Attached files
file | filename |
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EX-31.(1) - EX-31.(1) - CNA SURETY CORP | c64292exv31wx1y.htm |
EX-31.(2) - EX-31.(2) - CNA SURETY CORP | c64292exv31wx2y.htm |
EX-32.(1) - EX-32.(1) - CNA SURETY CORP | c64292exv32wx1y.htm |
EX-32.(2) - EX-32.(2) - CNA SURETY CORP | c64292exv32wx2y.htm |
Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 2011
OR
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number: 1-13277
CNA SURETY CORPORATION
(Exact name of Registrant as specified in its Charter)
DELAWARE (State or other jurisdiction of incorporation or organization) |
36-4144905 (I.R.S. Employer Identification No.) |
|
333 S. WABASH AVE., CHICAGO, ILLINOIS (Address of principal executive offices) |
60604 (Zip Code) |
(312) 822-5000
(Registrants telephone number, including area code)
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12
months (or for such shorter period that the registrant was required to submit and post such files).
Yes o No þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer, or a smaller reporting company. See definition of large
accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the
Exchange Act.
Large accelerated filer o | Accelerated filer þ | Non-accelerated filer o (Do not check if a smaller reporting company) |
Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes þ No
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and reports required to be
filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the
distribution of securities under a plan confirmed by a court. o Yes o No
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of
the latest practicable date:
44,973,466 shares of Common Stock, $.01 par value as of April 19, 2011.
CNA SURETY CORPORATION AND SUBSIDIARIES
INDEX
Page | ||||||||
PART I. FINANCIAL INFORMATION |
||||||||
Item 1. Condensed Consolidated Financial Statements (Unaudited): |
||||||||
3 | ||||||||
4 | ||||||||
5 | ||||||||
6 | ||||||||
7 | ||||||||
26 | ||||||||
45 | ||||||||
47 | ||||||||
48 | ||||||||
48 | ||||||||
48 | ||||||||
48 | ||||||||
48 | ||||||||
48 | ||||||||
EX-31.(1) | ||||||||
EX-31.(2) | ||||||||
EX-32.(1) | ||||||||
EX-32.(2) |
Table of Contents
CNA SURETY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(UNAUDITED)
March 31, | December 31, | |||||||
2011 | 2010 | |||||||
(Amounts in thousands, except | ||||||||
per share data) | ||||||||
Assets |
||||||||
Invested assets: |
||||||||
Fixed income securities, at fair value (amortized cost: $1,384,865 and $1,353,347) |
$ | 1,429,734 | $ | 1,404,375 | ||||
Equity securities, at fair value (cost: $1,938 and $1,687) |
2,178 | 1,916 | ||||||
Short-term investments, at amortized cost (approximates fair value) |
44,386 | 53,089 | ||||||
Total invested assets |
1,476,298 | 1,459,380 | ||||||
Cash |
5,513 | 7,313 | ||||||
Deferred policy acquisition costs |
101,365 | 98,572 | ||||||
Insurance receivables: |
||||||||
Premiums, including $8,917 and $10,840 from affiliates, (net of allowance for doubtful
accounts: $1,230 and $1,410) |
41,472 | 33,378 | ||||||
Reinsurance |
42,945 | 41,453 | ||||||
Deposit with affiliated ceding company |
17,391 | 23,446 | ||||||
Goodwill and other intangible assets (net of accumulated amortization: $25,523 and $25,523) |
138,785 | 138,785 | ||||||
Property and equipment, at cost (less accumulated depreciation and amortization: $39,245
and $38,931) |
14,367 | 15,645 | ||||||
Prepaid reinsurance premiums |
151 | 164 | ||||||
Accrued investment income |
16,803 | 17,307 | ||||||
Other assets, including $162 and $0 from affiliates |
2,545 | 2,291 | ||||||
Total assets |
$ | 1,857,635 | $ | 1,837,734 | ||||
Liabilities |
||||||||
Reserves: |
||||||||
Unpaid losses and loss adjustment expenses |
$ | 401,103 | $ | 389,089 | ||||
Unearned premiums |
253,946 | 245,986 | ||||||
Total reserves |
655,049 | 635,075 | ||||||
Long-term debt |
30,930 | 30,930 | ||||||
Deferred income taxes, net |
27,489 | 29,098 | ||||||
Reinsurance and other payables to affiliates |
141 | 177 | ||||||
Accrued expenses |
13,475 | 21,726 | ||||||
Liability for postretirement benefits |
12,577 | 12,330 | ||||||
Income tax payable |
6,820 | 13,775 | ||||||
Other liabilities |
23,079 | 25,890 | ||||||
Total liabilities |
769,560 | 769,001 | ||||||
Commitments and contingencies (See Notes 3, 5, 6 & 8) |
||||||||
Stockholders Equity |
||||||||
Common stock, par value $.01 per share, 100,000 shares authorized; 46,327 shares issued and
44,970 shares outstanding at March 31, 2011 and 46,104 shares issued and 44,748 shares
outstanding at December 31, 2010 |
463 | 461 | ||||||
Additional paid-in capital |
291,050 | 288,471 | ||||||
Retained earnings |
782,682 | 761,925 | ||||||
Accumulated other comprehensive income |
28,440 | 32,436 | ||||||
Treasury stock, 1,357 and 1,356 shares, at cost |
(14,560 | ) | (14,560 | ) | ||||
Total stockholders equity |
1,088,075 | 1,068,733 | ||||||
Total liabilities and stockholders equity |
$ | 1,857,635 | $ | 1,837,734 | ||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
3
Table of Contents
CNA SURETY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(UNAUDITED)
Three Months Ended | ||||||||
March 31, | ||||||||
2011 | 2010 | |||||||
(Amounts in thousands, except | ||||||||
per share data) | ||||||||
Revenues: |
||||||||
Net earned premium |
$ | 96,658 | $ | 98,252 | ||||
Net investment income |
14,435 | 13,377 | ||||||
Net realized investment gains (losses): |
||||||||
Other-than-temporary impairment losses |
| | ||||||
Portion of other-than-temporary impairment
losses recognized in other comprehensive income (before
taxes) |
| (94 | ) | |||||
Net impairment losses recognized in earnings |
| (94 | ) | |||||
Net realized investment gains, excluding impairment losses |
313 | 417 | ||||||
Total net realized investment gains |
313 | 323 | ||||||
Total revenues |
111,406 | 111,952 | ||||||
Expenses: |
||||||||
Net losses and loss adjustment expenses |
28,031 | 28,581 | ||||||
Net commissions, brokerage and other underwriting expenses |
52,266 | 52,788 | ||||||
Interest expense |
284 | 281 | ||||||
Other expense |
2,027 | | ||||||
Total expenses |
82,608 | 81,650 | ||||||
Income before income taxes |
28,798 | 30,302 | ||||||
Income tax expense |
8,041 | 9,497 | ||||||
Net income |
$ | 20,757 | $ | 20,805 | ||||
Earnings per common share |
$ | 0.46 | $ | 0.47 | ||||
Earnings per common share, assuming dilution |
$ | 0.46 | $ | 0.47 | ||||
Weighted average shares outstanding |
44,810 | 44,280 | ||||||
Weighted average shares outstanding, assuming dilution |
45,157 | 44,421 | ||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
4
Table of Contents
CNA SURETY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
(UNAUDITED)
(UNAUDITED)
Common | Accumulated | |||||||||||||||||||||||||||||||
Stock | Additional | Other | Treasury | Total | ||||||||||||||||||||||||||||
Shares | Common | Paid-in | Comprehensive | Retained | Comprehensive | Stock | Stockholders | |||||||||||||||||||||||||
Outstanding | Stock | Capital | Income | Earnings | Income (Loss) | At Cost | Equity | |||||||||||||||||||||||||
(Amounts in thousands) | ||||||||||||||||||||||||||||||||
Balance, January 1, 2010 |
44,268 | $ | 456 | $ | 279,388 | $ | 627,505 | $ | 30,406 | $ | (14,671 | ) | $ | 923,084 | ||||||||||||||||||
Comprehensive income: |
||||||||||||||||||||||||||||||||
Net income |
| $ | | $ | | $ | 20,805 | $ | 20,805 | $ | | $ | | $ | 20,805 | |||||||||||||||||
Other comprehensive income: |
||||||||||||||||||||||||||||||||
Change in unrealized gains on
securities, after income tax
expense of $865 (net of
reclassification adjustment
of $228, after income tax
expense of $123) |
| | | 1,607 | | 1,607 | | 1,607 | ||||||||||||||||||||||||
Other-than-temporary impairment
losses not recognized in the
Condensed Consolidated
Statements of Income, after
income tax expense of $41 (net
of reclassification adjustment
of ($353), after income tax
benefit of $190) |
| | | 77 | | 77 | | 77 | ||||||||||||||||||||||||
Net change related to
postretirement benefits, after
income tax benefit of $9 |
| | | (18 | ) | | (18 | ) | | (18 | ) | |||||||||||||||||||||
Total comprehensive income |
| | | $ | 22,471 | | | | | |||||||||||||||||||||||
Stock-based compensation |
| | 441 | | | | 441 | |||||||||||||||||||||||||
Stock options exercised and other |
30 | 1 | 297 | | | 65 | 363 | |||||||||||||||||||||||||
Balance, March 31, 2010 |
44,298 | $ | 457 | $ | 280,126 | $ | 648,310 | $ | 32,072 | $ | (14,606 | ) | $ | 946,359 | ||||||||||||||||||
Balance, January 1, 2011 |
44,748 | $ | 461 | $ | 288,471 | $ | 761,925 | $ | 32,436 | $ | (14,560 | ) | $ | 1,068,733 | ||||||||||||||||||
Comprehensive income: |
||||||||||||||||||||||||||||||||
Net income |
| $ | | $ | | $ | 20,757 | $ | 20,757 | $ | | $ | | $ | 20,757 | |||||||||||||||||
Other comprehensive income: |
||||||||||||||||||||||||||||||||
Change in unrealized gains on
securities, after income tax
benefit of $2,154 (net of
reclassification adjustment
of $140, after income tax
expense of $76) |
| | | (4,000 | ) | | (4,000 | ) | | (4,000 | ) | |||||||||||||||||||||
Other-than-temporary
impairment losses not
recognized in the Condensed
Consolidated Statements of
Income, after income tax
expense of $2 |
| | | 4 | | 4 | | 4 | ||||||||||||||||||||||||
Total comprehensive income |
| | | $ | 16,761 | | | | | |||||||||||||||||||||||
Stock-based compensation |
105 | 1 | 567 | | | | 568 | |||||||||||||||||||||||||
Stock options exercised and other |
117 | 1 | 2,012 | | | | 2,013 | |||||||||||||||||||||||||
Balance, March 31, 2011 |
44,970 | $ | 463 | $ | 291,050 | $ | 782,682 | $ | 28,440 | $ | (14,560 | ) | $ | 1,088,075 | ||||||||||||||||||
The accompanying notes are an integral part of these condensed consolidated financial
statements.
5
Table of Contents
CNA SURETY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(UNAUDITED)
Three Months Ended | ||||||||
March 31, | ||||||||
2011 | 2010 | |||||||
(Amounts in thousands) | ||||||||
Cash Flows from Operating Activities: |
||||||||
Net income |
$ | 20,757 | $ | 20,805 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: |
||||||||
Provision for doubtful accounts |
(21 | ) | 95 | |||||
Depreciation and amortization |
1,551 | 1,476 | ||||||
Amortization of bond premium, net |
1,709 | 1,492 | ||||||
Loss on disposal or impairment of property and equipment |
(12 | ) | (49 | ) | ||||
Net realized investment gains |
(313 | ) | (323 | ) | ||||
Stock-based compensation |
567 | 441 | ||||||
Deferred income tax expense |
242 | 661 | ||||||
Changes in: |
||||||||
Insurance receivables |
(9,565 | ) | (10,291 | ) | ||||
Reserve for unearned premiums |
7,960 | 8,395 | ||||||
Reserve for unpaid losses and loss adjustment expenses |
12,014 | 20,335 | ||||||
Deposit with affiliated ceding company |
6,055 | (26 | ) | |||||
Deferred policy acquisition costs |
(2,793 | ) | (2,824 | ) | ||||
Reinsurance and other payables to affiliates |
(36 | ) | 128 | |||||
Prepaid reinsurance premiums |
13 | 13 | ||||||
Accrued expenses |
(8,251 | ) | (6,417 | ) | ||||
Other assets and liabilities |
(8,966 | ) | (7,599 | ) | ||||
Net cash provided by operating activities |
20,911 | 26,312 | ||||||
Cash Flows from Investing Activities: |
||||||||
Fixed income securities: |
||||||||
Purchases |
(65,168 | ) | (63,950 | ) | ||||
Maturities |
26,749 | 14,834 | ||||||
Sales |
5,471 | 8,422 | ||||||
Purchases of equity securities |
(719 | ) | (274 | ) | ||||
Proceeds from the sale of equity securities |
490 | 65 | ||||||
Changes in short-term investments |
8,714 | 9,036 | ||||||
Purchases of property and equipment, net |
(262 | ) | (682 | ) | ||||
Changes in payables for securities purchased |
| 2,070 | ||||||
Net cash (used in) investing activities |
(24,725 | ) | (30,479 | ) | ||||
Cash Flows from Financing Activities: |
||||||||
Employee stock option exercises and other |
2,014 | 363 | ||||||
Net cash provided by financing activities |
2,014 | 363 | ||||||
(Decrease) in cash |
(1,800 | ) | (3,804 | ) | ||||
Cash at beginning of period |
7,313 | 5,822 | ||||||
Cash at end of period |
$ | 5,513 | $ | 2,018 | ||||
Supplemental Disclosure of Cash Flow Information: |
||||||||
Cash paid during the period for: |
||||||||
Interest |
$ | 289 | $ | 288 | ||||
Income taxes |
$ | 14,437 | $ | 14,404 |
The accompanying notes are an integral part of these condensed consolidated financial statements.
6
Table of Contents
CNA SURETY CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2011
(UNAUDITED)
MARCH 31, 2011
(UNAUDITED)
1. General
Formation of CNA Surety Corporation
In December 1996, CNA Financial Corporation (CNAF) and Capsure Holdings Corp. (Capsure)
agreed to merge (the Merger) the surety business of CNAF with Capsures insurance subsidiaries,
Western Surety Company (Western Surety), Surety Bonding Company of America (Surety Bonding) and
Universal Surety of America (Universal Surety), into CNA Surety Corporation (CNA Surety or the
Company). CNAF, through its operating subsidiaries, writes multiple lines of property and
casualty insurance, including surety business that is reinsured by Western Surety. The principal
operating subsidiaries of CNAF that wrote the surety line of business for their own account prior
to the Merger were Continental Casualty Company and its property and casualty affiliates
(collectively, CCC) and The Continental Insurance Company and its property and casualty
affiliates (collectively, CIC). Through its insurance subsidiaries, CNAF owns approximately 61%
of the outstanding common stock of CNA Surety. Loews Corporation owns approximately 90% of the
outstanding common stock of CNAF.
CNAF Proposal
In October 2010, the Company received an unsolicited proposal from CNAF to acquire all of the
outstanding shares of common stock that are not currently owned by subsidiaries of CNAF at a
purchase price of $22.00 per share in cash (the CNAF Proposal). The Companys Board of Directors
appointed a special committee (the Special Committee), comprised solely of the Companys three
independent directors, to review and evaluate the CNAF Proposal. The Special Committee retained
both legal and financial advisors to assist in their consideration of the CNAF Proposal. The
Company incurred expenses of $2.0 million in the first quarter of 2011 and $1.5 million in the
fourth quarter of 2010 directly related to the consideration of the proposal. These expenses are
shown as Other expense in the Condensed Consolidated Statements of Income.
Subsequent Event Merger Agreement and Tender Offer
On April 21, 2011, the Company and CNAF announced that they had signed a definitive merger
agreement pursuant to which CNAF will commence a tender offer to acquire all of the outstanding
shares of common stock of CNA Surety not currently owned by subsidiaries of CNAF for $26.55 per
share in cash.
The transaction has been approved by the Board of Directors of CNA Surety, following the
recommendation and approval of the Special Committee. The tender offer will be conditioned upon,
among other things, acceptance by the holders of a majority of the publicly held shares of CNA
Surety. Subject to the satisfaction of the foregoing, it is currently anticipated that the
transaction will be completed by the end of the second quarter.
Principles of Consolidation
The Condensed Consolidated Financial Statements include the accounts of CNA Surety and all
majority-owned subsidiaries.
Estimates
The preparation of financial statements in conformity with generally accepted accounting
principles (GAAP) requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
7
Table of Contents
Basis of Presentation
These unaudited Condensed Consolidated Financial Statements should be read in conjunction with
the Consolidated Financial Statements and Notes thereto included in the Companys 2010 Form 10-K.
Certain financial information that is included in annual financial statements prepared in
accordance with GAAP is not required for interim reporting and has been condensed or omitted. The
accompanying unaudited Condensed Consolidated Financial Statements reflect, in the opinion of
management, all adjustments necessary for a fair presentation of the interim financial statements.
All such adjustments are of a normal and recurring nature. The financial results for interim
periods may not be indicative of financial results for a full year.
Earnings Per Share
Basic earnings per common share is computed by dividing income available to common
stockholders by the weighted average number of common shares outstanding for the period. For the
purpose of calculating basic earnings per share, restricted stock shares granted under the
Companys stock-based compensation plan that have not yet vested are excluded from common shares
outstanding. Diluted earnings per common share is computed based on the weighted average number of
shares outstanding plus the dilutive effect of common stock equivalents, which includes restricted
stock shares, computed using the treasury stock method.
