Current Market Overview

According to the Surety & Fidelity Association of America (SAA) results for 2008 indicate that the surety industry produced earned revenues of $5.41 billion and direct incurred losses of $685.85 million. The 2008 year-end results compare favorably to the 2007 results of approximately $5.21 billion in earned premium and losses of $980.7 million. In 2008, earned premiums increased year-over-year by roughly $224 million, or 4.33%, while losses decreased by $293.0 million, or roughly 30%. Velocity of earned premium growth slowed in 2008, but more important to the industry, loss activity decreased.

The surety industry has now demonstrated stable loss results since the first quarter of 2006. While not evident in the results recorded to date, the overall financial impact of the credit crunch may have begun to impact surety providers, based on the numerous credit rating downgrades and bankruptcies seen in the past several quarters. Surety companies are beginning to recognize these trends in their underwriting as evidenced by increased pr ic ing , addi t iona l indemnity provisions and/or new or increased collateral requirements. Additionally, sector-specific financial declines have drastically reduced or eliminated unsecured surety credit for industry groups such as auto-makers, airlines, home-builders, mortgage brokers, retail businesses and certain financial institutions.

The economic conditions have also impacted the reinsurance community. Swiss Re recently announced that they will greatly reduce their position in the area of Credit Solutions. In the past, Swiss Re had been one of the largest and most consistent reinsurers in the surety industry. While reinsurance capacity remains available for surety, this change illustrates the need for insurance capital to focus on select risk and dedicate capital resources to business lines with the highest predictability and margins.

In the Contract Surety sector, the industry outlook for 2009 and 2010 is not optimistic, with the industry and its reinsurance partners bracing for increased losses. The projected higher frequency of contractor defaults will likely be caused by declining backlogs and increased competition for a reduced

INSIDE • Surety Association

of America Announces 2008 Year-End Results

• Current Market Overview

• Market Trends

• Advisory Update: Environmental Bonds

• New Bond Requirements

• Contract Surety Bond Claims Process

• Aon Surety In the Community

• Aon’s Surety Experts

Surety Marketplace UpdateSurety Marketplace Update

SPECIAL EDITION www.aonsuretyhub.com

Surety Association of America Announces 2008 Year-End Results

Spring 2009

SPECIAL EDITION

Current Market Overview (continued)

number of new projects, leading to compressed margins and higher overhead expenses as a percentage of sales. Ongoing instability in the credit markets will continue to restrict economic development, further increasing challenges in the construction marketplace. Surety underwriters will more closely scrutinize contractors that rely heavily on their bank facilities and those that are seeking bonding support for projects of greater size or of a different scope than their normal business operations. Contractors that decide to travel outside of their normal territories in the pursuit of new work will need to explore the new markets thoroughly and create detailed plans to penetrate these new territories prior to asking their sureties to support these projects.

Since much of the private sector construction work has been delayed or cancelled due to a lack of financing, the number of bidders on public work is growing. We are seeing signs that many contractors are now taking work at or below cost in order to maintain their backlogs. Numerous larger projects have also been postponed or entirely cancelled. In the past, recessionary periods followed by inflation have resulted in significant financial strains for subcontractors, which in turn has led to difficulties at the general construction level. Lumber and other building material capacity is now being taken off-line due to a lack of demand. This raises concern that once the economy turns and inflation returns over the next 24 months, the reduced capacity could lead to sharply higher material costs.

Certain states continue to pursue alternative delivery methods for longer-

term, high-value public works projects. In some instances, public-private alternatives are explored as a means to finance projects otherwise un-fundable due to state budgeting constraints. The increased exploration and use of such methods continue to evolve, as the surety industry works to provide necessary support for these contracts. While the public-private model is a rather recent US market trend, both Europe and Canada have successfully integrated it for years and as such, there has been an increase in global market entrants for these opportunities in the US.

