liquidator bonds etc

LOSS TRIGGER

Deliberate abuse of the fiduciary position (misappropriation), possibly also negligence / maladministration causing a financial loss/damage to the assets

OTHER RISK DETAILS

Lack of robust/evident parameters for assessment of character/ethics of the Fiduciary In some fiduciary bonds types (with PI element): - Open term, no possibility of cancelation - No PI coverage in place or cover cancelled during the lifespan of the bond

UNDERWRITING RECOMMENDATIONS

These bonds should only be underwritten in well developed, predictable legislations. There should be sufficient experience, legal expertise and monitoring capacity and effective control mechanisms in place. Cover of experienced principals only that have a lot to lose if they take the money and run away. For covers for more than three years only with adequate collateral. PI (professional indemnity) insurance should be in place during the entire term of the Fiduciary Bond to cover negligence / maladministration.

TERRITORIALITY

Fiduciary bonds with PI element are common mainly in Anglophonic countries like UK, Ireland, South Africa, Australia, USA but are also written in other countries like Denmark, France, Latin America etc. In most of these countries a fiduciary bond is required by the court when appointing a trustee/fiduciary (for example in South Africa / USA).

OTHER NAMES USED FOR THIS TYPE OF BOND

Liquidator Bonds, Asset Forfeiture Bonds, Trustee Bonds, Deceased Estate Bond, Curatorship Bonds, Business Rescue Bonds etc..

COMMENTS

PRINCIPAL

The (private building) developer being beneficial owner of the deposit

BENEFICIARY

Buyer of a dwelling depositing money in the project phase for the purchase of land and the subsequent construction works (used as advance payments)

BOND AMOUNT

Up to 100% of the advance payment; This generally includes (sometimes on top) the appropriate annual interest stated by law up to the maximum amount for the insured capital laid down in each individual certificate.

BOND TENOR

Usually max. 5 years

LOSS TRIGGER

Non-delivery of the dwelling within the contractually agreed time

OTHER RISK DETAILS

Negative development of both the macro-economics and the economic environment of the project (e.g. cost overrun; drop in sales prices). Infidelity of the developer as well as weak financial profile giving reason to consider breach of the fiduciary position.

UNDERWRITING RECOMMENDATIONS

Control of the deposit by the Surety; sufficient technical expertise within the surety i.r.o. the dwelling (construction engineering). The requirement of the housing bond should be a standard in the respective market (i.e. no anti-selection). The Principal should have a serious interest in continuous operations in the market; proven technical expertise/success and a trustable reputation and an acceptable financial standing. Regular monitoring (desirable: monthly) of the progress of the project by an external appraiser. In case of negative project development, the surety should have the right to require higher equity and/or collateral from the developer. The developer should first invest the equity into the project before financial credit and/or advance payments step in (alignment of interest). Developers equity injection and minimum pre-sales rates should provide a buffer of at least 30%. Purchasers should not be able to easily retract from the purchase agreement. Bridge financing should be secured (e.g. through committed banking line). Typical collaterals should be in place (such as 1st degree pledges of the land and on the project, floating charges over the project, etc.) in favor of the Surety (or at least shared pari passu with the financing bank).Special bank account: The Surety and the principal should establish an escrow account (preferably per project) where the advance payments of the buyers is paid in. The special bank account should be monitored by the Surety in order to supervise the account’s money outflows and taking into account the completion rate. Each payment should be authorized by the Surety.

TERRITORIALITY

Can be found in many countries

OTHER NAMES USED FOR THIS TYPE OF BOND

Venta en verde (Chile), Poliza de Afianzamiento de Cantidades Anticipadas para Viviendas (Spain) etc. COMMENTS Besides the housing bond described here (type advance payment bond) there also exist “normal” performance bonds (in the real estate sector) with a capping to a proportion of the contract amount, but also those who outright require fulfilment of the contract itself (like GFA and CMI).

PRINCIPAL

The constructor, usually using sub-contractors.

BENEFICIARY

The housing buyer BOND AMOUNT Bond amount corresponds to 100% of the object price

BOND TENOR

The bond has to be issued at the contract signature and remains valid until the housing buyer has signed the reception of the house without reserve (defects). Usually short term around 1 year.