The computation of earnings per common share is as follows (amounts in thousands, except for
per share data):
Three Months Ended | ||||||||
March 31, | ||||||||
2011 | 2010 | |||||||
Net income |
$ | 20,757 | $ | 20,805 | ||||
Shares: |
||||||||
Weighted average shares outstanding |
44,748 | 44,268 | ||||||
Weighted average shares of options exercised and additional stock issuance |
62 | 12 | ||||||
Total weighted average shares outstanding |
44,810 | 44,280 | ||||||
Effect of dilutive securities: |
||||||||
Common stock options |
271 | 128 | ||||||
Restricted common stock awards |
65 | | ||||||
Other |
11 | 13 | ||||||
Total effect of dilutive securities |
347 | 141 | ||||||
Total weighted average shares outstanding, assuming dilution |
45,157 | 44,421 | ||||||
Earnings per share |
$ | 0.46 | $ | 0.47 | ||||
Earnings per share, assuming dilution |
$ | 0.46 | $ | 0.47 | ||||
No adjustments were made to reported net income in the computation of earnings per share. No
options to purchase shares of common stock were excluded from the calculation of diluted
earnings per share for the three months ended March 31, 2011. At March 31, 2010, 0.7 million
options to purchase shares of common stock were excluded from the calculation of diluted earnings
per share because the exercise price of the options was greater than the average market price of
CNA Suretys common stock.
Adopted Accounting Pronouncements
In December 2010, the Financial Accounting Standards Board (FASB) issued Accounting
Standards Update (ASU) No. 2010-28, Intangibles Goodwill and Other (Topic 350) When to
Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying
Amounts. This guidance clarified application of Step 2 of the goodwill impairment tests. When Step
1 of the goodwill impairment test results in a zero or negative amount, some entities had concluded
that Step 2 of the test was unnecessary because the fair value of their reporting unit would be
greater than zero. The guidance requires an entity to perform Step 2 if it is more likely than not
that an impairment exists. This accounting guidance was effective for fiscal years beginning after
December 15, 2010. The adoption of this guidance did not have an impact on the Companys financial
condition or results of operations.
8
Table of Contents
Pending Accounting Pronouncements
In October 2010, the FASB issued ASU No. 2010-26, Financial Services Insurance (Topic 944)
Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts. This updated
accounting guidance modifies the definition of the types of costs incurred to acquire or renew
insurance contracts that may be capitalized. Under the new guidance, these costs include those
costs that are incremental direct costs and certain costs that are directly related to successful
contract acquisitions. This accounting guidance is effective for fiscal years, and interim periods
within those fiscal years, beginning after December 15, 2011 with prospective or retrospective
application allowed. The Company is currently assessing the available application methods as well
as the impact this accounting guidance will have on its financial condition and results of
operations.
2. Investments
Major categories of net investment income were as follows (dollars in thousands):
Three Months Ended | ||||||||
March 31, | ||||||||
2011 | 2010 | |||||||
Investment income: |
||||||||
Fixed income securities |
$ | 14,750 | $ | 13,666 | ||||
Equity securities |
9 | 8 | ||||||
Short-term investments |
18 | 15 | ||||||
Other |
10 | 13 | ||||||
Total investment income on available-for-sale securities |
14,787 | 13,702 | ||||||
Investment income on deposit with affiliated ceding company |
23 | 26 | ||||||
Investment expenses |
375 | 351 | ||||||
Net investment income |
$ | 14,435 | $ | 13,377 | ||||
The Company did not hold any non-income producing fixed income securities as of March 31, 2011
or December 31, 2010.
9
Table of Contents
Net realized investment gains and losses and the net change in unrealized gains and losses of
available-for-sale securities were as follows (dollars in thousands):
Three Months Ended | ||||||||
March 31, | ||||||||
2011 | 2010 | |||||||
Net realized investment gains (losses): |
||||||||
Fixed income securities: |
||||||||
Gross realized investment gains |
$ | 295 | $ | 425 | ||||
Gross realized investment losses: |
||||||||
Other-than-temporary impairment losses |
| (94 | ) | |||||
Realized losses from sales |
(4 | ) | (19 | ) | ||||
Total gross realized investment losses |
(4 | ) | (113 | ) | ||||
Net realized investment gains on fixed income securities |
291 | 312 | ||||||
Equity securities: |
||||||||
Gross realized investment gains |
22 | 11 | ||||||
Gross realized investment losses: |
||||||||
Other-than-temporary impairment losses |
| | ||||||
Realized losses from sales |
| | ||||||
Total gross realized investment losses |
| | ||||||
Net realized investment gains on equity securities |
22 | 11 | ||||||
Net realized investment gains |
$ | 313 | $ | 323 | ||||
Net change in unrealized gains (losses) |
||||||||
Fixed income securities |
$ | (6,159 | ) | $ | 2,569 | |||
Equity securities |
11 | 21 | ||||||
Total net change in unrealized gains (losses) |
$ | (6,148 | ) | $ | 2,590 | |||
Net realized gains and change in unrealized gains (losses) |
$ | (5,835 | ) | $ | 2,913 | |||
Management believes the Company has the ability to hold all fixed income securities to
maturity. However, the Company may dispose of securities prior to their scheduled maturity due to
changes in interest rates, prepayments, tax and credit considerations, liquidity or regulatory
capital requirements, or other similar factors. As a result, the Company considers all of its fixed
income securities and equity securities as available-for-sale, and as such, they are carried at
fair value.
10
Table of Contents
The amortized cost, gross unrealized gains, gross unrealized losses, estimated fair value
and unrealized other-than-temporary (OTTI) losses of fixed income securities and the cost, gross
unrealized gains, gross unrealized losses and estimated fair value of equity securities held by CNA
Surety at March 31, 2011, by investment category, were as follows (dollars in thousands):
Gross | Gross Unrealized Losses | |||||||||||||||||||||||
Amortized Cost | Unrealized | Less Than | More Than | Estimated | Unrealized | |||||||||||||||||||
March 31, 2011 | or Cost | Gains | 12 Months | 12 Months | Fair Value | OTTI Losses | ||||||||||||||||||
Fixed income securities: |
||||||||||||||||||||||||
U.S. Treasury securities and obligations of
U.S. Government and agencies: |
||||||||||||||||||||||||
U.S. Treasury |
$ | 17,289 | $ | 775 | $ | | $ | | $ | 18,064 | $ | | ||||||||||||
U.S. Agencies |
5,515 | 204 | | | 5,719 | | ||||||||||||||||||
Collateralized mortgage obligations
residential |
18,711 | 1,510 | | | 20,221 | | ||||||||||||||||||
Mortgage pass-through securities
residential |
63,956 | 2,854 | | | 66,810 | | ||||||||||||||||||
Obligations of states and political
subdivisions |
742,575 | 29,256 | (6,130 | ) | (2,083 | ) | 763,618 | | ||||||||||||||||
Corporate bonds |
494,708 | 19,459 | (1,806 | ) | | 512,361 | | |||||||||||||||||
Collateralized mortgage obligations
commercial |
10,016 | 581 | | | 10,597 | | ||||||||||||||||||
Other asset-backed securities: |
||||||||||||||||||||||||
Second mortgages/home equity loans
residential |
1,931 | | | (267 | ) | 1,664 | (873 | )(a) | ||||||||||||||||
Consumer credit receivables |
10,000 | 36 | | | 10,036 | | ||||||||||||||||||
Other |
20,164 | 523 | (43 | ) | | 20,644 | | |||||||||||||||||
Total fixed income securities |
1,384,865 | 55,198 | (7,979 | ) | (2,350 | ) | 1,429,734 | $ | (873 | ) | ||||||||||||||
Equity securities |
1,938 | 240 | | | 2,178 | |||||||||||||||||||
Total |
$ | 1,386,803 | $ | 55,438 | $ | (7,979 | ) | $ | (2,350 | ) | $ | 1,431,912 | ||||||||||||
(a) | The unrealized loss position of this security was $0.3 million at March 31, 2011. |
11
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The amortized cost, gross unrealized gains, gross unrealized losses, estimated fair value
and unrealized OTTI losses of fixed income securities and the cost, gross unrealized gains, gross
unrealized losses and estimated fair value of equity securities held by CNA Surety at December 31,
2010, by investment category, were as follows (dollars in thousands):
Gross | Gross Unrealized Losses | |||||||||||||||||||||||
Amortized Cost | Unrealized | Less Than | More Than | Estimated | Unrealized | |||||||||||||||||||
December 31, 2010 | or Cost | Gains | 12 Months | 12 Months | Fair Value | OTTI Losses | ||||||||||||||||||
Fixed income securities: |
||||||||||||||||||||||||
U.S. Treasury securities and obligations of
U.S. Government and agencies: |
||||||||||||||||||||||||
U.S. Treasury |
$ | 17,288 | $ | 914 | $ | | $ | | $ | 18,202 | $ | | ||||||||||||
U.S. Agencies |
6,518 | 250 | | | 6,768 | | ||||||||||||||||||
Collateralized mortgage obligations
residential |
20,769 | 1,558 | | | 22,327 | | ||||||||||||||||||
Mortgage pass-through securities
residential |
68,727 | 3,320 | | | 72,047 | | ||||||||||||||||||
Obligations of states and political
subdivisions |
746,514 | 30,932 | (5,096 | ) | (1,742 | ) | 770,608 | | ||||||||||||||||
Corporate bonds |
456,963 | 21,164 | (1,249 | ) | (5 | ) | 476,873 | | ||||||||||||||||
Collateralized mortgage obligations
commercial |
10,018 | 567 | | | 10,585 | | ||||||||||||||||||
Other asset-backed securities: |
||||||||||||||||||||||||
Second mortgages/home equity loans
residential |
3,878 | | (84 | ) | (272 | ) | 3,522 | (927 | )(a) | |||||||||||||||
Consumer credit receivables |
9,998 | 158 | | | 10,156 | | ||||||||||||||||||
Other |
12,674 | 617 | (4 | ) | | 13,287 | | |||||||||||||||||
Total fixed income securities |
1,353,347 | 59,480 | (6,433 | ) | (2,019 | ) | 1,404,375 | $ | (927 | ) | ||||||||||||||
Equity securities |
1,687 | 229 | | | 1,916 | |||||||||||||||||||
Total |
$ | 1,355,034 | $ | 59,709 | $ | (6,433 | ) | $ | (2,019 | ) | $ | 1,406,291 | ||||||||||||
(a) | The unrealized loss position of this security was $0.3 million at December 31, 2010. |
As of March 31, 2011 and December 31, 2010, no investments in any single issuer exceeded 10%
of stockholders equity.
A security is in an unrealized loss position, or impaired, if the fair value of the security
is less than its amortized cost, which includes adjustments for accretion, amortization and
previously recorded other-than-temporary impairment losses. When a security is impaired, the
impairment is evaluated to determine whether it is temporary or other-than-temporary.
A significant judgment in the valuation of investments is the determination of when an
other-than-temporary decline in value has occurred. The Company follows a consistent and systematic
process for identifying securities that sustain other-than-temporary declines in value. The Company
has established a watch list that is reviewed by the Chief Financial Officer and one other
executive officer on at least a quarterly basis. The watch list includes individual securities that
fall below certain thresholds or that exhibit evidence of impairment indicators including, but not
limited to, a significant adverse change in the financial condition and near-term prospects of the
investment or a significant adverse change in legal factors, the business climate or credit
ratings.
When a security is placed on the watch list, it is monitored for further market value changes
and additional news related to the issuers financial condition. The focus is on objective evidence
that may influence the evaluation of impairment factors. The decision to record an
other-than-temporary impairment loss incorporates both quantitative criteria and qualitative
information.
In determining whether an equity security is other-than-temporarily impaired, the Company
considers a number of factors including, but not limited to: (a) the length of time and the extent
to which the market value has been less than book value, (b) the financial condition and near-term
prospects of the issuer, (c) the intent and ability of the Company to retain its investment for a
period of time sufficient to allow for any anticipated recovery in value and (d) general market
conditions and industry or sector specific factors. Currently, the Companys equity portfolio is
comprised solely of mutual funds related to the Companys deferred compensation plan, which is an
unfunded, nonqualified deferred compensation plan for a select group of management or highly
compensated employees. Due to the nature of the plan, the Company does not assert the ability to
hold
12
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these securities until an anticipated recovery in value. As such, if any of these securities
are in an unrealized loss position, they are considered to be other-than-temporarily impaired.
For equity securities for which an other-than-temporary impairment loss has been identified,
the security is written down to fair value and the resulting losses are recognized in realized
gains/losses in the Condensed Consolidated Statements of Income.
Based on the Companys evaluation of this quantitative criteria and qualitative information,
the Company recorded no OTTI losses on equity securities for the three months ended March 31, 2011
and 2010, respectively.
Fixed income securities in an unrealized loss position that the Company intends to sell, or it
more likely than not will be required to sell before any anticipated recovery of amortized cost,
are considered to be other-than-temporarily impaired. These securities are written down to fair
value and the resulting losses are recognized in realized gains/losses in the Condensed
Consolidated Statements of Income.
The remaining fixed income securities in an unrealized loss position are evaluated to
determine if a credit loss exists. To determine if a credit loss exists, the Company considers a
number of factors including, but not limited to: (a) the financial condition and near-term
prospects of the issuer, (b) credit ratings of the securities, (c) whether the debtor is current on
interest and principal payments, (d) the length of time and the extent to which the market value
has been less than book value and (e) general market conditions and industry or sector specific
factors.
In addition to these factors, the Company considers the results of discounted cash flow
modeling using assumptions representative of current market conditions as well as those specific to
the Companys particular security holdings. For asset-backed and mortgage-backed securities, the
focus of this analysis is on assessing the sufficiency and quality of underlying collateral and
timing of cash flows. Significant assumptions considered by the Company in its cash flow
projections include delinquency rates, probable risk of default, over collateralization and credit
support from lower level tranches. If the discounted expected cash flows for a security equal or
exceed the amortized cost of that security, no credit loss exists and the security is deemed to be
temporarily impaired.
Fixed income securities in an unrealized loss position for which management believes a credit
loss exists are considered to be other-than-temporarily impaired. For these fixed income
securities, the Company bifurcates OTTI losses into a credit component and a non-credit component.
The credit component, which represents the difference between the discounted expected cash flows
and the fixed income securitys amortized cost, is recognized in earnings. The non-credit component
is recognized in other comprehensive income and represents the difference between fair value and
the discounted cash flows that the Company expects to collect.
Based on the Companys evaluation of this quantitative criteria and qualitative information,
the Company did not record credit-related OTTI losses on fixed income securities during the three
months ended March 31, 2011. During the three months ended March 31, 2010, the Company recorded
credit-related OTTI losses of $0.1 million on a security collateralized by sub-prime home loans and
rated below investment grade by Standard & Poors (S&P). The Company initially recorded
credit-related OTTI losses on this security in the second quarter of 2009.
The following table presents a roll-forward of the Companys cumulative credit losses
recognized in net realized gains/ losses on the Condensed Consolidated Statements of Income on
fixed income securities held as of March 31, 2011 and 2010, respectively (in thousands of dollars):
Three Months Ended March 31, | ||||||||
2011 | 2010 | |||||||
Beginning balance |
$ | 238 | $ | 116 | ||||
Credit losses for which an OTTI loss was not previously recognized |
| | ||||||
Credit losses for which an OTTI loss was previously recognized |
| 94 | ||||||
Ending balance |
$ | 238 | $ | 210 | ||||
13
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The amortized cost and estimated fair value of fixed income securities, by contractual
maturity, at March 31, 2011 and December 31, 2010 are shown below. Actual maturities may differ
from contractual maturities as borrowers may have the right to call or prepay obligations with or
without call or prepayment penalties (dollars in thousands):
March 31, 2011 | December 31, 2010 | |||||||||||||||
Amortized | Estimated Fair | Amortized | Estimated Fair | |||||||||||||
Cost | Value | Cost | Value | |||||||||||||
Fixed income securities: |
||||||||||||||||
Due within one year |
$ | 43,703 | $ | 44,313 | $ | 39,649 | $ | 40,035 | ||||||||
Due after one year but within five years |
418,872 | 437,713 | 422,319 | 441,895 | ||||||||||||
Due after five years but within ten years |
529,294 | 552,111 | 480,548 | 507,793 | ||||||||||||
Due after ten years |
268,218 | 265,625 | 284,767 | 282,728 | ||||||||||||
1,260,087 | 1,299,762 | 1,227,283 | 1,272,451 | |||||||||||||
Mortgage pass-through securities,
collateralized mortgage obligations and
asset-backed securities |
124,778 | 129,972 | 126,064 | 131,924 | ||||||||||||
$ | 1,384,865 | $ | 1,429,734 | $ | 1,353,347 | $ | 1,404,375 | |||||||||
The following table provides the composition of fixed income securities with an unrealized
loss at March 31, 2011 in relation to the total of all fixed income securities in an unrealized
loss position by contractual maturities:
% of | ||||||||
Estimated | % of | |||||||
Fair | Unrealized | |||||||
Contractual Maturity | Value | Loss | ||||||
Due after one year through five years |
16 | % | 6 | % | ||||
Due after five years through ten years |
37 | 24 | ||||||
Due after ten years |
43 | 67 | ||||||
Asset-backed securities |
4 | 3 | ||||||
Total |
100 | % | 100 | % | ||||
The following table summarizes for fixed income securities in an unrealized loss position at
March 31, 2011 and December 31, 2010, the aggregate fair value and gross unrealized loss by length
of time those securities have been continuously in an unrealized loss position (dollars in
thousands):
March 31, 2011 | December 31, 2010 | |||||||||||||||
Gross | Gross | |||||||||||||||
Estimated | Unrealized | Estimated | Unrealized | |||||||||||||
Unrealized Loss Aging | Fair Value | Loss | Fair Value | Loss | ||||||||||||
Fixed income securities: |
||||||||||||||||
Investment grade (a): |
||||||||||||||||
0-6 months |
$ | 281,785 | $ | 7,945 | $ | 223,778 | $ | 6,350 | ||||||||
Greater than 24 months |
4,785 | 760 | 7,903 | 663 | ||||||||||||
Total investment grade |
286,570 | 8,705 | 231,681 | 7,013 | ||||||||||||
Non-investment grade: |
||||||||||||||||
0-6 months |
6,208 | 25 | 11,256 | 83 | ||||||||||||
7-12 months |
1,532 | 9 | | | ||||||||||||
Greater than 24 months |
11,168 | 1,590 | 11,522 | 1,356 | ||||||||||||
Total non-investment grade |
18,908 | 1,624 | 22,778 | 1,439 | ||||||||||||
Total |
$ | 305,478 | $ | 10,329 | $ | 254,459 | $ | 8,452 | ||||||||
(a) | Investment grade is determined by using the S&P rating. If a security is not rated by S&P, the Moodys Investor Services (Moodys) rating is used. As of March 31, 2011 and December 31, 2010, all of the Companys fixed income securities were rated by S&P or Moodys. |
At March 31, 2011, the Company holds 275 fixed income securities in an unrealized gain
position with a total estimated fair value of $1,124.3 million in a gross unrealized gain position
of $55.2 million in the aggregate.