The acquisition of Safeco Surety by Liberty Mutual, combining the 5th and 4th largest writers of surety respectively, coupled with the ongoing financial issues of AIG, is currently and will continue to adversely impact surety industry capacity and co-surety flexibility on larger single projects and expanded aggregate work programs in 2009. While industry underwriting standards are expected to become more restrictive, current program pricing should remain fairly static throughout the year. The most competitive surety segment in 2009 will be for contractors with bonded backlogs of up to $350 million; continued industry profitability, combined with a fair number of bonding companies capable of supporting bonded backlogs in this range, make these larger, well-managed middle market accounts the most competitive segment of the contractor surety marketplace.

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Since much of the private sector construction work has been delayed or cancelled due to a lack of financing, the number of bidders on public work is growing.

SPECIAL EDITION

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non-financial companies carry non-investment grade or “junk” credit ratings. Standard & Poor’s projects that the three-year cumulative default rate between 2008 and 2010, among non-financial firms with poor credit will rise to 23.2%, the worst results since 1981. The overall impact of these factors on the surety indus-try has resulted in more cautious and conservative ap-proach, including efforts to strengthen indemnity terms, increase pricing and collateral, with non-investment grade credits the most highly impacted.

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Current Market Overview (continued)

S&P Global Debt Default/SAA Loss Correlation

In the commercial surety sector, losses may be significant over the next 18 months based on a projected rise in bankruptcies. It is not likely that these bankruptcies will replicate the signifi-cant losses produced in the period between 2001 and 2004, based on higher levels of collateral held by the sureties and the pricing discipline which has been maintained by the industry. Industry premiums in the commercial sector are likely to see material growth in 2009, based not only on higher pricing but also on an increase in bond opportunities as obligees seek third-party financial guarantees, such as surety bonds or let-ters of credit, where previously corporate guaran-tees were acceptable. Standard and Poor’s re-ported global defaults in excess of $400 billion in 2008. This is a significant increase from 2007 when they reported less than $25 billion in debt defaults. Naturally, a large amount of the debt defaults are from large financial institutions. We suspect additional defaults are likely forthcoming based on the lack of credit availability which will limit refinancing opportunities. Roughly 70% of

SPECIAL EDITION Page 4

Market Trends:

The credit crisis continues to impact both the commercial and contract surety markets with highlighted market reactions noted below. In summary, the industry is re-analyzing respective books of business resulting in revised underwriting with impact to pricing, indemnity, collateral, and capacity.

Pricing: • Proactively tightening terms and raising

rates on many accounts that continue to perform well in anticipation of worsening results and credit rating downgrades in the future.

• Increased rates for bond needs in certain higher risk industry sectors.

• In some instances, sureties are charging separate premiums for the performance and payment bonds; viewing them as distinct obligations under same contract.

Indemnity: • As a result of surety programs merging due

to M&A activity, we note that where both sureties participated on a shared bond program, unilateral substituting of indemnity terms.

• Collateral calls under place-in-funds indemnity language, usually targeted at difficult bond classes such as Worker’s Compensation, financial guarantees and subdivision.

• Replacement of older outdated indemnity agreements with new, more onerous indemnity forms.

• Sureties are executing on ratings trigger in advance of covenant violations and relying upon demand discharge language to exit the program.

Collateral: • Increased need for collateral on high risk

industries, highly leveraged balance sheets and riskier surety portfolios in spite of continued strong financial performance.

• When exiting an account or industry, requiring collateral when unable to replace bonds within the specified replacement window designated.

• Sureties that participate in shared surety programs are requiring collateral in advance of material financial deterioration to secure a preferred positions before the pool of available collateral is reduced by multiple surety demands or in fear of limited credit line availability in the future.

• Sureties are being more selective from which banks they will accept letters of credit. Reduced levels of letters of credit from any one financial institution, for example; a leading surety company is limiting a single letter of credit to $75 million from one bank for one principal.

Capacity: • Capacity reductions and suspensions, particularly

on larger bond accounts under financial and credit ratings pressures. In many cases providing short windows to find alternative capacity without enforcing collateral calls.

• Singling out certain business sectors, such as retailers and homebuilders, which are suffering the most in the current environment, and severely tightening terms and conditions or completely eliminating these accounts / sectors from their books of business.

• Strict underwriting to gap financing/alternative delivery contract methods.