LOSS TRIGGER

The constructor goes bankrupt or does not respect his commitment

OTHER RISK DETAILS

Strong regulated by Law, being the non-providing of the bond punishable Payment plan to the constructor also regulated and limited The obligation of the guarantor is to deliver the houses and pay contractual penalties if any but it is not possible for the buyers to cancel the sales contract under the guarantee cover An individual bond is issued for each individual house Details about the law on legifrance.gouv.fr

UNDERWRITING RECOMMENDATIONS

Assessment of the project margins Type of house (first residence) Type of constructor Region Regular audits to the constructor

TERRITORIALITY

France OTHER NAMES USED FOR THIS TYPE OF BOND Delivery bond : Garantie de livraison (GL)

PRINCIPAL

To be provided by real estate promoter

BENEFICIARY

Buyers / investors BOND AMOUNT Bond amount corresponds to 100% of sale price of a construction project but the amount is undefined on the bond because the guarantor will pay until the completion even if the cost represents more than the sale price.

BOND TENOR

Until completion of the works, usually could go from 1-3 years.

LOSS TRIGGER

Default of the promoter and lack of financing for completion of the works

OTHER RISK DETAILS

Full subrogation of the rights to the insurer Delay penalties are not included in the bond cover Reimbursement could be covered for residentials; however, based upon a Court Decision and previous agreement of Guarantor. Insurers usually excludes the reimbursement from the scope of cover This bond does not cover defects revealed after completion, since completion precisely puts an end to this guarantee

UNDERWRITING RECOMMENDATIONS

-Deep assessment of the construction costs / margins -Assessment of the pre-commercialization -Confirmation of the pre-financing -Monitoring the usage of the anticipated payments of buyer through specific Bank account for each work - strong and experienced real estate promoter

TERRITORIALITY

France, Belgium , Luxembourg, Morocco, Monaco

PRINCIPAL

The litigants in a judicial process, could be private persons and or companies for all activity sectors

BENEFICIARY

The different judicial institutions, courts and tribunals of a country, or the winning litigant part directly

BOND AMOUNT

100% of the amount defined by the judge /court. This amount could be reviewed during the process, and could suffer adjustments (according to the interest rates)

BOND TENOR

Bonds usually should be alive until the closure of the judicial process. In some cases the duration of the bonds are limited, with the obligation to renew and/or to replace the bonds through an bank guarantee, bank deposit, cash or any other instrument accepted by the Court. Average duration observed between 3-5 years.

LOSS TRIGGER

Lose the trial and not be able to fulfield the obligations /payments

PARTICULARITIES

One of the particularities of those bonds, in comparision with other type of bonds like performance, licence bond is that the underlying obligation is not related to the activity of the principal. Another particularity is that the first loss trigger is related to a court decision, which is not always predictable and could be influenced by various external factors. In some cases judicial bonds are also an integrated element of the economic dynamic in a country (Brazil) as are used to support the companies liquidity (tax litigation bonds)

UNDERWRITING RECOMMENDATIONS

Only for court cases in regions where the law allows for effective time limitation of the bond irrespective of the duration of the court case. Where this is not given only for financially sound blue chip corporations with undoubted reputation and a strong balance sheet (incl. cash position) in relation to the deposit required; only for sustainably profitable clients of the surety as a service; only in well developed, predictable legislations and with sureties that can show sufficient experience, legal expertise and monitoring capacity; for bond periods over three years, with adequate collateral

TERRITORIALITY

Judicial Bonds are required in several countries, being USA, Brazil and the Asia Region territories with an strong development in this kind of bonds

OTHER NAMES USED FOR THIS TYPE OF BOND

Court Bonds / Appeal Bonds / Fianzas judiciales; Plaintiff's Bond (Attachement bonds / Counter Attachement Bond /Release Attachement Bonds, Indemnity to Sheriff Bonds, Injunction bonds; Counter Injuction Bond, Replevin Bonds, Counter Replevin Bonds); Guardians Bonds; Cost Bonds; Heir's Bonds; Bail Bonds; Supersedeas Bond; Administrator Bond; Appeal Bonds; Release of Lien Bonds; Claim and Delivery Bonds;