14
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The following table summarizes securities in a gross unrealized loss position by investment
category and by credit rating. The table also discloses the corresponding count of securities in an
unrealized loss position and estimated fair value by category (in thousands of dollars):
Gross Unrealized Losses | Estimated | |||||||||||||||||||||||||||
March 31, 2011 | AAA | AA | A | BBB | Total | Count | Fair Value | |||||||||||||||||||||
Fixed income securities: |
||||||||||||||||||||||||||||
Investment grade(a): |
||||||||||||||||||||||||||||
Obligations of states and political subdivisions |
$ | 577 | $ | 4,170 | $ | 2,143 | $ | | $ | 6,890 | 34 | $ | 173,884 | |||||||||||||||
Corporate bonds |
| 39 | 1,405 | 328 | 1,772 | 22 | 102,232 | |||||||||||||||||||||
Other asset-backed securities: |
||||||||||||||||||||||||||||
Other |
43 | | | | 43 | 2 | 10,454 | |||||||||||||||||||||
Total investment grade |
620 | 4,209 | 3,548 | 328 | 8,705 | 58 | 286,570 | |||||||||||||||||||||
Non-investment grade: |
||||||||||||||||||||||||||||
Obligations of states and political subdivisions |
| | | | 1,323 | 1 | 9,504 | |||||||||||||||||||||
Corporate bonds |
| | | | 34 | 5 | 7,740 | |||||||||||||||||||||
Other asset-backed securities: |
||||||||||||||||||||||||||||
Second mortgages/home equity loans
residential |
| | | | 267 | 1 | 1,664 | |||||||||||||||||||||
Total non-investment grade |
| | | | 1,624 | 7 | 18,908 | |||||||||||||||||||||
Total |
$ | 620 | $ | 4,209 | $ | 3,548 | $ | 328 | $ | 10,329 | 65 | $ | 305,478 | |||||||||||||||
(a) | Securities are categorized using the S&P rating. If a security is not rated by S&P, the Moodys rating is used. At March 31, 2011, all of the Companys fixed income securities were rated by S&P or Moodys. |
The unrealized losses on the Companys investments in obligations of states and political
subdivisions are due to changes in credit spreads and rising interest rates. Of the thirty-four
investment grade obligations of states and political subdivisions in an unrealized loss position at
March 31, 2011, only nine were in an unrealized loss position exceeding 5% of the securitys
amortized cost. The largest unrealized loss, $0.8 million, or 13.7% of the securitys amortized
cost, was on a security issued by a governmental utility authority. The unrealized loss position of
this security has deteriorated slightly compared to December 31, 2010 when it was $0.7 million, or
11.9% of the securitys amortized cost.
While the overall unrealized loss position of obligations of states and political subdivisions
grew from $5.8 million, or 3.4% of their amortized cost, at December 31, 2010 to $6.9 million, or
3.8% of their amortized cost at March 31, 2011, the Company continues to believe that all interest
and principal will be paid according to their contractual terms. In addition to credit reviews,
each municipal bond investment is reviewed as to the sources of debt service and the margins of
safety around those sources. The Companys municipal bond investments are focused in revenue bonds
and full-faith-and-credit general obligation bonds. For revenue bonds, the focus is on bonds where
the sources of debt service are from fees from public universities, transportation, such as toll
ways and airports, and essential services, such as power, water and sewer. The Company focuses on
bonds where there is a monopoly provider with ratemaking authority and where there are specific
taxes pledged directly to bond repayments. The Company has no current intent to sell these
securities, nor is it more likely than not that it will be required to sell prior to recovery of
amortized cost. The Company does not believe the unrealized losses on these securities are
indicative of credit losses and, as such, has not recorded an OTTI loss on these securities at
March 31, 2011.
Of the Companys twenty-two investment grade corporate bond investments in an unrealized loss
position at March 31, 2011, the largest unrealized loss was $0.3 million, or 4.8% of the amortized
cost of a security issued by a public utility. Only one of these corporate bond investments was in
an unrealized loss position that exceeded 5% of the securitys amortized cost. This security, also
issued by a public utility, had an unrealized loss of $0.2 million, or 5.4% of the securitys
amortized cost. Interest rate increases in the first quarter of 2011 caused the overall unrealized
loss position on the Companys investment grade corporate bond holdings to increase by $0.6 million
at March 31, 2011 compared to December 31, 2010. The Company has no current intent to sell these
securities, nor is it more likely than not that it will be required to sell prior to recovery of
amortized cost. The Company does not believe the unrealized losses on these securities are
indicative of credit losses and, as such, has not recorded any OTTI losses on these securities at
March 31, 2011.
Two investment grade asset-backed securities held by the Company were in an unrealized loss
position at March 31, 2011. Neither of these securities was in an unrealized loss position that
exceeded 5% of the securitys amortized cost. The Company
15
Table of Contents
has no current intent to sell these securities, nor is it more likely than not that it will be
required to sell prior to recovery of amortized cost. The Company does not believe the unrealized
losses on these securities are indicative of credit losses and, as such, has not recorded any OTTI
losses on these securities at March 31, 2011.
Only one of the Companys investments in obligations of states and political subdivisions was
rated below investment grade and was in an unrealized loss position at March 31, 2011. This
security, issued by a governmental utility authority, was in an unrealized loss position of $1.3
million, or 12.2% of its amortized cost, at March 31, 2011. The Company believes that this security
is rated below investment grade because an inconsequential contingency amount is insured with one
of the major monoline insurers which is rated B by S&P. The Company believes that this insurer is
the lowest rated source of security involved in the transaction and, despite the fact that the
amount of security provided by this insurer is inconsequential, the entire transaction is rated to
the lowest rated component. Based on the Companys analysis of the sources of debt service on this
bond and the fact that the security is current on all interest payments due through March 31, 2011,
the Company continues to believe that all interest and principal will be paid according to their
contractual terms. The Company has no current intent to sell this security, nor is it more likely
than not that it will be required to sell prior to recovery of amortized cost. The Company does not
believe the unrealized loss on this security is indicative of credit loss and, as such, has
not recorded an OTTI loss on this security at March 31, 2011.
During 2010, the Company began a program to invest a modest amount in non-investment grade
corporate bonds due to the relative attractiveness of this sector. Five of the securities purchased
under this program were in an unrealized loss position at March 31, 2011. In the aggregate, these
five securities had an unrealized loss of less than $0.1 million as of March 31, 2011. Each of
these securities was in an unrealized loss position representing 0.6% or less of that securitys
amortized cost. The Company has no current intent to sell these securities, nor is it more likely
than not that it will be required to sell prior to recovery of amortized cost. The Company does not
believe the unrealized losses on these securities are indicative of credit losses and, as such, has
not recorded an OTTI loss on these securities at March 31, 2011.
At March 31, 2011 the Companys exposure to sub-prime home loans was limited to one
asset-backed security collateralized by sub-prime home loans which originated prior to 2005. The
estimated fair value of this non-investment grade security was $1.7 million at March 31, 2011. This
security was in an unrealized loss position of $0.3 million, or 13.8% of its amortized cost at
March 31, 2011. During 2011, the Company received repayments on this security of $0.1 million, or
approximately 5% of the par value outstanding at December 31, 2010. As discussed previously, the
Company previously recorded credit-related OTTI losses on this security, however, the Company
determined that there were no additional credit losses during the first quarter of 2011. The
Company believes the non-credit component of the unrealized loss on this security is primarily
attributable to this asset class being out of favor with investors and is not indicative of the
quality of the underlying collateral. The Company has no current intent to sell this security, nor
is it more likely than not that it will be required to sell prior to recovery of the adjusted
amortized cost.
Based on the current facts and circumstances discussed above for the Companys securities in
an unrealized loss position, the Company has determined that no additional OTTI losses related to
the securities in an unrealized loss position are required to be recorded at March 31, 2011.
Invested assets are exposed to various risks, such as interest rate, market and credit risks.
Due to the level of risk associated with certain of these invested assets and the level of
uncertainty related to changes in the value of these assets, it is possible that changes in risks
in the near term may significantly affect the amounts reported in the Condensed Consolidated
Balance Sheets and Condensed Consolidated Statements of Income.
16
Table of Contents
3. Reinsurance
The Companys insurance subsidiaries, in the ordinary course of business, cede insurance to
other insurance companies and affiliates. Reinsurance arrangements are used to limit maximum loss,
provide greater diversification of risk, minimize exposure on larger risks and to meet certain
regulatory restrictions that would otherwise limit the size of bonds the Company can write.
Reinsurance contracts do not relieve the Company of its primary obligations to claimants.
Therefore, a contingent liability exists with respect to insurance ceded to the extent that any
reinsurer is unable to meet the obligations assumed under the reinsurance contracts. The Company
evaluates the financial condition of its reinsurers, assesses the need for allowances for
uncollectible amounts and monitors concentrations of credit risk.
There were no amounts past due under reinsurance contracts and no allowances were established
for uncollectible reinsurance receivables at March 31, 2011 or December 31, 2010.
The effect of reinsurance on the Companys written and earned premium was as follows (dollars
in thousands):
Three Months Ended March 31, | ||||||||||||||||
2011 | 2010 | |||||||||||||||
Written | Earned | Written | Earned | |||||||||||||
Direct |
$ | 88,882 | $ | 80,602 | $ | 91,963 | $ | 81,879 | ||||||||
Assumed |
21,209 | 21,529 | 20,564 | 22,253 | ||||||||||||
Ceded |
(5,461 | ) | (5,473 | ) | (5,867 | ) | (5,880 | ) | ||||||||
Net premiums |
$ | 104,630 | $ | 96,658 | $ | 106,660 | $ | 98,252 | ||||||||
Assumed premiums primarily include surety business written or renewed, net of reinsurance, by
CCC and CIC after September 30, 1997 that is reinsured by Western Surety pursuant to reinsurance
and related agreements. Because of certain regulatory restrictions that limit Western Suretys
ability to write certain business on a direct basis, the Company utilizes the underwriting capacity
available through these agreements while retaining control of the underwriting and claim management
of the assumed business.
Assumed premium also includes surety business written by another affiliate, First Insurance
Company of Hawaii, Ltd. and its subsidiaries First Indemnity Insurance of Hawaii, Inc., First Fire
and Casualty Insurance of Hawaii, Inc. and First Security Insurance of Hawaii, Inc. (collectively,
FICOH). Through its insurance subsidiaries, CNAF owns approximately 50% of the outstanding common
stock of First Insurance Company of Hawaii, Ltd. Under the terms of this excess of loss agreement
effective January 1, 2011 through December 31, 2011 that covers certain contract surety business,
FICOH retains losses of $2 million per principal and Western Surety assumes 80% of $5 million per
principal in excess of $2 million subject to an aggregate annual limit of $8 million. Premiums
assumed by Western Surety under this agreement were less than $0.1 million for both the three
months ended March 31, 2011 and 2010.
CNA Surety also assumes premium on contract and commercial surety bonds for international
risks. Such premiums are assumed pursuant to the terms of reinsurance treaties or as a result of
specific international bond requirements of domestic customers. For the three month periods ended
March 31, 2011 and 2010, assumed premiums written under such arrangements were $1.1 million and
$1.3 million, respectively.
The effect of reinsurance on the Companys provision for loss and loss adjustment expenses and
the corresponding ratio to earned premium was as follows (dollars in thousands):
Three Months Ended March 31, | ||||||||||||||||
2011 | 2010 | |||||||||||||||
$ | Ratio | $ | Ratio | |||||||||||||
Gross losses and loss adjustment expenses |
$ | 29,618 | 29.0 | % | $ | 27,815 | 26.7 | % | ||||||||
Ceded amounts |
(1,587 | ) | 29.0 | % | 766 | (13.0 | )% | |||||||||
Net losses and loss adjustment expenses |
$ | 28,031 | 29.0 | % | $ | 28,581 | 29.1 | % | ||||||||
The unusual impact of ceded amounts as an increase in net loss and loss adjustment expenses
for the three months ended March 31, 2010 resulted from large indemnification recoveries on claims
subject to excess of loss reinsurance contracts.
17
Table of Contents
Excess of Loss Reinsurance
The Companys ceded reinsurance program is predominantly comprised of excess of loss
reinsurance contracts that limit the Companys retention on a per principal basis. The Companys
reinsurance coverage is provided by third party reinsurers and related parties. Due to the terms of
these excess of loss treaties, reinsurers may cover some principals in one year but then exclude
these same principals in subsequent years. As a result, the Company may have exposures to these
principals that have limited or no reinsurance coverage.
2010 Third Party Reinsurance
Effective January 1, 2010, CNA Surety entered into an excess of loss treaty (2010 Excess of
Loss Treaty) with a group of third party reinsurers on terms similar to the excess of loss treaty
effective in 2009. Under the 2010 Excess of Loss Treaty, the Companys net retention per principal
was $15 million with a 5% co-participation in the $90 million layer of third party reinsurance
coverage above the Companys retention. The contract provided aggregate coverage of $185 million
and included an optional extended discovery period, which was not exercised. The contract also
included a provision for additional premiums of up to $12.3 million based on losses ceded under the
contract. The actual ceded premiums for the 2010 Excess of Loss Treaty were $23.7 million.
2011 Third Party Reinsurance
Effective January 1, 2011, CNA Surety entered into an excess of loss treaty (2011 Excess of
Loss Treaty) with a group of third party reinsurers on terms similar to the 2010 Excess of Loss
Treaty. Under the 2011 Excess of Loss Treaty, the Companys net retention per principal remains at
$15 million with a 5% co-participation in the $90 million layer of third party reinsurance coverage
above the Companys retention. The contract provides aggregate coverage of $185 million and
includes an optional extended discovery period, for an additional premium (a percentage of the
original premium based on any unexhausted aggregate limit by layer), which will provide coverage
for losses discovered beyond 2011 on bonds that were in force during 2011. The contract also
includes a provision for additional premiums of up to $10.7 million based on losses ceded under the
contract. The base annual premium for the 2011 Excess of Loss Treaty is $21.7 million.
Related Party Reinsurance
Reinsurance agreements together with the Services and Indemnity Agreement described below
provide for the transfer of the surety business written by CCC and CIC to Western Surety.
Agreements originally entered into on September 30, 1997 (the Merger Date) include: (i) the
Surety Quota Share Treaty (the Quota Share Treaty) and (ii) the Aggregate Stop Loss Reinsurance
Contract (the Stop Loss Contract). Although the contracts entered on the Merger Date have
expired, some have been renewed on different terms as described below.
Through the Quota Share Treaty, CCC and CIC transfer to Western Surety surety business written
or renewed by CCC and CIC after the Merger Date. The Quota Share Treaty was renewed on January 1,
2011 and expires on December 31, 2011 and is annually renewable thereafter. CCC and CIC transfer
the related liabilities of such business and pay to Western Surety an amount in cash equal to CCCs
and CICs net written premiums written on all such business, minus a quarterly ceding commission to
be retained by CCC and CIC equal to $50,000 plus 25% of net written premiums written on all such
business. For 2010, this resulted in an override commission on their actual direct acquisition
costs of 4.7% to CCC and CIC.
Under the terms of the Quota Share Treaty, CCC has guaranteed the loss and loss adjustment
expense reserves transferred to Western Surety as of the Merger Date by agreeing to pay Western
Surety, within 30 days following the end of each calendar quarter, the amount of any adverse
development on such reserves, as re-estimated as of the end of such calendar quarter. There was no
adverse reserve development for the period from the Merger Date through March 31, 2011.
Through the Stop Loss Contract, the Companys insurance subsidiaries were protected from
adverse loss development on certain business underwritten after the Merger Date. The Stop Loss
Contract between the Companys insurance subsidiaries and CCC limited the insurance subsidiaries
prospective net loss ratios with respect to certain accounts and lines of insured business for
three full accident years following the Merger Date. In the event the insurance subsidiaries
accident year net loss ratio exceeds 24% in any of the accident years 1997 through 2000 on certain
insured accounts (the Loss Ratio Cap), the Stop Loss Contract requires CCC at the end of each
calendar quarter following the Merger Date, to pay to the insurance subsidiaries a dollar amount
equal to (i) the amount, if any, by which the Companys actual accident year net loss ratio exceeds
the
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applicable Loss Ratio Cap, multiplied by (ii) the applicable net earned premiums. In
consideration for the coverage provided by the Stop Loss Contract, the Companys insurance
subsidiaries paid CCC an annual premium of $20,000. The CNA Surety insurance subsidiaries have paid
CCC all required annual premiums. Through March 31, 2011 and December 31, 2010, losses incurred
under the Stop Loss Contract were $47.2 million. At March 31, 2011, the amount received under the
Stop Loss Contract included $2.8 million held by the Company for losses covered under this contract
that were incurred but not paid.