• Re-underwriting trade and marginally capitalized general contractors as well as contractors depending on their line of credit for working capital needs.

Surety Market Reactions in the Current Economic Environment

Underwriting: • More thorough underwriting than in the

past, including closer reviews of bank covenants, compliance certificates and SEC documents, and requests for underwriting meetings / calls in advance of when they would typically be held.

• Re-analyzing methods used to calculate run-off of performance bonds on commercial surety accounts; switching from a cost-to-complete to a completed contract analysis method in order to limit or suspend capacity without directly defining their capacity analysis to the clients.

• Restrictive joint-venture partnering and redefined acceptable co-surety partners.

SPECIAL EDITION Page 5

Surety Market Reactions in the Current Economic Environment Market Trends: (continued)

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SOURCE: The Surety & Fidelity Association of America

A 40% loss ratio is usually considered the break even point for a surety company. It is common in the surety industry to have loss ratios well below 40% for many years. The companies must build adequate capital to cover periods with high claim payments, an example 2001 through 2004.

• Reporting requirements are becoming more formalized. Surety companies are defining financial reporting dates and they are seeking debt covenant compliance certificates on a frequent basis. Complete copies of all loan and debt facilities are also being reviewed.

• Performance & Payment bond approvals often require greater scrutiny of project financing to ensure that project funds are in place and sufficient to complete the work.

Surety Association of America Premium & Loss Results

SPECIAL EDITION

Environmental Surety Update

Advisory Update:

Surety bonds for projects on environmental sites, or for work on sites with a large amount of remediation, are still needed and available in the marketplace. A brief history of environmental surety bonding shows that the surety bond industry started to respond to asbestos remediation in the mid to late 1980s. Specialty insurers with surety facilities decided to carefully enter the market at this time and to write surety bonds on either (1)commercial asbestos remediation on buildings built prior to 1974 (date on which asbestos was deemed unsafe and no longer used as an insulating material), or (2) hazardous sites (either EPA Superfund sites, or environmental polluted “brownfield” sites). The industry prospered, few claims were tendered, and most commercial buildings built prior to 1974 were remediated, either by encapsulation or outright removal. The environmental industry then moved to the current mature phase, in which private industry and the U.S. government are currently cleansing and remediating ground that had been polluted for several generations.

The current environmental surety bond industry includes a handful of AM Best “A” rated players, with specialty underwriting units willing to write surety bonds for environmental construction projects subject to strict underwriting requirements. The demands usually include an application detailing the risk elements of a project, evidence of pollution insurance, either on a claims made or occurrence basis, and a completed copy of the contract with the owner. Projects on EPA

Superfund sites are underwritten more carefully due to the inherent nature of the risks. The current environmental surety industry will, in most instances, refuse to consider nuclear risk. For example, bonds for dismantling nuclear facilities, either for utility owners or research universities are not commercially available, with one or two major exceptions.

The U.S. government has numerous Air Force, Naval and Army bases that are being converted to private industry, and the sites often require environmental work, including the remediation of unexploded ordinance, cleaning groundwater that may have been contaminated by toxic substances over a lengthy period and removal of structures that still contain encapsulated asbestos. The careful underwriting of these projects requires analysis of risk elements to assure the underwriters that their applicants do not assume risk that could deem them to be a transporter or generator of toxic substances under CERCLA (Comprehensive Environmental Response and Compensation Liability Act).

Aon’s environmental surety capabilities are unparalleled in the market, with a staff of surety professionals in over three dozen offices nationwide. We can address any environmental opportunity, no matter how complex or leveraged. The practice has produced successful placements for environmental projects in all 50 states as well as for environmentally sensitive overseas projects. Please feel free to contact your local Aon surety representative to obtain more detail on potential capacity and placement needs related to environmental security.

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SPECIAL EDITION

Compliance dates for this new regulation are as follows:

May 4, 2009 This is the effective requirement date for:

New NPI applications Changes in ownership, mergers New locations October 2, 2009 This will serve as the date that all existing DMEPOS will

need to have bonds filed for this obligation.