PRINCIPAL

Building company or real estate company

BENEFICIARY

Land owner

BOND AMOUNT

The bond amount is usually equivalent to 100% of the value of the units (apartments, houses etc.) to be ceded to the Beneficiary. However, the percentage of the cost value can vary

BOND TENOR

Such real estate projects usually have a term between 1 and 4 years. The bond term will be from the signature of the Permuta contract until the conclusion of the project. Usually a grace period of 6 months is also considered

LOSS TRIGGER

Any default in completion of the construction and/or cession of the pre-established fraction/units to the previous land owner

OTHER RISK DETAILS

Miscalculation of the project or misjudgment of the sales perspectives through the building company leading to faulty or delayed construction of the real estate complex; fraudulent transfer of the land to be returned to the previous land owner to a third party

UNDERWRITING RECOMMENDATIONS

Recommended only for “standardized” projects which have proven to be marketable – not for speculative projects; and only for building companies with a proven track record in the construction and sale of the relevant types of real estate; the development of the works should be controlled; the existing projects are not cross-subsidizing the new developments; new project should not depend on future sales; principals with good past experience in such undertakings; units that fall under the Permuta contract should be clearly defined. A sufficient level of cash generation by the developer should not depend on the new units to be sold. The construction activities should be related to the main economic activities of the principal.

TERRITORIALITY

This type of bond can be found in many countries. One example: Brazil

OTHER NAMES USED FOR THIS TYPE OF BOND

COMMENTS

Permuta bonds are a special type of housing bonds.

PRINCIPAL

Any company agreeing on such specific pre-retirement scheme with his employees.

BENEFICIARY

The employee entering into an Altersteilzeit-scheme.

MAXIMUM AMOUNT OF RISK

The aggregate amount of credits accrued by employees adhering to the scheme plus the related taxes and social contributions.

BOND TENOR

Duration can be fixed to six or twelve months, but the guarantor remains bound to the risk incurred for the whole duration of the pre-retirement agreement (which normally ranges five to seven years). In order to reflect the development of the credits of the population covered, new bonds with an updated amount are issued after expiry to replace the previous ones.

LOSS TRIGGER

Insolvency of the employer, causing inability to honour payments for salaries as well as the related tax and social security charges.

OTHER RISK DETAILS

To establish the required bond amount, sureties depend on company information, which is why adequate structures for data reporting are considered in the underwriting process. Some sureties accept that reporting responsibilities are delegated the head of a company's workers council, acting as trustee.

UNDERWRITING RECOMMENDATIONS

Duration of the bond and its payment nature require a financially strong counterparty with a solid cash generation.

TERRITORIALITY

Germany, based on the law regulating early retirement ("AltersteilzeitGesetzt")

OTHER NAMES USED FOR THIS TYPE OF BOND

ATZ Bürgschaften

PRINCIPAL

Company or subsidiary domiciled in Sweden that offers an ITP 2 pension plan and uses the above mentioned book reserve method.

BENEFICIARY

PRI Pensionsgaranti (www.pri.se). PRI are a mutual non-life insurance company.

BOND AMOUNT

100% of the guarantee amount. The amount depend on the size of the ITP 2 commitment.

BOND TENOR

Generally unlimited. Renewable annually, every other year or every three years. In some cases with a fixed expiry without any extend-or-pay provision.

LOSS TRIGGER

In case of bankruptcy or if the guarantee has not been extended two months before the guarantee expires (see "Bond tenor") without been replaced with an another acceptable guarantee ("pay or prolong").

OTHER RISK DETAILS

An existing pension fund of the Principal may serve as collateral.

UNDERWRITING RECOMMENDATIONS

As it is payment guarantees which have an unlimited tenor ("pay or prolong") it has to been offered only to very strong, large and wellknown companies. Approval of a guarantor by PRI is individual and based on external financial strength rating.

TERRITORIALITY

Only in Sweden (PRI are based in Sweden and only active in Sweden)

OTHER NAMES USED FOR THIS TYPE OF BOND

PRINCIPAL

The employer / the legal entity(ies) that would like to become own-risk bearer.