The Services and Indemnity Agreement provides the Companys insurance subsidiaries with the
authority to perform various administrative, management, underwriting and claim functions in order
to conduct the surety business of CCC and CIC and to be reimbursed by CCC for services rendered. In
consideration for providing the foregoing services, CCC has agreed to pay Western Surety a
quarterly fee of $50,000. This agreement was renewed on January 1, 2011 and expires on December
31, 2011 and is annually renewable thereafter. As of March 31, 2011, there were no amounts due to
the CNA Surety insurance subsidiaries under this agreement.
On January 1, 2010, the Company and CCC entered into separate agreements that provide for the
transfer of the Canadian surety business of CCC to Western Surety. These agreements, which include
a quota share treaty (the Canadian Quota Share Treaty) and a services and indemnity agreement
(the Canadian Services and Indemnity Agreement), are substantially similar to the Quota Share
Treaty and the Services and Indemnity Agreement discussed above. The Canadian Services and
Indemnity Agreement provides Western Surety with the authority to supervise various administrative,
underwriting and claim functions associated with the surety business written by CCC, through its
Canadian branch, on behalf of the Company. Through the Canadian Quota Share Treaty, this Canadian
surety business is transferred to Western Surety. Pursuant to these agreements, CCC will transfer
the subject premium and related liabilities of such business and pay to Western Surety an amount
equal to CCCs net written premiums on all such business, minus a ceding commission of 33.5% of net
written premiums. Further, Western Surety will pay an additional ceding commission to CCC in the
amount of actual direct expense in producing such premium. This agreement was renewed on January 1,
2011 and expires on December 31, 2011 and is annually renewable thereafter.
As of March 31, 2011 and December 31, 2010, CNA Surety had an insurance receivable balance
from CCC and CIC of $8.9 million and $10.8 million, respectively, comprised of premiums receivable.
At March 31, 2011 and December 31, 2010, CNA Surety had no reinsurance receivable from affiliates.
CNA Surety had no reinsurance payables to CCC or CIC as of March 31, 2011 or December 31, 2010.
The Companys Condensed Consolidated Balance Sheets also include a Deposit with affiliated
ceding company of $17.4 million and $23.4 million at March 31, 2011 and December 31, 2010,
respectively. In 2005, pursuant to an agreement with the claimant on a bond regarding certain
aspects of the claim resolution, the Company deposited $32.7 million with an affiliate to enable
the affiliate to establish a trust to fund future payments under the bond. The bond was written by
the affiliate and assumed by one of the Companys insurance subsidiaries pursuant to the Quota
Share Treaty. The Company is entitled to the interest income earned by the trust. Prior to the
establishment of the trust, the Company had fully reserved its obligation under the bond and the
claim remains fully reserved.
4. Fair Value of Financial Instruments
Fair value is the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the measurement date. The
Company uses the following fair value hierarchy in selecting inputs, with the highest priority
given to Level 1, as these are the most transparent or reliable:
| Level 1 Quoted prices for identical instruments in active markets. | ||
| Level 2 Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs are observable in active markets. | ||
| Level 3 Valuations derived from valuation techniques in which one or more significant inputs are unobservable. |
The Company utilizes a pricing service for the valuation of the majority of securities held.
This pricing service is an independent, third party vendor recognized to be an industry leader with
access to market information who obtains or computes fair market values from quoted market prices,
pricing for similar securities, recently executed transactions, cash flow
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models with yield curves and other pricing models. For valuations obtained from the pricing
service, the Company performs due diligence to understand how the valuation was calculated or
derived, focusing on the valuation technique used and the nature of the inputs.
The following section describes the valuation methodologies used to measure different
financial instruments at fair value, including an indication of the level in the fair value
hierarchy in which the instrument is generally classified.
Fixed Income Securities
Securities valued using Level 1 inputs include highly liquid government bonds for which quoted
market prices are available. Securities using Level 2 inputs are valued using pricing for similar
securities, recently executed transactions, cash flow models with yield curves and other pricing
models utilizing observable inputs. Most fixed income securities are valued using Level 2 inputs.
Level 2 includes corporate bonds, municipal bonds, asset-backed securities and mortgage
pass-through securities.
Equity Securities
Level 1 includes publicly traded securities valued using quoted market prices.
Short-Term Investments
The valuation of securities that are actively traded and have quoted prices are classified as
Level 1. These securities include money market funds and U.S. Treasury bills. Level 2 includes
commercial paper, for which all significant inputs are observable.
Assets measured at fair value on a recurring basis as of March 31, 2011 and December 31, 2010
are summarized below (amounts in thousands):
March 31, 2011 | ||||||||||||||||
Fair Value Measurement Using | Assets at Fair | |||||||||||||||
Level 1 | Level 2 | Level 3 | Value | |||||||||||||
Assets: |
||||||||||||||||
Fixed income securities: |
||||||||||||||||
U.S. Treasury securities and obligations of U.S.
Government and agencies: |
||||||||||||||||
U.S. Treasury |
$ | 18,064 | $ | | $ | | $ | 18,064 | ||||||||
U.S. Agencies |
| 5,719 | | 5,719 | ||||||||||||
Collateralized mortgage obligations residential |
| 20,221 | | 20,221 | ||||||||||||
Mortgage pass-through securities residential |
| 66,810 | | 66,810 | ||||||||||||
Obligations of states and political subdivisions |
| 763,618 | | 763,618 | ||||||||||||
Corporate bonds |
| 512,361 | | 512,361 | ||||||||||||
Collateralized mortgage obligations commercial |
| 10,597 | | 10,597 | ||||||||||||
Other asset-backed securities: |
||||||||||||||||
Second mortgages/home equity loans residential |
| 1,664 | | 1,664 | ||||||||||||
Consumer credit receivables |
| 10,036 | | 10,036 | ||||||||||||
Other |
| 20,644 | | 20,644 | ||||||||||||
Total fixed income securities |
18,064 | 1,411,670 | | 1,429,734 | ||||||||||||
Equity securities at fair value |
2,178 | | | 2,178 | ||||||||||||
Short-term investments at fair value (a) |
24,397 | 19,989 | | 44,386 | ||||||||||||
Total assets |
$ | 44,639 | $ | 1,431,659 | $ | | $ | 1,476,298 | ||||||||
(a) | Includes commercial paper, U.S. Government agency discount notes and money market funds. |
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December 31, 2010 | ||||||||||||||||
Fair Value Measurement Using | Assets at Fair | |||||||||||||||
Level 1 | Level 2 | Level 3 | Value | |||||||||||||
Assets: |
||||||||||||||||
Fixed income securities: |
||||||||||||||||
U.S. Treasury securities and obligations of U.S.
Government and agencies: |
||||||||||||||||
U.S. Treasury |
$ | 18,202 | $ | | $ | | $ | 18,202 | ||||||||
U.S. Agencies |
| 6,768 | | 6,768 | ||||||||||||
Collateralized mortgage obligations residential |
| 22,327 | | 22,327 | ||||||||||||
Mortgage pass-through securities residential |
| 72,047 | | 72,047 | ||||||||||||
Obligations of states and political subdivisions |
| 770,608 | | 770,608 | ||||||||||||
Corporate bonds |
| 476,873 | | 476,873 | ||||||||||||
Collateralized mortgage obligations commercial |
| 10,585 | | 10,585 | ||||||||||||
Other asset-backed securities: |
||||||||||||||||
Second mortgages/home equity loans residential |
| 3,522 | | 3,522 | ||||||||||||
Consumer credit receivables |
| 10,156 | | 10,156 | ||||||||||||
Other |
| 13,287 | | 13,287 | ||||||||||||
Total fixed income securities |
18,202 | 1,386,173 | | 1,404,375 | ||||||||||||
Equity securities at fair value |
1,916 | | | 1,916 | ||||||||||||
Short-term investments at fair value (a) |
16,842 | 36,247 | | 53,089 | ||||||||||||
Total assets |
$ | 36,960 | $ | 1,422,420 | $ | | $ | 1,459,380 | ||||||||
(a) | Includes commercial paper, U.S. Government agency discount notes and money market funds. |
5. Reserves for Losses and Loss Adjustment Expenses
Activity in the reserves for unpaid losses and loss adjustment expenses was as follows
(dollars in thousands):
Three Months Ended | ||||||||
March 31, | ||||||||
2011 | 2010 | |||||||
Reserves at beginning of period: |
||||||||
Gross |
$ | 389,089 | $ | 406,123 | ||||
Ceded reinsurance |
43,007 | 50,968 | ||||||
Net reserves at beginning of period |
346,082 | 355,155 | ||||||
Net incurred loss and loss adjustment expenses: |
||||||||
Provision for insured events of current year |
28,031 | 28,581 | ||||||
Increase (decrease) in provision for insured events of prior years |
| | ||||||
Total net incurred |
28,031 | 28,581 | ||||||
Net payments attributable to: |
||||||||
Current year events |
778 | 690 | ||||||
Prior year events |
16,568 | 8,092 | ||||||
Total net payments |
17,346 | 8,782 | ||||||
Foreign currency transaction adjustments |
98 | 74 | ||||||
Net reserves at end of period |
356,865 | 375,028 | ||||||
Ceded reinsurance at end of period |
44,238 | 51,430 | ||||||
Gross reserves at end of period |
$ | 401,103 | $ | 426,458 | ||||
6. Debt
In May 2004, the Company, through a wholly-owned trust, privately issued $30.0 million of
preferred securities through two pooled transactions. These securities, issued by CNA Surety
Capital Trust I (the Issuer Trust), bear interest at the London Interbank Offered Rate (LIBOR)
plus 337.5 basis points with a 30-year term. As of May 2009, the Company may redeem these
securities, in whole or in part, at par value at any scheduled quarterly interest payment date. As
of March 31, 2011, none of these preferred securities have been redeemed.
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The Companys investment of $0.9 million in the Issuer Trust is carried at cost in Other
assets in the Companys Condensed Consolidated Balance Sheets. The sole asset of the Issuer Trust
consists of a $30.9 million junior subordinated debenture issued by the Company to the Issuer
Trust. Due to the underlying characteristics of this debt, the carrying value of the debenture
approximates its estimated fair value.
The Company has also guaranteed the dividend payments and redemption of the preferred
securities issued by the Issuer Trust. The maximum amount of undiscounted future payments the
Company could make under the guarantee is approximately $55.6 million, consisting of annual
dividend payments of approximately $1.1 million until maturity and the redemption value of the
preferred securities of $30.0 million. Because payment under the guarantee would only be required
if the Company does not fulfill its obligations under the debentures held by the Issuer Trust, the
Company has not recorded any additional liabilities related to this guarantee.
The junior subordinated debenture bears interest at a rate of LIBOR plus 337.5 basis points
and matures in April 2034. As of March 31, 2011 and 2010, the interest rate on the junior
subordinated debenture was 3.688% and 3.625%, respectively.
7. Employee Benefits
Western Surety sponsors two postretirement benefit plans covering certain employees. One plan
provides medical benefits and the other plan provides sick leave termination payments. The medical
benefit plan provides coverage for employees, and their eligible dependents, hired by Western
Surety before November 1, 1992 and who retire at age 55 or later with at least 15 years of service.
Only employees hired by Western Surety prior to 1988 are eligible for the sick leave plan. Further,
benefits for the sick leave plan are based on unused accrued sick leave as of December 31, 2003,
the date the accruals were frozen. The postretirement medical benefit plan is contributory and the
sick leave plan is non-contributory. Western Surety uses a December 31 measurement date for both of
its postretirement benefit plans. There were no plan assets for either of the postretirement
benefit plans at March 31, 2011 or December 31, 2010.
The postretirement benefit plan that provides medical benefits has been determined to be
actuarially equivalent to Medicare Part D on an estimated basis under the rules provided in final
regulations issued in 2005. As such, the federal subsidy to plan sponsors under the Medicare
Modernization Act has been recognized in the accounting for that plan. In 2010, enactment of the
Patient Protection and Affordable Care Act (the Act) and the Healthcare and Education
Affordability Reconciliation Act, which modified certain provisions of the Act, repealed the rule
permitting deduction, for tax purposes, of the entire cost of providing prescription drug benefits
even though a portion is offset by the federal subsidy. The impact of these provisions has been
recognized in the accounting for this postretirement benefit plan and included recognition of
additional tax expense of $0.5 million for the three months ended March 31, 2010.
The plans combined net periodic postretirement benefit cost included the following components
(amounts in thousands):
Three Months Ended | ||||||||
March 31, | ||||||||
2011 | 2010 | |||||||
Net periodic benefit cost: |
||||||||
Service cost |
$ | 66 | $ | 61 | ||||
Interest cost |
169 | 158 | ||||||
Amortization of prior service cost (benefit) |
(14 | ) | (28 | ) | ||||
Net amortization of actuarial loss |
16 | 1 | ||||||
Net periodic benefit cost |
$ | 237 | $ | 192 | ||||
The Company expects to contribute $0.2 million to the postretirement benefit plans to pay
benefits in 2011. As of March 31, 2011, less than $0.1 million of contributions have been made to
the postretirement benefit plans.
8. Commitments and Contingencies
At March 31, 2011 the future minimum commitments under operating leases were as follows: 2011
$1.6 million; 2012 $1.1 million; 2013 $0.2 million; 2014 $0.2 million; 2015 $0.2
million.
In addition to these operating lease commitments, in September 2010 CNA Surety entered into a
lease agreement for a new property to be occupied following the 2012 expiration of the lease for
its primary processing and service center in Sioux Falls,
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South Dakota. The new lease includes various contingencies including completion of
construction of the building and office space to be occupied. The lease term shall be ten years
from its commencement date as defined in the agreement. Other specific lease terms such as final
rental square feet and cost will be finalized upon satisfaction of the required contingencies.
The Company and its subsidiaries are parties to various lawsuits arising in the normal course
of business. The Company believes the resolution of these lawsuits will not have a material adverse
effect on its financial condition or its results of operations.
9. Income Taxes
The Company is subject to taxation in the United States, Puerto Rico and various state
jurisdictions. The Companys tax years 2007 through 2010 remain open as to the applicable statute
of limitations and are subject to examination by the Internal Revenue Service.
The Company has not recognized any liabilities for uncertain income taxes as of March 31, 2011
or December 31, 2010, respectively. Also, the Company does not anticipate any material change in
the total amount of unrecognized tax benefits to occur within the next twelve months.
10. Stockholders Equity
The Company reserved shares of its common stock for issuance to directors, officers, employees
and certain advisors of the Company through incentive stock options, nonqualified stock options,
restricted stock, bonus shares or stock appreciation rights (collectively, awards) to be granted
under the CNA Surety 2006 Long-Term Equity Compensation Plan (the 2006 Plan), approved by
shareholders on April 25, 2006. The aggregate number of shares initially available for which awards
may be granted under the 2006 Plan was 3,000,000.
The 2006 Plan provides for the granting of incentive stock options as defined under Section
409A of the Internal Revenue Code of 1986, as amended. All nonqualified stock options and incentive
stock options granted under the 2006 Plan expire ten years after the date of grant and vest ratably
over the four-year period following the date of grant.
The 2006 Plan is administered by the Compensation Committee of the Board of Directors (the
Committee), consisting of two or more directors of the Company. Subject to the provisions set
forth in the 2006 Plan, all of the members of the Committee shall be independent members of the
Board of Directors. The Committee determines the types and sizes of awards under the 2006 Plan.
Through 2010, only nonqualified stock options were awarded under the 2006 Plan. Based on an
evaluation of current best practices for stock-based compensation plans and alignment with the
Companys goals, in 2011 awards to employees and officers under the 2006 Plan consisted solely of
restricted stock.
For stock option awards, the Committee determines the exercise price, which may not be less
than the fair market value of the Companys common stock on the date of grant for incentive stock
options and may not be less than the par value of the Companys common stock for nonqualified stock
options. For restricted stock awards, the Committee determines the amount paid by the grantee for
the restricted stock, which may not be less than the par value of the Companys common stock for
shares to be settled in newly issued common shares. Both restricted stock awards and option
exercises under the 2006 Plan are settled in newly issued common shares.
On February 4, 2011, 104,876 shares of restricted stock were granted under the 2006 Plan. The
grant price per share was $25.08, which was the closing sale price for the Companys common stock
as reported on the New York Stock Exchange on the grant date. These restricted stock awards vest
ratably over the four-year period following the date of the grant. As of March 31, 2011, the
number of shares available for granting of awards under the 2006 Plan was 1,904,712.
On February 5, 2010, 281,260 options were granted under the 2006 Plan. The fair market value
(at grant date) per option granted was $7.25 for these options. The fair value of these options was
estimated at the grant date using a Black-Scholes option pricing model with the following weighted
average assumptions: risk free interest rate of 2.32%; dividend yield of 0.0%; expected option life
of 5.3 years and volatility of 55.5%, which was based on historical volatility. The Company
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estimated the expected option life of the 2010 grant based on its analysis of past exercise
patterns for similar options. As of March 31, 2010, the number of shares available for granting of
awards under the 2006 Plan was 1,980,165.
The compensation expense recorded for the Companys stock-based compensation plans was $0.6
million and $0.4 million for the three months ended March 31, 2011 and 2010, respectively. The
total income tax benefit recognized in the Condensed Consolidated Statements of Income for
stock-based compensation arrangements was $0.2 million for both the three months ended March 31,
2011 and 2010. The amount of cash received from the exercise of stock options was $2.3 million and
$0.3 million for the three months ended March 31, 2011 and 2010, respectively.
