Predicting surety claims
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This document provides an overview of a predictive model developed by Transparent Solutions to forecast surety claims in the construction industry. The model was able to accurately predict 78% of claims on a back-tested basis by analyzing operational, financial, and macroeconomic risk factors for over 18,000 contractors. The ratings assigned by the model can help insurers and banks better price bonds and loans based on contractor risk levels. Implementing this predictive solution could help reduce losses from project failures in the construction industry.
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Predicting surety claims
- 1. Confidential and Proprietary ® MMO Discovery Project Findings and Recommendations Transparent Solutions July 2014 The Prediction of Contractor Claims An Overview of Our Solution
- 2. Confidential and Proprietary 2Pain Points in Construction Risk Poor Metrics Current credit metrics are not tailored to construction risk. Surety Confusion Which contractors do I worry about? Project owners & GCs can’t police everyone. Boom-Bust Cycle Bad times often wipe out results from good times. Let’s break the cycle. High Cost of Failure Project failure is a major expense. 2
- 3. Confidential and Proprietary 3The Big Idea Construction surety losses approached $1 billion for the insurance sector in 2011. Chief Risk Officers need to leverage sophisticated capital markets techniques to predict losses better. Transparent Solutions has built a beta predictive model based on real world data that accurately forecasts material surety claims 12 months out. “ 3
- 4. Confidential and Proprietary 4Understanding the True Risks Surety involves a complex data set, since it lies between both corporate and consumer credit models, across operational and credit risks. Corporate Income/Demographics Driven (small companies) Financial Statement Driven (large and medium firms) Consumer Ideal Surety Solution “Contractor Rating” Components of Surety Defaults Credit Risk Operational Risk Systemic Risk Financial Performance Probability that contractor has enough financial strength to meet performance Operational Performance Performance and execution record of contractor. Five categories of performance Macroeconomic Events Effect of business cycle on proper contract performance Large, Medium & Small Firms Strategic Solution = (1) Contractor Score + (2) Active Portfolio Management 8
- 5. Confidential and Proprietary 5Alpha Rating Model Results Recap: large P&C company provided 18K financial years of data. Model identified 78% of claims on a back-tested basis. 50% Contractor Risk Buckets PercentofClaimsCaptured 12345 28% 14% 6% 2% Low Risk High Risk Majority of claims captured in risk buckets “5” + “4” Claims Prediction Model Results 16
- 6. Confidential and Proprietary 6Value of Ratings to Insurers & Banks Bond Price Per $1,000 Rating Bond #1 $6.00 3 Bond #2 $8.00 7 Bond #3 $12.00 9 Bond #4 $6.50 4 Bond #5 $7.00 6 Underwriting Committee Who should we bond? And at what price? Ratings enhance bond and loan underwriting and… It better predicts the risk of a claim or default It creates an optimal price for each bucket of risk It returns reason codes for the assigned score It improves market pricing discipline and credit insight Contractor Rating (1=Best Risk, 10=Worst Risk)