New Bond Requirements

Aon Surety Prepares Clients For DMEPOS Bond Requirement:

Aon Surety Issues New CO2 Emission Allowance Auction Bonds

The surety community continues to see new legislation passed impacting the need for security as a part of industry regulation. Below are recent developments with national impact:

The Regional Greenhouse Gas Initiative, Inc. (RGGI, Inc.) is a non-profit entity that will support a cap-&-trade program to reduce greenhouse gas emissions. This initiative is in conjunction with ten Mid-Atlantic and Northeastern states that are working together to reduce CO2 emissions through the auction of carbon dioxide emission allowances. Aon Surety has been successful in the issuance of surety for early RGGI, Inc. auctions. Recognizing the short, two-day payment requirement in the RGGI, Inc. required bond form, Aon has established a market relationship that has addressed the RGGI, Inc. requirements and has provided terms suitable for this bond.

Aon Surety and Aon Affinity Insurance Services, Inc. have combined to deliver an efficient structure to meet this new CMS bond requirement. Aon Surety has developed program terms with various DMEPOS approved surety companies to offer competitive pricing and underwriting flexibility to fit specific needs of our clients. The Centers for Medicare & Medicaid Services (CMS) will have a new bond requirement for Durable Medical Equipment, Prosthetics, Orthotics and Supplies (DMEPOS). This legislation will require that most Medicare suppliers of DMEPOS will need to provide, at a minimum, a $50,000 bond to CMS for each National Provider Identifier (NPI) number. Entities with multiple NPIs will be able to issue one bond with all applicable NPIs scheduled on the bond. Please contact your local Aon Surety advisor for more information regarding the DMEPOS requirement or look on Aon Surety’s web portal: www.aonsuretyhub.com

Page 7

Surety Bonds are typically required to guarantee two types of obligations:

Contracts

Government Statues

New obligations are often viewed with extra caution until loss activity associated with the bond becomes more predictable.

The Surety & Fidelity Association of America monitors and reports on class codes of hundreds of various surety bonds.

SPECIAL EDITION

Contract Surety Bond Claims Process

With the dramatic downturn in the overall North American economy, we already see clear signs of a slower and much more difficult construction environment. Consequently, we will undoubtedly experience an increase in contractor defaults and as a result an increase in contract surety bond claims.

In light of the above, it is critically important that Public/Private Owners, along with General/Prime Contractors fully understand and clearly fulfill all of their respective contractual and bond obligations in order to better preserve the right to advance a valid claim under the Performance Bond.

To begin it is vital that the Owner (as the Beneficiary under the Bond) fully comprehends that the standard AIA 312 Performance Bond is not a demand/forfeiture (one-sided) type of instrument.

In other words, the Surety’s obligation under the standard AIA 312 Performance Bond is conditional in nature. There are three fundamental conditions precedent for an Owner, before the Surety’s obligations are triggered under the Bond:

• The Owner must have declared a Contractor Default and formally terminated the Contractor’s right to complete the bonded Contract.

• The Contractor must actually be in Default of the bonded Contract.

• The Owner must have fulfilled its obligations under the bonded Contract.

Unless and until the Owner has complied with these express conditions precedent, the Surety is not obligated to respond to a demand made on the Bond.

It is also important to emphasize that the standard AIA 312 Performance Bond also requires, as per Section 3.1, that prior to declaring an actual Contractor Default, the Owner must notify both the Contractor and the Surety that it is considering declaring a Contractor Default – and hence is requesting a conference, which would involve all three parties, in an attempt to find common agreement as to the best method of completing the Contract. In addition, prior to declaring a Contractor Default under the Performance Bond, the Owner needs to have followed the specific Default and Termination provisions comprising an integral part of the bonded Contract.

It is very important that in order to advance a proper claim under the Performance Bond, the Owner fulfill all of its contractual obligations to the Contractor, the most important being to pay (in a timely and proper way) the Contractor as per the specific terms and conditions of the bonded Contract.

There is an additional benefit contained in Section 3.1 of the Bond – it allows

Page 8

SPECIAL EDITION

Contract Surety Bond Claims Process (continued)

the Surety to provide to both the Owner and the Contractor additional hidden services in better assuring the completion of the work. Some of these behind the scenes services are as follows:

• Facilitate the resolution of a dispute between the Owner and the Contractor.