A summary of option activity for the
three months ended March 31, 2011 is presented below:
Weighted | ||||||||
Average Option | ||||||||
Shares Subject | Price per | |||||||
to Option | Share | |||||||
Outstanding options at January 1, 2011 |
1,093,181 | $ | 15.67 | |||||
Options granted |
| | ||||||
Options forfeited |
| | ||||||
Options expired |
| | ||||||
Options exercised |
(116,993 | ) | $ | 17.01 | ||||
Outstanding options at March 31, 2011 |
976,188 | $ | 15.51 | |||||
A summary of the status of the
Companys non-vested options as of March 31, 2011 and changes during the three months then ended is presented below:
Weighted | ||||||||
Average | ||||||||
Shares Subject | Grant Date | |||||||
to Option | Fair Value | |||||||
Non-vested options at January 1, 2011 |
603,859 | $ | 7.71 | |||||
Options granted |
| | ||||||
Options vested |
(243,984 | ) | $ | 7.90 | ||||
Options forfeited |
| | ||||||
Non-vested options at March 31, 2011 |
359,875 | $ | 7.58 | |||||
A summary of the options vested or expected to vest and options exercisable as of March 31,
2011 is presented below:
Options Vested or Expected to Vest | ||||||||||||||||
Weighted | Weighted Average | |||||||||||||||
Average | Aggregate | Remaining | ||||||||||||||
Number | Exercise Price | Intrinsic Value | Contractual Life | |||||||||||||
March 31, 2011 |
938,153 | $ | 15.49 | $ | 9,166,415 | 6.3 years |
Options Exercisable | ||||||||||||||||
Weighted | Weighted Average | |||||||||||||||
Average | Aggregate | Remaining | ||||||||||||||
Number | Exercise Price | Intrinsic Value | Contractual Life | |||||||||||||
March 31, 2011 |
616,313 | $ | 15.27 | $ | 2,728,695 | 5.3 years |
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The total intrinsic value of options exercised was $0.9 million and $0.1 million for the three
months ended March 31, 2011 and 2010, respectively. The tax benefits recognized by the Company for
these exercises were $0.3 million and less than $0.1 million for the three months ended March 31,
2011 and 2010, respectively.
A summary of the status of the Companys restricted stock awards as of March 31, 2011 and
changes during the three months then ended is presented below:
Shares Subject | Weighted Average Grant Date |
|||||||
to Grant | Fair Value | |||||||
Non-vested restricted stock awards at January 1, 2011 |
| | ||||||
Restricted shares granted |
104,876 | $ | 25.08 | |||||
Restricted shares vested |
| | ||||||
Restricted shares forfeited |
(292 | ) | $ | 25.08 | ||||
Non-vested restricted stock awards at March 31, 2011 |
104,584 | $ | 25.08 | |||||
As of March 31, 2011, there was $3.1 million of total unrecognized compensation cost related
to non-vested stock-based compensation arrangements granted under the Companys equity compensation
plans. That cost is expected to be recognized as follows: 2011 $1.5 million; 2012 $1.0
million; 2013 $0.5 million and 2014 $0.1 million.
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CNA SURETY CORPORATION AND SUBSIDIARIES
ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
The following is a discussion and analysis of CNA Surety Corporation and its subsidiaries
(collectively, CNA Surety or the Company) operating results, liquidity and capital resources,
and financial condition. This discussion should be read in conjunction with the Condensed
Consolidated Financial Statements in Item 1 of Part 1 of this Quarterly Report on Form 10-Q and the
Companys Annual Report on Form 10-K for the year ended December 31, 2010.
CNAF Merger Agreement and Tender Offer
In October 2010, the Company received an unsolicited proposal from CNAF to acquire all of the
outstanding shares of common stock that are not currently owned by subsidiaries of CNAF at a
purchase price of $22.00 per share in cash (the CNAF Proposal). The Companys Board of Directors
appointed a special committee (the Special Committee), comprised solely of the Companys three
independent directors, to review and evaluate the CNAF Proposal. The Special Committee retained
both legal and financial advisors to assist in their consideration of the CNAF Proposal.
On April 21, 2011, the Company and CNAF announced that they had signed a definitive merger
agreement pursuant to which CNAF will commence a tender offer to acquire all of the outstanding
shares of common stock of CNA Surety not currently owned by subsidiaries of CNAF for $26.55 per
share in cash.
The transaction has been approved by the Board of Directors of CNA Surety, following the
recommendation and approval of the Special Committee. The tender offer will be conditioned upon,
among other things, acceptance by the holders of a majority of the publicly held shares of CNA
Surety. Subject to the satisfaction of the foregoing, it is currently anticipated that the
transaction will be completed by the end of the second quarter.
Critical Accounting Policies
The Companys accounting policies related to reserves and disclosures for unpaid losses and
loss adjustment expenses and related estimates of reinsurance recoverables are particularly
critical to an assessment of the Companys financial results. Given the nature of the surety
business, the determination of these balances is inherently a highly subjective exercise which
requires management to analyze, weigh and balance numerous macroeconomic, customer specific and
claim specific factors and trends, most of which, in and of themselves, are inherently uncertain
and difficult to predict. In addition, management believes the other most critical accounting
policies and related disclosures for purposes of understanding the Companys results of operations
and financial condition pertain to investments, goodwill and other intangible assets, recognition
of premium revenue and the related unearned premium liability, premiums receivable and deferred
policy acquisition costs.
Reserves for Unpaid Losses and Loss Adjustment Expenses and Reinsurance
CNA Surety accrues liabilities for unpaid losses and loss adjustment expenses (LAE) under
its surety and property and casualty insurance contracts based upon estimates of the ultimate
amounts payable under the contracts related to losses occurring on or before the balance sheet
date.
Reported claims are in various stages of the settlement process. Due to the nature of surety,
which is the relationship among three parties whereby the surety guarantees the performance of the
principal to a third party (the obligee), the investigation of claims and the establishment of case
estimates on claim files can be a complex process that can occur over a period of time depending on
the type of bond(s) and the facts and circumstances involving the particular bond(s), the claim(s)
and the principal. Case reserves are typically established after a claim is filed and an
investigation and analysis has been conducted as to the validity of the claim, the principals
response to the claim and the principals financial viability. To the extent it is determined that
there are no bona fide defenses to the claim and the principal is unwilling or financially unable
to resolve the claim, a case reserve is established on the claim file for the amount the Company
estimates it will have to pay to honor its obligations under the provisions of the bond(s).
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While the Company intends to establish initial case reserve estimates that are sufficient to
cover the ultimate anticipated loss on a claim file, some estimates need to be adjusted during the
life cycle of the claim file as matters continue to develop. Factors that can necessitate case
reserve increases or decreases are the complexity of the bond(s) and/or underlying contract(s), if
additional and/or unexpected claims are filed, if the financial condition of the principal or
obligee changes or as claims develop and more information is discovered that was unknown and/or
unexpected at the time the initial case reserve estimate was established. Ultimately, claims are
resolved through payment and/or a determination that, based on the information available, a case
reserve is no longer required.
As of any balance sheet date, not all claims have been reported and some claims may not be
reported for many years. As a result, the liability for unpaid losses includes significant
estimates for incurred-but-not-reported (IBNR) claims. The IBNR reserves also include provisions
for losses in excess of the current case reserve for previously reported claims and for claims that
may be reopened. The IBNR reserves also include offsets for anticipated indemnity recoveries.
In 2011, the Company changed its classification of LAE reserves to better reflect the
methodologies used to estimate these reserves. Previously, the Company allocated a portion of the
estimated LAE liability and classified it as a case LAE reserve. As of March 31, 2011, the
estimated liability for LAE is classified only as IBNR reserve. Reported case LAE reserves at
December 31, 2010 were $22.5 million. This change in classification had no impact on the total LAE
reserve estimate as of March 31, 2011 nor did it have any impact on the Companys results of
operations for the three months ended March 31, 2011.
The following table shows the estimated liability as of March 31, 2011 for unpaid claims
applicable to reported claims and to IBNR (dollars in thousands) for each sub-line of business:
Gross Case Loss | Gross IBNR Loss | Total Gross | ||||||||||
Reserves | and LAE Reserves | Reserves | ||||||||||
Contract |
$ | 57,719 | $ | 213,785 | $ | 271,504 | ||||||
Commercial |
38,688 | 79,941 | 118,629 | |||||||||
Fidelity and other |
2,265 | 8,705 | 10,970 | |||||||||
Total |
$ | 98,672 | $ | 302,431 | $ | 401,103 | ||||||
Periodic actuarial analyses of the Companys loss reserves are performed. These analyses
include a comprehensive review performed in the fourth quarter based on data as of September 30 and
an update of the comprehensive review performed in January based on data as of December 31. In
between these analyses, management monitors claim activity against benchmarks of expected claim
activity prepared in connection with the comprehensive review and records adjustments as necessary.
The actuarial analysis is the primary tool that management utilizes in determining its best
estimate of loss reserves. However, the carried reserve may differ from the actuarial point
estimate as a result of managements consideration of the impact of factors such as the following,
especially as they relate to the current accident year:
| Current claim activity, including the frequency and severity of current claims; | ||
| Changes in underwriting standards and business mix such as the Companys efforts to reduce exposures to large commercial bonds; | ||
| Changes in the claims handling process; | ||
| Potential changes in the Companys reinsurance program; and | ||
| Current economic conditions, especially corporate default rates and the condition of the construction economy. |
Management believes that the impact of the factors listed above, and others, may not be fully
quantifiable through actuarial analysis. Accordingly, management applies its judgment of the impact
of these factors, and others, to its selection of the recorded loss reserves.
Receivables recorded with respect to insurance losses ceded to reinsurers under reinsurance
contracts are estimated in a manner similar to liabilities for insurance losses and, therefore, are
also subject to uncertainty. In addition to the factors cited above, assumptions are made regarding
the impact of reinsurance programs to be in place in future periods. Estimates of reinsurance
recoveries may prove uncollectible if the reinsurer is unable to perform under the contract.
Reinsurance contracts do not relieve the ceding company of its obligations to indemnify its own
policyholders.
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Casualty insurance loss reserves are subject to a significant amount of uncertainty. Given the
nature of surety losses with its low frequency, high severity characteristics, this is particularly
true for surety loss reserves. As a result, the range of reasonable loss reserve estimates may be
broader than that associated with traditional property/casualty insurance products. While the loss
reserve estimates represent the best professional judgments, arrived at after careful actuarial
analysis of the available data, it is important to note that variation from the estimates is not
only possible but, in fact, probable. The sources of this inherent variability are numerous
future economic conditions, court decisions, legislative actions and individual large claim
impacts, for example.
Due to the inherent uncertainties in the process of establishing the liabilities for unpaid
losses and loss adjustment expenses, the actual ultimate claims amounts will differ from the
currently recorded amounts. This difference could have a material effect on reported earnings and
financial condition. Future effects from changes in these estimates will be recorded in the period
such changes are determined to be needed.
Investments
Management believes the Company has the ability to hold all fixed income securities to
maturity. However, the Company may dispose of securities prior to their scheduled maturity due to
changes in interest rates, prepayments, tax and credit considerations, liquidity or regulatory
capital requirements, or other similar factors. As a result, the Company considers all of its fixed
income securities and equity securities as available-for-sale. These securities are reported at
fair value, with unrealized gains and losses, net of deferred income taxes, reported in
stockholders equity as a separate component of accumulated other comprehensive income.
All securities transactions are recorded on the trade date. Investment gains or losses
realized on the sale of securities are determined using the first-in, first-out method. Cash flows
from purchases, sales and maturities of fixed income and equity securities are reported gross in
the investing activities section of the Condensed Consolidated Statements of Cash Flows.
Fixed income securities in an unrealized loss position that the Company intends to sell, or it
more likely than not will be required to sell before recovery of amortized cost, are considered to
be other-than-temporarily impaired (OTTI). These securities are written down to fair value and
the resulting losses are recognized in realized gains/losses in the Condensed Consolidated
Statements of Income. Fixed income securities in an unrealized loss position for which management
believes a credit loss exists are also considered to be other-than-temporarily impaired. For those
securities, the Company bifurcates the impairment into a credit component and a non-credit
component. The credit component, which represents the difference between discounted expected cash
flows and the fixed income securitys amortized cost, is recognized in earnings and the non-credit
component is recognized in other comprehensive income.
The amortized cost of fixed income securities is determined based on cost, adjustments for
previously recorded OTTI losses and the cumulative effect of amortization of premiums and accretion
of discounts using the interest method. Such amortization and accretion are included in investment
income. For mortgage-backed and asset-backed securities, the Company considers estimates of future
prepayments in the calculation of the effective yield used to apply the interest method. If a
difference arises between the anticipated prepayments and the actual prepayments, the Company
recalculates the effective yield based on actual prepayments and the currently anticipated future
prepayments. The amortized costs of such securities are adjusted to the amount that would have
resulted had the recalculated effective yields been applied since the acquisition of the securities
with a corresponding charge or credit to investment income. Prepayment estimates are based on the
structural elements of specific securities, interest rates and generally recognized prepayment
speed indices.
Short-term investments, that generally include U.S. Treasury bills, corporate notes, money
market funds and investment grade commercial paper equivalents, are carried at amortized cost,
which approximates fair value.
Invested assets are exposed to various risks, such as interest rate risk, market risk and
credit risk. Due to the level of risk associated with invested assets and the level of uncertainty
related to changes in the value of these assets, it is possible that changes in risks in the near
term may materially affect the amounts reported in the Condensed Consolidated Balance Sheets and
Condensed Consolidated Statements of Income.
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Goodwill and Other Intangible Assets
CNA Suretys Condensed Consolidated Balance Sheets as of March 31, 2011 and December 31, 2010
include goodwill and intangible assets of approximately $138.8 million. This amount primarily
represents goodwill and identified intangibles with indefinite useful lives arising from the
acquisition of Capsure Holdings Corp.
A significant amount of judgment is required in performing intangible assets impairment tests.
Such tests include periodically determining or reviewing the estimated fair value of CNA Suretys
reporting units. Under the relevant standard, fair value of a reporting unit refers to the price
that would be received to sell the reporting unit as a whole in an orderly transaction between
market participants. There are several methods of estimating fair value, including market
quotations, asset and liability fair values and other valuation techniques, such as discounted cash
flows and multiples of earnings or revenues. The Company uses a valuation technique based on
discounted cash flows. Significant inputs to the Companys discounted cash flow model include
estimated capital requirements to support the business, expected cash flows from underwriting
activity, required capital reinvestment to support growth and the selected discount rates. If the
carrying amount of a reporting unit, including goodwill, exceeds the estimated fair value, then an
additional test must be performed to determine whether goodwill has been impaired and to calculate
the amount of that impairment. To determine the implied value of intangible assets, individual
assets, including identifiable intangible assets and liabilities of
the reporting unit, are
estimated at fair value. The excess of the estimated fair value of the reporting unit over the
estimated fair value of net assets would establish the implied value of intangible assets. The
excess of the recorded amount of intangible assets over the implied value of intangible assets is
recorded as an impairment loss.
Insurance Premiums
Insurance premiums are recognized as revenue ratably over the term of the related policies in
proportion to the insurance protection provided. Contract bonds provide coverage for the length of
the bonded project and not a fixed time period. As such, the Company uses estimates of the contract
length as the basis for recognizing premium revenue on these bonds. Premium revenues are net of
amounts ceded to reinsurers. Unearned premiums represent the portion of premiums written, before
ceded reinsurance which is shown as an asset, applicable to the unexpired terms of policies in
force determined on a pro rata basis.
Insurance premium receivables do not include financing costs or other fees and are presented
net of an estimated allowance for doubtful accounts. This allowance is based on a periodic
evaluation of the aging and collectibility of premium receivables. Premium receivables and any
related allowance are written off after collection efforts have been exhausted.
Deferred Policy Acquisitions Costs
Policy acquisition costs, consisting of commissions, premium taxes and other underwriting
expenses which vary with, and are primarily related to, the production of business, net of
reinsurance commissions, are deferred and amortized as a charge to income as the related premiums
are earned. The Company periodically tests that deferred policy acquisition costs are recoverable
based on the expected profitability embedded in the reserve for unearned premium. If the expected
profitability is less than the balance of deferred policy acquisition costs, a charge to net income
is taken and the deferred policy acquisition cost balance is reduced to the amount determined to be
recoverable. Anticipated investment income is considered in the determination of the recoverability
of deferred policy acquisition costs.
Results of Operations
Financial Measures
The Managements Discussion and Analysis of Financial Condition and Results of Operations
(MD&A) discusses certain accounting principles generally accepted in the United States of America
(GAAP) and non-GAAP financial measures in order to provide information used by management to
monitor the Companys operating performance. Management utilizes various financial measures to
monitor the Companys insurance operations and investment portfolio. Underwriting results, which
are derived from certain income statement amounts, are considered a non-GAAP financial measure and
are used by management to monitor performance of the Companys insurance operations.
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Underwriting results are computed as net earned premiums less net losses and loss adjustment
expenses and net commissions, brokerage and other underwriting expenses. Management uses
underwriting results to monitor its insurance operations results without the impact of certain
factors, including net investment income, net realized investment gains (losses) and interest
expense. Management excludes these factors in order to analyze the direct relationship between net
earned premiums and the related net losses and loss adjustment expenses along with net commissions,
brokerage and other underwriting expenses.