BENEFICIARY

Formal beneficiary (bond wording): The Dutch tax authority. Final/physical beneficiary: Disabled employee.

BOND AMOUNT

Unlimited, respectively no fixed bond amount. The cover is indirectly limited by the number of partially or temporarily disabled employees, by the degree and duration of the disabilities (up to a max of 10 years), and by the WGA salary cap. Max annual WGA benefit: 70% of the 100% “WIA" reference salary. The latter is determined each year and currently amounts at EUR 58,307 for one year, hence the covered max. annual “WGA”-salary currently is EUR 40,815. Insurance companies apply actuarial methods to calculate the Maximum Possible Loss.

BOND TENOR

Unlimited in time. Guarantee can be cancelled at anytime (daily), in practise ususally within a couple of weeks/months. Subsequent to cancellation of the bond, no new inflow of disabled cases (start of sickness decisive) are covered and thus the exposure reduces in a maximum tenor of 12 years time to zero. Subsequent to an insolvency (and the guarantee was not cancelled in the meantime) the exposure reduces in a maximum tenor of 12 years (first 2 years grace period). Average disability payment period ~7 years.

LOSS TRIGGER

Trigger to claim is insolvency of the insured employer / legal entity(ies).

PARTICULARITIES

Some local Dutch regulations could change on an annual basis. For example regulation from the Dutch regulatory body UWV changes the maximum WGA salaries and the maximum of salaries on an annual basis, that partially changes the underlying risk. Currently also discussions ongoing to decrease the tenor from 10 years towards 5 years. Risk of underestimation of the expected frequency of disablement of employees. Risk of underestimation of the expected average loss per disabled employee.

UNDERWRITING RECOMMENDATIONS

As the WGA guarantee has a long tenor after cancellation/insolvency and no fixed guarantee amount is included, this type of guarantee can only be provided to satisfactory and stable performing companies, and usually only issued for mid sized / large sized corporates with an adequate trackrecord. Guarantee documentation in general should include a positive pledge to ask for (cash) collateral if the company performance (substantially) deteriorates.

TERRITORIALITY

The Netherlands only

OTHER NAMES USED FOR THIS TYPE OF BOND

WGA Bond

COMMENTS

WGA = Werkhervatting gedeeltelijk arbeidsgeschikten = Retur WIA Act = Wet werk en inkomen naar arbeidsvermogen = Work and Income (Capacity for Work) Act The WIA encompasses two schemes: WGA: Return to Work (Partially or temporarily Disabled Persons) Scheme, for people who are temporarily or partially (at least 35%) incapacitated for work; IVA: Full Invalidity Benefit Regulation, for people who are completely (at least 80%) and permanently incapacitated for work. Source: https://ec.europa.eu/social/main.jsp?catId=1122&langId=en&intPageId=4990

The UW decision for an individual bond is based on the Surety’s conviction that the underlying obligation will certainly be fulfilled from today’s perspective. If the unexpected occurs – the principal defaults and the surety has to pay – at least the full recourse against the Principal will be successful, again from the present day perspective of the surety.

“The idea of zero loss philosophy for an insurance company seems unnatural, since the very principle of insurance is based on the concept of losses occurring. They are an indispensable ingredient for the demand for insurance cover. It is the fear of potential loss that makes people and corporations buy insurance. Nevertheless while even surety´s “cousin” credit insurance operates from the insurance principle surety does not” (IPCIS, The Business of Surety, Steven Sandberg, page 19).

Why does Surety bond business operate differently?

In insurance, when a loss occurs, the insured party is not expected to repay the insurance company. However, in a surety transaction, when a surety makes a payment, the principal is expected to repay the surety´s losses (i.e. right of recourse). This is also reflected in the premium rate level (compared to the risk exposure).

On the other hand, the number of risks tend to be much lower than in traditional insurance lines (for example fire insurance). Whereas every house owner usually has insurance against the risk of fire, the number of transactions covered by a surety bond is relatively small. Moreover the demand in surety business is often “anti-selected”.  Due to the low premium basis in comparison to the exposures and the generally heterogeneous portfolio, a (large) loss in one year can significantly impair results across many years.