• Advise the Contractor on best practices with regard to management, administration, job costing, and project execution.

• Provide additional real and direct financial assistance to the Contractor.

• Obtain outside technical expertise for the Contractor.

Upon receipt of a claim made under the Performance Bond, the Surety Company will commence an investigation in order to ascertain the validity of the claim. In other words the Surety will attempt to determine if both the Owner and Contractor have met their respective obligations under the Contract and Bond.

If it is a valid claim, under the standard AIA 312 Performance Bond, the Surety has available the following four options in order to remedy the Default of the

Contractor:

1. Arrange for the Contractor to complete the Contract (with the Owner’s consent).

2. Complete the Contract itself (by way of agents retained directly by the Surety).

3. Re-tender the remaining portion of the Contract (by arranging for a new contractor to complete the work).

4. Pay the Owner the amount the Surety has determined it is liable to the Owner, up to the penal amount of the Bond; or deny liability in whole or in part, and provide to the Owner the reasons for such denial.

As outlined, there are a number of diverse factors that an Owner needs to take into consideration and act upon, in order to preserve its right to claim under the s t andard AIA 312 Performance Bond. Other bond forms, too, may contain similar procedural steps with which an Owner must comply.

If an Owner is contending with a contractual dispute or has concerns with a Contractor’s performance, either of which could very well lead to a claim being advanced under a Performance Bond and desires advice and assistance in this regard… he/she should contact a local Aon surety professional.

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SPECIAL EDITION

On Friday, March 13, the Philadelphia surety group hosted a career day field trip for students from UrbanPromise, an organization that offers support to children and teens in the Camden, New Jersey area. Through his involvement with UrbanPromise as a high school business mentor, Doug Wheeler, Regional Director of Surety in Philadelphia, sponsored a group of ten students and other business mentors to visit Aon’s Philadelphia office. The UrbanPromise students met as a group and individually with Aon surety employees to learn about their personal experiences in beginning in a business career. “It was inspirational to take a bit of time from our routines to share how we all started in business and to reflect upon personal and collective accomplishments,” said Wheeler. “The students brought great questions, energy and knowledge that even in this difficult economy, so much opportunity remains available for growth.”

The mission of UrbanPromise is to equip children and teens with the skills necessary for academic achievement, life management, spiritual growth and leadership rooted in the principles of Christian faith. As a non-denominational organization, UrbanPromise provides after school programs, summer camps, alternative schools, job training initiatives and a host of other programs that challenge youth to develop their potential. Founded in Camden, NJ twenty years ago, a New York City chapter of UrbanPromise opened last year. To discover more about UrbanPromise, visit www.urbanpromiseusa.com.

Two UrbanPromise students review Aon PR pieces.

Liz Marrero shows two students around the Aon Surety office.

Rosi Caponi shares some time with a student.

Darella White discovers she and this student grew up in the same neighborhood.

Maureen McNeill shows a student AonBondLink.

The Aon team and the students share a smile.

Doug Wheeler with the students.

Aon Surety - In the Community

Philadelphia Surety Group Hosts UrbanPromise Students

Page 10

SPECIAL EDITION

Aon Surety - In the Community

Team Building through Volunteering In Chicago

Page 11

On February 26, approximately 50 members of Aon Chicago’s Construction Services Group volunteered their time at the Greater Chicago Food Depository. Instead of the usual holiday party, CSG decided this year to team-build and to give something back to the community by volunteering at this important Chicago non-profit organization. The GCFD’s purpose is as follows:

The Greater Chicago Food Depository, Chicago’s food bank, is a nonprofit food distribution and training center providing food for hungry people while striving to end hunger in our community. The Food Depository distributes donated and purchased food through a network of 600 food pantries, soup kitchens and shelters to 500,000 adults and children every year. Last year, the Food Depository distributed more than 46 million pounds of nonperishable food and fresh produce, dairy products and meat, the equivalent of more than 95,000 meals every day.