Operating ratios are calculated using insurance results and are widely used by the insurance
industry and regulators such as state departments of insurance and the National Association of
Insurance Commissioners for financial regulation and as a basis of comparison among companies. The
ratios discussed in the Companys MD&A are calculated using GAAP financial results and include the
net loss and loss adjustment expense ratio (loss ratio) as well as the net commissions, brokerage
and other underwriting expense ratio (expense ratio) and combined ratio. The loss ratio is the
percentage of net incurred losses and loss adjustment expenses to net earned premiums. The expense
ratio is the percentage of net commissions, brokerage and other underwriting expenses, including
the amortization of deferred policy acquisition costs, to net earned premiums. The combined ratio
is the sum of the loss ratio and expense ratio.
While management uses various GAAP and non-GAAP financial measures to monitor various aspects
of the Companys performance, net income is the most directly comparable GAAP measure and
represents a more comprehensive measure of operating performance. Management believes that its
process of evaluating performance through the use of these non-GAAP financial measures provides a
basis for enhanced understanding of the operating performance and the impact to net income as a
whole. Management also believes that investors may find these widely used financial measures
described above useful in interpreting the underlying trends and performance, as well as to provide
visibility into the significant components of net income.
Comparison of CNA Surety Actual Results for the Three Months Ended March 31, 2011 and 2010
Analysis of Net Income
Net income for the three months ended March 31, 2011 was $20.8 million, or $0.46 per diluted
share, compared to $20.8 million, or $0.47 per diluted share, for the same period in 2010.
The components of net income are discussed in the following sections.
Results of Insurance Operations
Underwriting components for the Company for the three months ended March 31, 2011 and 2010 are
summarized in the following table (dollars in thousands):
Three Months Ended March 31, | ||||||||
2011 | 2010 | |||||||
Gross written premiums |
$ | 110,091 | $ | 112,527 | ||||
Net written premiums |
$ | 104,630 | $ | 106,660 | ||||
Net earned premiums |
$ | 96,658 | $ | 98,252 | ||||
Net losses and loss adjustment expenses |
$ | 28,031 | $ | 28,581 | ||||
Net commissions, brokerage and other underwriting expenses |
$ | 52,266 | $ | 52,788 | ||||
Loss ratio |
29.0 | % | 29.1 | % | ||||
Expense ratio |
54.1 | 53.7 | ||||||
Combined ratio |
83.1 | % | 82.8 | % | ||||
Premiums Written/Earned
CNA Surety primarily markets contract and commercial surety bonds. Contract surety bonds
generally secure a contractors performance and/or payment obligation with respect to a
construction project. Contract surety bonds are generally required by federal, state and local
governments for public works projects. The most common types include bid, performance and payment
bonds. Commercial surety bonds include all surety bonds other than contract and cover obligations
typically required by law or regulation. The commercial surety market includes numerous types of
bonds categorized as court judicial, court fiduciary, public official, license and permit and many
miscellaneous bonds that include guarantees of financial performance. The
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Company also writes fidelity bonds that cover losses arising from employee dishonesty and
other insurance products that are generally companion products to certain surety bonds. For
example, the Company writes surety bonds for notaries and also offers related errors and omissions
insurance coverage.
Through one of its insurance subsidiaries, Western Surety Company (Western Surety), the
Company assumes significant amounts of premiums primarily from affiliates. This includes surety
business written or renewed, net of reinsurance, by Continental Casualty Company (CCC) and The
Continental Insurance Company (CIC), and their affiliates, after September 30, 1997 that is
reinsured by Western Surety pursuant to reinsurance and related agreements. Because of certain
regulatory restrictions that limit the Companys ability to write certain business on a direct
basis, the Company continues to utilize the underwriting capacity available through these
agreements. The Company is in full control of all aspects of the underwriting and claim management
of the assumed business from CCC and CIC.
CNA Surety also assumes premium on contract and commercial surety bonds for international
risks. Such premiums are assumed pursuant to the terms of reinsurance treaties or as a result of
specific international bond requirements of domestic customers. For the three months ended March
31, 2011 and 2010, premiums assumed under such arrangements were $1.1 million and $1.3 million,
respectively.
Gross written premium, which is the aggregate of direct written premiums and assumed written
premiums, for the three months ended March 31, 2011 and 2010 is shown in the table below (dollars
in thousands) for each sub-line of business:
Three Months Ended March 31, | ||||||||
2011 | 2010 | |||||||
Contract |
$ | 66,212 | $ | 68,457 | ||||
Commercial |
34,994 | 35,221 | ||||||
Fidelity and other |
8,885 | 8,849 | ||||||
Total |
$ | 110,091 | $ | 112,527 | ||||
For the three months ended March 31, 2011, gross written premiums decreased 2.2 percent to
$110.1 million compared to $112.5 million for the three months ended March 31, 2010. Contract
surety gross written premiums decreased 3.3 percent to $66.2 million due to continued challenges in
the construction industry. Commercial surety gross written premiums decreased 0.6 percent to $35.0
million, reflecting a modest decline in the small commercial market, partially offset by selective
growth in the corporate commercial market.
The Companys insurance subsidiaries purchase reinsurance from other insurance companies and
affiliates. Reinsurance arrangements are used to limit maximum loss, provide greater
diversification of risk and minimize exposure on larger risks. The cost of this reinsurance is
recorded as ceded written premium. Ceded written premium decreased from $5.9 million for the three
months ended March 31, 2010 to $5.5 million for the three months ended March 31, 2011 due to the
lower cost of the Companys 2011 third party excess of loss reinsurance treaty.
Net written premium, which is gross written premiums less ceded written premiums, for the
three months ended March 31, 2011 and 2010 are shown in the table below (dollars in thousands) for
each sub-line of business:
Three Months Ended March 31, | ||||||||
2011 | 2010 | |||||||
Contract |
$ | 61,439 | $ | 63,313 | ||||
Commercial |
34,306 | 34,498 | ||||||
Fidelity and other |
8,885 | 8,849 | ||||||
Total |
$ | 104,630 | $ | 106,660 | ||||
Net written premiums decreased 1.9 percent to $104.6 million for the three months ended March
31, 2011 compared to the same period of 2010, reflecting the decrease in gross written premium
partially offset by the reduction in ceded written premium discussed above.
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Net written premiums are recognized as revenue over the policy term as net earned premiums.
Net earned premiums for the three months ended March 31, 2011 and 2010 are shown in the table below
(dollars in thousands) for each sub-line of business:
Three Months Ended March 31, | ||||||||
2011 | 2010 | |||||||
Contract |
$ | 57,223 | $ | 58,526 | ||||
Commercial |
31,937 | 32,276 | ||||||
Fidelity and other |
7,498 | 7,450 | ||||||
Total |
$ | 96,658 | $ | 98,252 | ||||
For the three months ended March 31, 2011, net earned premiums decreased by $1.6 million to
$96.7 million as compared to the same period of 2010 reflecting the impact of adverse economic
conditions on net written premiums in the current and prior periods. Net earned premiums for
contract surety business decreased 2.2 percent to $57.2 million for the three months ended March
31, 2011 compared to the three months ended March 31, 2010. Net earned premiums for commercial
surety decreased 1.1 percent to $31.9 million, while fidelity and other net earned premiums
increased 0.6 percent to $7.5 million for the three months ended March 31, 2011 compared to the
three months ended March 31, 2010.
Net Loss Ratio
The loss ratios for the three months ended March 31, 2011 and 2010 were 29.0% and 29.1%,
respectively. These loss ratios typically include re-estimates of prior accident year reserves,
known as reserve development. There were no revisions of prior year reserves for the three months
ended March 31, 2011 and 2010. The Companys estimates of losses for the current accident year as
well as for accident years 2010 and 2009 continue to reflect the impact of difficult economic
conditions.
Expense Ratio
The expense ratios for the three months ended March 31, 2011 and 2010 were 54.1% and 53.7%,
respectively. Expected upward pressure on the expense ratio resulting from the impact on earned
premiums of lower gross written premiums was partially offset by the impact of lower ceded written
premium and the Companys continued expense management.
Other Expense
As previously discussed, in October 2010, the Company received an unsolicited proposal from
CNAF to acquire all of the outstanding shares of common stock that are not currently owned by
subsidiaries of CNAF. The Special Committee appointed to review and evaluate the CNAF Proposal
retained both legal and financial advisors to assist in their consideration of the CNAF Proposal.
The Company incurred expenses of $2.0 million in the three months ended March 31, 2011 related to
the evaluation of the CNAF Proposal. These expenses are shown as Other expense in the Condensed
Consolidated Statements of Income and are not included in the expense ratio discussed above.
Investment Income and Realized Investment Gains/Losses
Net investment income was $14.4 million for the three months ended March 31, 2011 compared to
$13.4 million for the three months ended March 31, 2010. This increase is due to an increase in
invested assets resulting from cash flows from operations partially offset by a decline in yields.
The annualized pre-tax yield was 4.1% and 4.2% for the three months ended March 31, 2011 and 2010,
respectively. The annualized after-tax yield was 3.3% and 3.4% for the three months ended March 31,
2011 and 2010, respectively.
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The following summarizes net realized investment gains (losses) activity (dollars in
thousands):
Three Months Ended | ||||||||
March 31, | ||||||||
2011 | 2010 | |||||||
Net realized investment gains (losses): |
||||||||
Fixed income securities: |
||||||||
Gross realized investment gains |
$ | 295 | $ | 425 | ||||
Gross realized investment losses: |
||||||||
Other-than-temporary impairment losses |
| (94 | ) | |||||
Realized losses from sales |
(4 | ) | (19 | ) | ||||
Total gross realized investment losses |
(4 | ) | (113 | ) | ||||
Net realized investment gains on fixed income securities |
291 | 312 | ||||||
Equity securities: |
||||||||
Gross realized investment gains |
22 | 11 | ||||||
Gross realized investment losses: |
||||||||
Other-than-temporary impairment losses |
| | ||||||
Realized losses from sales |
| | ||||||
Total gross realized investment losses |
| | ||||||
Net realized investment gains on equity securities |
22 | 11 | ||||||
Net realized investment gains |
$ | 313 | $ | 323 | ||||
The Companys investment portfolio is generally managed to maximize after-tax investment
return, while minimizing credit risk with investments concentrated in high quality fixed income
securities. CNA Suretys portfolio is managed to provide diversification by limiting exposures to
any one industry, issue or issuer, and to provide liquidity by investing in the public securities
markets. The portfolio is structured to support CNA Suretys insurance underwriting operations and
to consider the expected duration of liabilities and short-term cash needs. In achieving these
goals, assets may be sold to take advantage of market conditions or other investment opportunities
or regulatory, credit and tax considerations. These activities will produce realized gains and
losses.
Interest Expense
Interest expense was $0.3 million for both the three months ended March 31, 2011 and 2010.
The benchmark interest rate for the Companys variable interest rate debt is the London Interbank
Offered Rate (LIBOR). The weighted average interest rate for the three months ended March 31,
2011 was 3.7% as compared with 3.6% for the same period in 2010. Weighted average debt outstanding
was $30.9 million for each of these periods.
Income Taxes
The Companys income tax expense for the three months ended March 31, 2011 was $8.0 million
compared to $9.5 million for the three months ended March 31, 2010. The effective income tax rates
for these periods were 27.9% and 31.3%, respectively. The effective tax rates are lower than the
statutory tax rates primarily due to the Companys ability to exclude interest income from its
significant investments in tax-exempt securities. Tax-exempt investment income was $6.5 million and
$6.3 million for the three months ended March 31, 2011 and 2010, respectively.
Income tax expense for the three months ended March 31, 2010 also included additional income
tax expense of $0.5 million as the result of enacted health care reform legislation. The Patient
Protection and Affordable Care Act and the Healthcare and Education Affordability Reconciliation
Act repealed the rule permitting deduction, for tax purposes, of the entire cost of providing
prescription drug benefits even though a portion is offset by a federal subsidy. The Companys
postretirement benefit plan that provides medical benefits includes such prescription drug
coverage.
Exposure Management
The Companys business is subject to certain risks and uncertainties associated with the
current economic environment and corporate credit conditions. In response to these risks and
uncertainties, the Company has enacted various exposure
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management initiatives. With respect to risks on large commercial accounts, the Company
generally limits its exposure to $50.0 million per account, but will selectively accept higher
exposures.
With respect to contract surety, the Companys portfolio is predominantly comprised of
contractors with bonded backlog of less than $30.0 million. Bonded backlog is an estimate of the
Companys exposure in the event of default before indemnification. The Company has accounts with
bonded backlogs significantly greater than $30.0 million, and in 2010 extended its strategy to also
target contractors with the largest work programs. Often referred to as jumbo contractors, these
accounts are typically served by a group of sureties with each surety taking a share of bonds
written for the account.
The Company manages its exposure on each account and aggressively looks for co-surety, shared
accounts and other means to support or reduce larger exposures. Reinsurance and indemnification
rights, including rights to contract proceeds on construction projects in the event of default,
exist that substantially reduce CNA Suretys exposure to loss.
Excess of Loss Reinsurance
The Companys ceded reinsurance program is predominantly comprised of excess of loss
reinsurance contracts that limit the Companys retention on a per principal basis. The Companys
reinsurance coverage is provided by third party reinsurers and related parties. Due to the terms of
these excess of loss treaties, reinsurers may cover some principals in one year but then exclude
these same principals in subsequent years. As a result, the Company may have exposures to these
principals that have limited or no reinsurance coverage.
2010 Third Party Reinsurance
Effective January 1, 2010, CNA Surety entered into an excess of loss treaty (2010 Excess of
Loss Treaty) with a group of third party reinsurers on terms similar to the excess of loss treaty
effective in 2009. Under the 2010 Excess of Loss Treaty, the Companys net retention per principal
was $15 million with a 5% co-participation in the $90 million layer of third party reinsurance
coverage above the Companys retention. The contract provided aggregate coverage of $185 million
and included an optional extended discovery period, which was not exercised. The contract also
included a provision for additional premiums of up to $12.3 million based on losses ceded under the
contract. The actual ceded premiums for the 2010 Excess of Loss Treaty were $23.7 million.
2011 Third Party Reinsurance
Effective January 1, 2011, CNA Surety entered into an excess of loss treaty (2011 Excess of
Loss Treaty) with a group of third party reinsurers on terms similar to the 2010 Excess of Loss
Treaty. Under the 2011 Excess of Loss Treaty, the Companys net retention per principal remains at
$15 million with a 5% co-participation in the $90 million layer of third party reinsurance coverage
above the Companys retention. The contract provides aggregate coverage of $185 million and
includes an optional extended discovery period, for an additional premium (a percentage of the
original premium based on any unexhausted aggregate limit by layer), which will provide coverage
for losses discovered beyond 2011 on bonds that were in force during 2011. The contract also
includes a provision for additional premiums of up to $10.7 million based on losses ceded under the
contract. The base annual premium for the 2011 Excess of Loss Treaty is $21.7 million.
Related Party Reinsurance
Reinsurance agreements together with the Services and Indemnity Agreement described below
provide for the transfer of the surety business written by CCC and CIC to Western Surety.
Agreements originally entered into on September 30, 1997 (the Merger Date) include: (i) the
Surety Quota Share Treaty (the Quota Share Treaty) and (ii) the Aggregate Stop Loss Reinsurance
Contract (the Stop Loss Contract). Although the contracts entered on the Merger Date have
expired, some have been renewed on different terms as described below.
Through the Quota Share Treaty, CCC and CIC transfer to Western Surety surety business written
or renewed by CCC and CIC after the Merger Date. The Quota Share Treaty was renewed on January 1,
2011 and expires on December 31, 2011 and is annually renewable thereafter. CCC and CIC transfer
the related liabilities of such business and pay to Western Surety an amount in cash equal to CCCs
and CICs net written premiums written on all such business, minus a quarterly ceding commission to
be retained by CCC and CIC equal to $50,000 plus 25% of net written premiums written on all such
business. For 2010, this resulted in an override commission on their actual direct acquisition
costs of 4.7% to CCC and CIC.
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Under the terms of the Quota Share Treaty, CCC has guaranteed the loss and loss adjustment
expense reserves transferred to Western Surety as of the Merger Date by agreeing to pay Western
Surety, within 30 days following the end of each calendar quarter, the amount of any adverse
development on such reserves, as re-estimated as of the end of such calendar quarter. There was no
adverse reserve development for the period from the Merger Date through March 31, 2011.
Through the Stop Loss Contract, the Companys insurance subsidiaries were protected from
adverse loss development on certain business underwritten after the Merger Date. The Stop Loss
Contract between the Companys insurance subsidiaries and CCC limited the insurance subsidiaries
prospective net loss ratios with respect to certain accounts and lines of insured business for
three full accident years following the Merger Date. In the event the insurance subsidiaries
accident year net loss ratio exceeds 24% in any of the accident years 1997 through 2000 on certain
insured accounts (the Loss Ratio Cap), the Stop Loss Contract requires CCC at the end of each
calendar quarter following the Merger Date, to pay to the insurance subsidiaries a dollar amount
equal to (i) the amount, if any, by which the Companys actual accident year net loss ratio exceeds
the applicable Loss Ratio Cap, multiplied by (ii) the applicable net earned premiums. In
consideration for the coverage provided by the Stop Loss Contract, the Companys insurance
subsidiaries paid CCC an annual premium of $20,000. The CNA Surety insurance subsidiaries have paid
CCC all required annual premiums. Through March 31, 2011 and December 31, 2010, losses incurred
under the Stop Loss Contract were $47.2 million. At March 31, 2011, the amount received under the
Stop Loss Contract included $2.8 million held by the Company for losses covered under this contract
that were incurred but not paid.
The Services and Indemnity Agreement provides the Companys insurance subsidiaries with the
authority to perform various administrative, management, underwriting and claim functions in order
to conduct the surety business of CCC and CIC and to be reimbursed by CCC for services rendered. In
consideration for providing the foregoing services, CCC has agreed to pay Western Surety a
quarterly fee of $50,000. This agreement was renewed on January 1, 2011 and expires on December
31, 2011 and is annually renewable thereafter. As of March 31, 2011, there were no amounts due to
the CNA Surety insurance subsidiaries under this agreement.
On January 1, 2010, the Company and CCC entered into separate agreements that provide for the
transfer of the Canadian surety business of CCC to Western Surety. These agreements, which include
a quota share treaty (the Canadian Quota Share Treaty) and a services and indemnity agreement
(the Canadian Services and Indemnity Agreement), are substantially similar to the Quota Share
Treaty and the Services and Indemnity Agreement discussed above. The Canadian Services and
Indemnity Agreement provides Western Surety with the authority to supervise various administrative,
underwriting and claim functions associated with the surety business written by CCC, through its
Canadian branch, on behalf of the Company. Through the Canadian Quota Share Treaty, this Canadian
surety business is transferred to Western Surety. Pursuant to these agreements, CCC will transfer
the subject premium and related liabilities of such business and pay to Western Surety an amount
equal to CCCs net written premiums on all such business, minus a ceding commission of 33.5% of net
written premiums. Further, Western Surety will pay an additional ceding commission to CCC in the
amount of actual direct expense in producing such premium. This agreement was renewed on January 1,
2011 and expires on December 31, 2011 and is annually renewable thereafter.
As of March 31, 2011 and December 31, 2010, CNA Surety had an insurance receivable balance
from CCC and CIC of $8.9 million and $10.8 million, respectively, comprised of premiums receivable.
CNA Surety had no reinsurance payables to CCC or CIC as of March 31, 2011 or December 31, 2010.
The Companys Condensed Consolidated Balance Sheets also include a Deposit with affiliated
ceding company of $17.4 million and $23.4 million at March 31, 2011 and December 31, 2010,
respectively. In 2005, pursuant to an agreement with the claimant on a bond regarding certain
aspects of the claim resolution, the Company deposited $32.7 million with an affiliate to enable
the affiliate to establish a trust to fund future payments under the bond. The bond was written by
the affiliate and assumed by one of the Companys insurance subsidiaries pursuant to the Quota
Share Treaty. The Company is entitled to the interest income earned by the trust. Prior to the
establishment of the trust, the Company had fully reserved its obligation under the bond and the
claim remains fully reserved.
Liquidity and Capital Resources
It is anticipated that the liquidity requirements of CNA Surety will be met primarily by funds
generated from operations. The principal sources of operating cash flows are premiums, investment
income and recoveries under reinsurance contracts. The primary cash flow uses are payments for
claims, operating expenses, federal income taxes and debt service. In general,
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surety operations generate premium collections from customers in advance of cash outlays for
claims. Premiums are invested until such time as funds are required to pay claims and claims
adjusting expenses.
The Company believes that total invested assets, including cash and short-term investments,
are sufficient in the aggregate and have suitably scheduled maturities to satisfy all policy claims
and other operating liabilities, including dividend and income tax sharing payments of its
insurance subsidiaries. If cash requirements unexpectedly exceed cash inflows, the Company may
raise additional cash by liquidating fixed income securities ahead of their scheduled maturity.
Depending on the interest rate environment at that time, the Company could generate realized gains
or losses that would increase or decrease net income for the period. The extent of these gains or
losses would depend on a number of factors such as the prevailing interest rates and credit
spreads, the duration of the assets sold and the marketability of the assets. The need to liquidate
fixed income securities would be expected to cause a reduction in future investment income.
At March 31, 2011, the carrying value of the Companys insurance subsidiaries invested assets
was comprised of $1,430.0 million of fixed income securities, $35.9 million of short-term
investments and $3.0 million of cash. At December 31, 2010, the carrying value of the Companys
insurance subsidiaries invested assets was comprised of $1,404.4 million of fixed income
securities, $39.7 million of short-term investments and $3.4 million of cash.
Cash flow at the parent company level is derived principally from dividend and tax sharing
payments from its insurance subsidiaries, and to a lesser extent, investment income. During the
first three months of 2011, parent company cash flows included significant cash flows from the
exercise of stock options under the Companys stock-based compensation plan. The principal
obligations at the parent company level are to service debt and pay operating expenses, including
income taxes. At March 31, 2011, the parent companys invested assets consisted of $2.2 million of
equity securities and $10.4 million of short-term investments and cash. At December 31, 2010, the
parent companys invested assets consisted of $1.9 million of equity securities and $16.7 million
of short-term investments and cash. At March 31, 2011 and December 31, 2010, parent company
short-term investments and cash included $5.6 million and $11.5 million, respectively, of cash and
short-term investments primarily related to premium receipt collections ultimately due to the
Companys insurance subsidiaries.
The Companys consolidated net cash flow provided by operating activities was $20.9 million
for the three months ended March 31, 2011 compared to net cash flow provided by operating
activities of $26.3 million for the comparable period in 2010. The decrease in net cash flow
provided by operating activities primarily relates to higher claim payments and expense payments
related to the CNAF Proposal discussed previously.
In May 2004, the Company, through a wholly-owned trust, privately issued $30.0 million of
preferred securities through two pooled transactions. These securities, issued by CNA Surety
Capital Trust I (the Issuer Trust), bear interest at LIBOR plus 337.5 basis points with a 30-year
term. As of May 2009, the Company may redeem these securities, in whole or in part, at par value at
any scheduled quarterly interest payment date. As of March 31, 2011, none of these preferred
securities have been redeemed.
The Companys investment of $0.9 million in the Issuer Trust is carried at cost in Other
assets in the Companys Condensed Consolidated Balance Sheets. The sole asset of the Issuer Trust consists
of a $30.9 million junior subordinated debenture issued by the Company to the Issuer Trust. Due to
the underlying characteristics of this debt, the carrying value of the debenture approximates its
estimated fair value.
The Company has also guaranteed the dividend payments and redemption of the preferred
securities issued by the Issuer Trust. The maximum amount of undiscounted future payments the
Company could make under the guarantee is approximately $55.6 million, consisting of annual
dividend payments of approximately $1.1 million until maturity and the redemption value of the
preferred securities of $30.0 million. Because payment under the guarantee would only be required
if the Company does not fulfill its obligations under the debentures held by the Issuer Trust, the
Company has not recorded any additional liabilities related to this guarantee.
The junior subordinated debenture bears interest at a rate of LIBOR plus 337.5 basis points
and matures in April 2034. As of March 31, 2011 and 2010, the interest rate on the junior
subordinated debenture was 3.688% and 3.625%, respectively.
The Company does not have any material off-balance sheet arrangements as defined by Item 303
of Regulation S-K under the Securities Act of 1933 and the Securities Exchange Act of 1934.
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A summary of the Companys commitments as of March 31, 2011 is presented in the following
table (in millions):
Contractual Obligations as of March 31, 2011 | 2011 | 2012 | 2013 | 2014 | 2015 | Thereafter | Total | |||||||||||||||||||||
(In millions) | ||||||||||||||||||||||||||||
Debt(a) |
$ | 0.9 | $ | 1.1 | $ | 1.1 | $ | 1.1 | $ | 1.1 | $ | 52.1 | $ | 57.4 | ||||||||||||||
Operating leases |
1.6 | 1.1 | 0.2 | 0.2 | 0.2 | | 3.3 | |||||||||||||||||||||
Loss and loss adjustment expense reserves |
84.1 | 101.4 | 73.9 | 47.2 | 30.1 | 64.4 | 401.1 | |||||||||||||||||||||
Other long-term liabilities(b) |
0.3 | 1.4 | 1.0 | 0.5 | 0.5 | 11.6 | 15.3 | |||||||||||||||||||||
Total |
$ | 86.9 | $ | 105.0 | $ | 76.2 | $ | 49.0 | $ | 31.9 | $ | 128.1 | $ | 477.1 | ||||||||||||||
(a) | Reflects expected principal and interest payments. | |
(b) | Reflects unfunded postretirement benefit plans and long-term incentive plan payments to certain executives. |
In addition to the operating lease obligations included in the table above, in September 2010
CNA Surety entered into a lease agreement for a new property to be occupied following the 2012
expiration of the lease for its primary processing and service center in Sioux Falls, South Dakota.
The new lease includes various contingencies including completion of construction of the building
and office space to be occupied. The lease term shall be ten years from its commencement date as
defined in the agreement. Other specific lease terms such as final rental square feet and cost will
be finalized upon satisfaction of the required contingencies.
As an insurance holding company, CNA Surety is dependent upon dividends and other permitted
payments from its insurance subsidiaries to pay operating expenses and meet debt service
requirements, as well as to potentially pay cash dividends. The payment of dividends by the
insurance subsidiaries is subject to varying degrees of supervision by the insurance regulatory
authorities in the insurance subsidiaries state of domicile. Western Surety, Surety Bonding
Company of America (Surety Bonding) and Universal Surety of America (Universal Surety) are
domiciled in South Dakota. In South Dakota, insurance companies may only pay dividends from earned
surplus excluding surplus arising from unrealized capital gains or revaluation of assets. The
insurance subsidiaries may pay dividends without obtaining prior regulatory approval only if such
dividend or distribution (together with dividends or distributions made within the preceding
12-month period) is less than, as of the end of the immediately preceding year, the greater of (i)
10% of the insurers surplus to policyholders or (ii) statutory net income. In South Dakota, net
income includes net realized capital gains in an amount not to exceed 20% of net unrealized capital
gains. All dividends must be reported to the South Dakota Division of Insurance prior to payment.
The dividends that may be paid without prior regulatory approval are determined by formulas
established by the applicable insurance regulations, as described above. The formulas that
determine dividend capacity in the current year are dependent on, among other items, the prior
years ending statutory surplus and statutory net income. Dividend capacity for 2011 is based on
statutory surplus and income at and for the year ended December 31, 2010. Without prior regulatory
approval in 2011, Western Surety may pay dividends of $140.2 million to CNA Surety. CNA Surety
received no dividends from its insurance subsidiaries or its non-insurance subsidiaries during the
first three months of 2011 or 2010.
Combined statutory surplus totaled $846.2 million at March 31, 2011, resulting in a net
written premium to statutory surplus ratio of to 0.5 to 1. Insurance regulations restrict Western
Suretys maximum net retention on a single surety bond to 10 percent of statutory surplus. Under
the 2011 Excess of Loss Treaty, the Companys net retention on new bonds would generally be $15
million plus a 5% co-participation in the $90 million layer of excess reinsurance above the
Companys retention. Based on statutory surplus as of March 31, 2011, this regulation would limit
Western Suretys largest gross risk to $170.1 million. This surplus requirement may limit the
amount of future dividends Western Surety could otherwise pay to CNA Surety.
In accordance with the provisions of intercompany tax sharing agreements between CNA Surety
and its subsidiaries, the income tax of each subsidiary shall be determined based upon each
subsidiarys separate return liability. Intercompany tax payments are made at such times when
estimated tax payments would be required by the Internal Revenue Service. CNA Surety received tax
sharing payments of $15.1 million and $14.0 million from its subsidiaries for the three months
ended March 31, 2011 and 2010, respectively.
Western Surety and Surety Bonding each qualify as an acceptable surety for federal and other
public works project bonds pursuant to U.S. Department of Treasury regulations. U.S. Treasury
underwriting limitations, the maximum net retention on a single federal surety bond, are based on
an insurers statutory surplus. Effective July 1, 2010 through June 30, 2011, the
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underwriting limitations of Western Surety and Surety Bonding are $67.1 million and $0.8
million, respectively. Through the Quota Share Treaty previously discussed, CNA Surety has access
to CCC and its affiliates U.S. Department of Treasury underwriting limitations. Effective July 1,
2010 through June 30, 2011, the underwriting limitations of CCC and its affiliates utilized under
the Quota Share Treaty total $892.1 million. CNA Surety management believes that the foregoing
U.S. Treasury underwriting limitations are sufficient for the conduct of its business.
CNA Surety management believes that the Company has sufficient available resources, including
capital protection against large losses provided by the Companys excess of loss reinsurance
arrangements, to meet its present capital needs.
Insurance Regulation and Supervision
CNA Suretys insurance subsidiaries are subject to periodic financial and market conduct
examinations. These examinations are generally performed by the domiciliary state insurance
regulatory authorities, however, they may be performed by any jurisdiction in which the insurer
transacts business. In March 2011, the California Department of Insurance began preliminary work on
a market conduct examination of Western Surety as of and for the period February 1, 2010 through
January 31, 2011. To date, no issues have been brought to the attention of management.
The reports for the most recent financial examinations of Western Surety, Surety Bonding and
Universal Surety by the South Dakota Division of Insurance, as of and for the period January 1,
2004 through December 31, 2008, were adopted as filed by the Director of the South Dakota Division
of Insurance in January, 2010. No adverse findings were included in the final examination reports.
Financial Condition
Investment Portfolio
The amortized cost, gross unrealized gains, gross unrealized losses, estimated fair value and
unrealized OTTI losses of fixed income securities and the cost, gross unrealized gains, gross
unrealized losses and estimated fair value of equity securities held by CNA Surety at March 31,
2011, by investment category, were as follows (dollars in thousands):
Gross | Gross Unrealized Losses | |||||||||||||||||||||||
Amortized Cost | Unrealized | Less Than | More Than | Estimated | Unrealized | |||||||||||||||||||
March 31, 2011 | or Cost | Gains | 12 Months | 12 Months | Fair Value | OTTI Losses | ||||||||||||||||||
Fixed income securities: |
||||||||||||||||||||||||
U.S. Treasury securities and obligations of
U.S. Government and agencies: |
||||||||||||||||||||||||
U.S. Treasury |
$ | 17,289 | $ | 775 | $ | | $ | | $ | 18,064 | $ | | ||||||||||||
U.S. Agencies |
5,515 | 204 | | | 5,719 | | ||||||||||||||||||
Collateralized mortgage obligations
residential |
18,711 | 1,510 | | | 20,221 | | ||||||||||||||||||
Mortgage pass-through securities
residential |
63,956 | 2,854 | | | 66,810 | | ||||||||||||||||||
Obligations of states and political
subdivisions |
742,575 | 29,256 | (6,130 | ) | (2,083 | ) | 763,618 | | ||||||||||||||||
Corporate bonds |
494,708 | 19,459 | (1,806 | ) | | 512,361 | | |||||||||||||||||
Collateralized mortgage obligations
commercial |
10,016 | 581 | | | 10,597 | | ||||||||||||||||||
Other asset-backed securities: |
||||||||||||||||||||||||
Second mortgages/home equity loans
residential |
1,931 | | | (267 | ) | 1,664 | (873 | )(a) | ||||||||||||||||
Consumer credit receivables |
10,000 | 36 | | | 10,036 | | ||||||||||||||||||
Other |
20,164 | 523 | (43 | ) | | 20,644 | | |||||||||||||||||
Total fixed income securities |
1,384,865 | 55,198 | (7,979 | ) | (2,350 | ) | 1,429,734 | $ | (873 | ) | ||||||||||||||
Equity securities |
1,938 | 240 | | | 2,178 | |||||||||||||||||||
Total |
$ | 1,386,803 | $ | 55,438 | $ | (7,979 | ) | $ | (2,350 | ) | $ | 1,431,912 | ||||||||||||
(a) | The unrealized loss position of this security was $0.3 million at March 31, 2011. |
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The amortized cost, gross unrealized gains, gross unrealized losses, estimated fair value
and unrealized OTTI losses of fixed income securities and the cost, gross unrealized gains, gross
unrealized losses and estimated fair value of equity securities held by CNA Surety at December 31,
2010, by investment category, were as follows (dollars in thousands):
Gross | Gross Unrealized Losses | |||||||||||||||||||||||
Amortized Cost | Unrealized | Less Than | More Than | Estimated | Unrealized | |||||||||||||||||||
December 31, 2010 | or Cost | Gains | 12 Months | 12 Months | Fair Value | OTTI Losses | ||||||||||||||||||
Fixed income securities: |
||||||||||||||||||||||||
U.S. Treasury securities and obligations of
U.S. Government and agencies: |
||||||||||||||||||||||||
U.S. Treasury |
$ | 17,288 | $ | 914 | $ | | $ | | $ | 18,202 | $ | | ||||||||||||
U.S. Agencies |
6,518 | 250 | | | 6,768 | | ||||||||||||||||||
Collateralized mortgage obligations
residential |
20,769 | 1,558 | | | 22,327 | | ||||||||||||||||||
Mortgage pass-through securities
residential |
68,727 | 3,320 | | | 72,047 | | ||||||||||||||||||
Obligations of states and political
subdivisions |
746,514 | 30,932 | (5,096 | ) | (1,742 | ) | 770,608 | | ||||||||||||||||
Corporate bonds |
456,963 | 21,164 | (1,249 | ) | (5 | ) | 476,873 | | ||||||||||||||||
Collateralized mortgage obligations
commercial |
10,018 | 567 | | | 10,585 | | ||||||||||||||||||
Other asset-backed securities: |
||||||||||||||||||||||||
Second mortgages/home equity loans
residential |
3,878 | | (84 | ) | (272 | ) | 3,522 | (927 | )(a) | |||||||||||||||
Consumer credit receivables |
9,998 | 158 | | | 10,156 | | ||||||||||||||||||
Other |
12,674 | 617 | (4 | ) | | 13,287 | | |||||||||||||||||
Total fixed income securities |
1,353,347 | 59,480 | (6,433 | ) | (2,019 | ) | 1,404,375 | $ | (927 | ) | ||||||||||||||
Equity securities |
1,687 | 229 | | | 1,916 | |||||||||||||||||||
Total |
$ | 1,355,034 | $ | 59,709 | $ | (6,433 | ) | $ | (2,019 | ) | $ | 1,406,291 | ||||||||||||
(a) | The unrealized loss position of this security was $0.3 million at December 31, 2010. |
Invested assets are exposed to various risks, such as interest rate, market and credit risks.