The CSG team worked in a human assembly line to package macaroni in one of the facility’s “clean rooms,” wearing hair nets and breathing masks. The three hours of hard labor included scooping the food into boxes, weighing and sealing the boxes, labeling them and loading them. According to the GCFD, our team set a record for the number of 21 lb. macaroni bags packed in one session!

Aon Chicago’s Construction Services Group packages food for the Greater Chicago Food Depository.

SPECIAL EDITION

Aon Surety Group Updates

Aon’s Surety Experts

Rich Moore, Regional Director of Aon Surety, was named to the Risk and Insurance annual listing of “Power Brokers”. Rich was nominated as part of his efforts within the Gaming/Hospitality industry. He was highlighted for numerous successes, including the building of a $1.4 billion credit facility for one of his client’s needs. The surety credit not only allowed the firm to access working capital, but at lower prices than competing letters of credit, all of which provided an attractive off-balance sheet value. Further, Rich was recognized for saving another client $1 million by designing an alternative funding facility, which allowed for the release of the client’s held collateral.

Doug Wheeler, Regional Director of Aon Surety, was named a finalist for the prestigious insurance award for his efforts within the Construction surety sector.

Congratulations to both Rich and Doug for this outstanding accomplishment!

We believe companies will continue to need timely, customized and innovative solutions in order to meet the demands of a challenging and fluid economic environment. Aon’s national practice group of surety experts stands ready to continue to assist worldwide clients in meeting these demands on a daily basis. We pride ourselves on providing a brand of solutions that benefit our clients, even in the most difficult of times.

Within Aon Surety’s four core deliverables; Advisory, Syndication, Fulfillment, and Technology our approach is client-focused and results driven; to provide quality advocacy, value, and consistency for each of our clients. As the only surety broker with an integrated platform, Aon offers the benefits of national reach and scope with the local familiarity provided by our extensive network of offices. Our award-winning technology, AonBondLink, further differentiates Aon’s personnel and protocols.

We look forward to working with both existing clients and prospects to provide relevant and reliable solutions to meet their surety needs in 2009 and beyond.

Page 12

Risk and Insurance Names Rich Moore as “Power Broker”

Aon Surety 200 East Randolph Street Chicago, IL 60601 tel: (312) 381-4580 www.aonsuretyhub.com Michael Cusack ~ Boston (617) 457-7719 Michael Herrod ~ Houston (832) 476-5834 Robert McDonough ~ New York (212) 441-2628 Richard Moore ~ Chicago (312) 381-4591 Michael Parizino ~ Irvine (949) 608-6381 Paul Rodriguez ~ San Francisco (415) 378-8886 Douglas Wheeler ~ Philadelphia (215) 255-1705

Aon Corporation (NYSE: AOC) is the leading global provider of risk management services, insurance and reinsurance brokerage, human capital and management consulting. Through its 36,000 colleagues worldwide, Aon readily delivers distinctive client value via innovative and effective risk management and workforce productivity solutions. Our industry-leading global resources, technical expertise and industry knowledge are delivered locally through more than 500 offices in more than 120 countries. Aon was named the world's best broker by Euromoney magazine's 2008 Insurance Survey. In 2008, Aon ranked highest on the Business Insurance ranking of the world's largest insurance brokers based on commercial retail, wholesale, reinsurance and personal lines brokerage revenues. Aon also was ranked by A.M. Best as the number one insurance broker based on brokerage revenues in 2007 and 2008, and was voted best insurance intermediary, best reinsurance intermediary, and best employee benefits consulting firm in 2007 and 2008 by the readers of Business Insurance. For more information on Aon, log onto http://www.aon.com/.

This publication is distributed with the understanding that all reasonable care has been taken in preparing this publication.

Aon accepts no responsibility for any errors it may contain, whether caused inadvertently or otherwise, or for any losses allegedly attributable to it.

Nothing contained in this publication should be construed as establishing or recommending any specific guidelines or standards of the Surety market. Nothing contained in this publication should be construed as establishing or recommending any specific guidelines or standards.

Reproduction permitted with written authorization.

Copyright Aon 2009