Due to the level of risk associated with certain of these invested assets and the level of
uncertainty related to changes in the value of these assets, it is possible that changes in risks
in the near term may significantly affect the amounts reported in the Condensed Consolidated
Balance Sheets and Condensed Consolidated Statements of Income. The Companys Quantitative and
Qualitative Disclosures about Market Risk is contained in Item 3 of this Form 10-Q. The Companys
investments in fixed income securities do not contain any industry concentration of credit risk.
The following table sets forth the ratings assigned by Standard & Poors (S&P) or Moodys
Investor Services, Inc. (Moodys) of the fixed income securities portfolio of the Company as of
March 31, 2011 and December 31, 2010 (dollars in thousands):
March 31, 2011 | December 31, 2010 | |||||||||||||||
Credit Rating(a) | Estimated Fair Value |
% of Total | Estimated Fair Value |
% of Total | ||||||||||||
AAA |
$ | 373,210 | 26.1 | % | $ | 377,757 | 26.9 | % | ||||||||
AA |
586,965 | 41.1 | 597,065 | 42.5 | ||||||||||||
A |
389,320 | 27.2 | 360,128 | 25.7 | ||||||||||||
BBB |
35,829 | 2.5 | 31,439 | 2.2 | ||||||||||||
Non-investment grade |
44,410 | 3.1 | 37,986 | 2.7 | ||||||||||||
Total |
$ | 1,429,734 | 100.0 | % | $ | 1,404,375 | 100.0 | % | ||||||||
(a) | Securities are categorized using the S&P rating. If a security is not rated by S&P, the Moodys rating is used. At March 31, 2011 and December 31, 2010, all of the Companys fixed income securities were rated by S&P or Moodys. |
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As of March 31, 2011, $398.5 million of the Companys investments were guaranteed by one of
three major monoline bond insurers. This includes $396.8 million of bonds of states and political
obligations, or about 52% of the Companys investments in this type of security. Investments in
obligations of states and political subdivisions represent approximately 53% of the Companys
invested assets. The ratings on these securities reflect the higher of the underlying rating of the
issuer or the insurers rating. Of the $396.8 million of bonds of states and political
subdivisions that were insured, $45.0 million of these securities reflect credit rating enhancement
due to the guarantee. The underlying ratings of the enhanced securities is A. The underlying
ratings of all municipal holdings remain very strong and carry an average rating of AA. The Company
views bond insurance as credit enhancement and not credit substitution and a credit review is
performed on each issuer of bonds purchased. Based on the strong underlying credit quality of its
insured bonds of states and political subdivisions, the Company believes that any impact of
additional ratings downgrades or other difficulties of the monoline bond insurers would not have a
significant impact on the Companys financial position or results of operations.
Beginning in 2010, municipal securities have come under increased investor scrutiny and
heightened concerns of default. In addition to the credit reviews noted above, each municipal bond
investment is reviewed as to the sources of debt service and the margins of safety around those
sources. The Companys municipal bond investments are focused in revenue bonds and
full-faith-and-credit general obligation bonds. For revenue bonds, the focus is on bonds where the
sources of debt service are from fees from public universities, transportation, such as toll ways
and airports, and essential services, such as power, water and sewer. The Company focuses on bonds
where there is a monopoly provider with ratemaking authority and where there are specific taxes
pledged directly to bond repayments. The Companys municipal bond investments are widely
diversified with a largest single exposure of $15.9 million and an average exposure of
approximately $5.1 million per issuer. Also, approximately $72.6 million of the Companys municipal
bonds are secured by U.S. Treasury obligations that are held in escrow pending the retirement of
the municipal bonds, typically at a future call date.
The following table provides the composition of fixed income securities with an unrealized
loss at March 31, 2011 in relation to the total of all fixed income securities in an unrealized
loss position by contractual maturities:
% of | ||||||||
Estimated | % of | |||||||
Fair | Unrealized | |||||||
Contractual Maturity | Value | Loss | ||||||
Due after one year through five years |
16 | % | 6 | % | ||||
Due after five years through ten years |
37 | 24 | ||||||
Due after ten years |
43 | 67 | ||||||
Asset-backed securities |
4 | 3 | ||||||
Total |
100 | % | 100 | % | ||||
The following table summarizes for fixed income securities in an unrealized loss position at
March 31, 2011 and December 31, 2010, the aggregate fair value and gross unrealized loss by length
of time those securities have been continuously in an unrealized loss position (dollars in
thousands):
March 31, 2011 | December 31, 2010 | |||||||||||||||
Gross | Gross | |||||||||||||||
Estimated | Unrealized | Estimated | Unrealized | |||||||||||||
Unrealized Loss Aging | Fair Value | Loss | Fair Value | Loss | ||||||||||||
Fixed income securities: |
||||||||||||||||
Investment grade (a): |
||||||||||||||||
0-6 months |
$ | 281,785 | $ | 7,945 | $ | 223,778 | $ | 6,350 | ||||||||
Greater than 24 months |
4,785 | 760 | 7,903 | 663 | ||||||||||||
Total investment grade |
286,570 | 8,705 | 231,681 | 7,013 | ||||||||||||
Non-investment grade: |
||||||||||||||||
0-6 months |
6,208 | 25 | 11,256 | 83 | ||||||||||||
7-12 months |
1,532 | 9 | | | ||||||||||||
Greater than 24 months |
11,168 | 1,590 | 11,522 | 1,356 | ||||||||||||
Total non-investment grade |
18,908 | 1,624 | 22,778 | 1,439 | ||||||||||||
Total |
$ | 305,478 | $ | 10,329 | $ | 254,459 | $ | 8,452 | ||||||||
(a) | Investment grade is determined by using the S&P rating. If a security is not rated by S&P, the Moodys rating is used. As of March 31, 2011 and December 31, 2010, all of the Companys fixed income securities were rated by S&P or Moodys. |
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Management believes the Company has the ability to hold all fixed income securities to
maturity. However, the Company may dispose of securities prior to their scheduled maturity due to
changes in interest rates, prepayments, tax and credit considerations, liquidity or regulatory
capital requirements, or other similar factors. As a result, the Company considers all of its fixed
income securities and equity securities as available-for-sale, and as such, they are carried at
fair value.
A security is in an unrealized loss position, or impaired, if the fair value of the security
is less than its amortized cost, which includes adjustments for accretion, amortization and
previously recorded OTTI losses. When a security is impaired, the impairment is evaluated to
determine whether it is temporary or other-than-temporary.
A significant judgment in the valuation of investments is the determination of when an
other-than-temporary decline in value has occurred. The Company follows a consistent and systematic
process for identifying securities that sustain other-than-temporary declines in value. The Company
has established a watch list that is reviewed by the Chief Financial Officer and one other
executive officer on at least a quarterly basis. The watch list includes individual securities that
fall below certain thresholds or that exhibit evidence of impairment indicators including, but not
limited to, a significant adverse change in the financial condition and near-term prospects of the
investment or a significant adverse change in legal factors, the business climate or credit
ratings.
When a security is placed on the watch list, it is monitored for further market value changes
and additional news related to the issuers financial condition. The focus is on objective evidence
that may influence the evaluation of impairment factors. The decision to record an
other-than-temporary impairment loss incorporates both quantitative criteria and qualitative
information.
In determining whether an equity security is other-than-temporarily impaired, the Company
considers a number of factors including, but not limited to: (a) the length of time and the extent
to which the market value has been less than book value, (b) the financial condition and near-term
prospects of the issuer, (c) the intent and ability of the Company to retain its investment for a
period of time sufficient to allow for any anticipated recovery in value and (d) general market
conditions and industry or sector specific factors. Currently, the Companys equity portfolio is
comprised solely of mutual funds related to the Companys deferred compensation plan, which is an
unfunded, nonqualified deferred compensation plan for a select group of management or highly
compensated employees. Due to the nature of the plan, the Company does not assert the ability to
hold these securities until their recovery in value. As such, if any of these securities are in an
unrealized loss position, they are considered to be other-than-temporarily impaired.
For equity securities for which an other-than-temporary impairment loss has been identified,
the security is written down to fair value and the resulting losses are recognized in realized
gains/losses in the Condensed Consolidated Statements of Income.
Fixed income securities in an unrealized loss position that the Company intends to sell, or it
more likely than not will be required to sell before any anticipated recovery of amortized cost,
are considered to be other-than-temporarily impaired. These securities are written down to fair
value and the resulting losses are recognized in realized gains/losses in the Condensed
Consolidated Statements of Income.
The remaining fixed income securities in an unrealized loss position are evaluated to
determine if a credit loss exists. To determine if a credit loss exists, the Company considers a
number of factors including, but not limited to: (a) the financial condition and near-term
prospects of the issuer, (b) credit ratings of the securities, (c) whether the debtor is current on
interest and principal payments, (d) the length of time and the extent to which the market value
has been less than book value and (e) general market conditions and industry or sector specific
factors.
In addition to these factors, the Company considers the results of discounted cash flow
modeling using assumptions representative of current market conditions as well as those specific to
the Companys particular security holdings. For asset-backed and mortgage-backed securities, the
focus of this analysis is on assessing the sufficiency and quality of underlying collateral and
timing of cash flows. Significant assumptions considered by the Company in its cash flow
projections include delinquency rates, probable risk of default, over collateralization and credit
support from lower level tranches. If the discounted expected cash flows for a security equal or
exceed the amortized cost of that security, no credit loss exists and the security is deemed to be
temporarily impaired.
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Fixed income securities in an unrealized loss position for which management believes a credit
loss exists are considered to be other-than-temporarily impaired. For these fixed income
securities, the Company bifurcates OTTI losses into a credit component and a non-credit component.
The credit component, which represents the difference between the discounted expected cash flows
and the fixed income securitys amortized cost, is recognized in earnings. The non-credit component
is recognized in other comprehensive income and represents the difference between fair value and
the discounted cash flows that the Company expects to collect.
At March 31, 2011, the Company holds 275 fixed income securities in an unrealized gain
position with a total estimated fair value of $1,124.3 million in a gross unrealized gain position
of $55.2 million in the aggregate.
The following table summarizes securities in a gross unrealized loss position by investment
category and by credit rating. The table also discloses the corresponding count of securities in an
unrealized loss position and estimated fair value by category (in thousands of dollars):
Gross Unrealized Losses | ||||||||||||||||||||||||||||
Estimated | ||||||||||||||||||||||||||||
March 31, 2011 | AAA | AA | A | BBB | Total | Count | Fair Value | |||||||||||||||||||||
Fixed income securities: |
||||||||||||||||||||||||||||
Investment grade(a): |
||||||||||||||||||||||||||||
Obligations of states and political subdivisions |
$ | 577 | $ | 4,170 | $ | 2,143 | $ | | $ | 6,890 | 34 | $ | 173,884 | |||||||||||||||
Corporate bonds |
| 39 | 1,405 | 328 | 1,772 | 22 | 102,232 | |||||||||||||||||||||
Other asset-backed securities: |
||||||||||||||||||||||||||||
Other |
43 | | | | 43 | 2 | 10,454 | |||||||||||||||||||||
Total investment grade |
620 | 4,209 | 3,548 | 328 | 8,705 | 58 | 286,570 | |||||||||||||||||||||
Non-investment grade: |
||||||||||||||||||||||||||||
Obligations of states and political subdivisions |
| | | | 1,323 | 1 | 9,504 | |||||||||||||||||||||
Corporate bonds |
| | | | 34 | 5 | 7,740 | |||||||||||||||||||||
Other asset-backed securities: |
||||||||||||||||||||||||||||
Second mortgages/home equity loans
residential |
| | | | 267 | 1 | 1,664 | |||||||||||||||||||||
Total non-investment grade |
| | | | 1,624 | 7 | 18,908 | |||||||||||||||||||||
Total |
$ | 620 | $ | 4,209 | $ | 3,548 | $ | 328 | $ | 10,329 | 65 | $ | 305,478 | |||||||||||||||
(a) | Securities are categorized using the S&P rating. If a security is not rated by S&P, the Moodys rating is used. At March 31, 2011, all of the Companys fixed income securities were rated by S&P or Moodys. |
The Company has no current intent to sell any of the securities in an unrealized loss
position, nor is it more likely than not that it will be required to sell these securities prior to
recovery of amortized cost. The Company believes that all of the securities in an unrealized loss
position will recover in value and that none of these unrealized losses were indicative of credit
losses. Based on the current facts and circumstances of the Companys particular security holdings,
the Company has determined that no additional OTTI losses related to the securities in an
unrealized loss position are required to be recorded.
Obligations of States and Political Subdivisions
The unrealized losses on the Companys investments in obligations of states and political
subdivisions are due to changes in credit spreads and rising interest rates. Of the thirty-four
investment grade obligations of states and political subdivisions in an unrealized loss position at
March 31, 2011, only nine were in an unrealized loss position exceeding 5% of the securitys
amortized cost. The largest unrealized loss, $0.8 million, or 13.7% of the securitys amortized
cost, was on a security issued by a governmental utility authority. The unrealized loss position of
this security has deteriorated slightly compared to December 31, 2010 when it was $0.7 million, or
11.9% of the securitys amortized cost. While the overall unrealized loss position of obligations
of states and political subdivisions grew from $5.8 million, or 3.4% of their amortized cost, at
December 31, 2010 to $6.9 million, or 3.8% of their amortized cost, at March 31, 2011 the Company
continues to believe that all interest and principal will be paid according to their contractual
terms. The Company has no current intent to sell these securities, nor is it more likely than not
that it will be required to sell prior to recovery of amortized cost. The Company does not believe
the unrealized losses on these securities are indicative of credit losses and, as such, has not
recorded any OTTI losses on these securities at March 31, 2011.
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Only one of the Companys
investments in obligations of states and political subdivisions was
rated below investment grade at March 31, 2011. This security, issued by a governmental utility
authority, was in an unrealized loss position of $1.3 million, or 12.2% of amortized cost, at March
31, 2011. The Company believes that this security is rated below investment grade because an
inconsequential contingency amount is insured with one of the major monoline insurers which is
rated B by S&P. The Company believes that this insurer is the lowest rated source of security
involved in the transaction and, despite the fact that the amount of security provided by this
insurer is inconsequential, the entire transaction is rated to the lowest rated component. Based on
the Companys analysis of the sources of debt service on this bond and the fact that the security
is current on all interest payments due through March 31, 2011, the Company continues to believe
that all interest and principal will be paid according to their contractual terms. The Company has
no current intent to sell this security, nor is it more likely than not that it will be required to
sell prior to recovery of amortized cost. The Company does not believe the unrealized loss on
this security is indicative of credit loss and, as such, has not recorded an OTTI loss on
this security at March 31, 2011.
Corporate Bonds
Of the Companys twenty-two investment grade corporate bond investments in an unrealized loss
position at March 31, 2011, the largest unrealized loss was $0.3 million, or 4.8% of the amortized
cost of a security issued by a public utility. Only one of these corporate bond investments was in
an unrealized loss position that exceeded 5% of the securitys amortized cost. This security, also
issued by a public utility, had an unrealized loss of $0.2 million, or 5.4% of the securitys
amortized cost. Interest rate increases in the first quarter of 2011 caused the overall unrealized
loss position on the Companys investment grade corporate bond holdings to increase by $0.6 million
at March 31, 2011 compared to December 31, 2010. The Company has no current intent to sell these
securities, nor is it more likely than not that it will be required to sell prior to recovery of
amortized cost. The Company does not believe the unrealized losses on these securities are
indicative of credit losses and, as such, has not recorded any OTTI losses on these securities at
March 31, 2011.
During 2010, the Company began a program to invest a modest amount in non-investment grade
corporate bonds due to the relative attractiveness of this sector. Five of the securities purchased
under this program were in an unrealized loss position at March 31, 2011. In the aggregate, these
five securities had an unrealized loss of less than $0.1 million as of March 31, 2011. Each of
these securities was in an unrealized loss position representing 0.6% or less of that securitys
amortized cost. The Company has no current intent to sell these securities, nor is it more likely
than not that it will be required to sell prior to recovery of amortized cost. The Company does not
believe the unrealized losses on these securities are indicative of credit losses and, as such, has
not recorded any OTTI losses on these securities at March 31, 2011.
Other Asset-backed Securities
Two investment grade asset-backed securities held by the Company were in an unrealized loss
position at March 31, 2011. Neither of these securities was in an unrealized loss position that
exceeded 5% of the securitys amortized cost. The Company has no current intent to sell these
securities, nor is it more likely than not that it will be required to sell prior to recovery of
amortized cost. The Company does not believe the unrealized losses on these securities are
indicative of credit losses and, as such, has not recorded any OTTI losses on these securities at
March 31, 2011.
At March 31, 2011 the Companys exposure to sub-prime home loans was limited to one
asset-backed security collateralized by sub-prime home loans which originated prior to 2005. The
estimated fair value of this non-investment grade security was $1.7 million at March 31, 2011. This
security was in an unrealized loss position of $0.3 million, or 13.8% of its amortized cost at
March 31, 2011. During 2011, the Company received repayments on this security of $0.1 million, or
approximately 5% of the par value outstanding at December 31, 2010. This security was determined to
have credit losses totaling $0.2 million during 2009 and 2010. The non-credit component of this
securitys OTTI recognized in accumulated other comprehensive income at March 31, 2011 was $0.3
million. The Company believes the non-credit component of the unrealized loss on this security is
primarily attributable to this asset class being out of favor with investors and is not indicative
of the quality of the underlying collateral. The Company has no current intent to sell this
security, nor is it more likely than not that it will be required to sell prior to recovery of the
adjusted amortized cost.
Pending Accounting Pronouncements
In October 2010, the Financial Accounting Standards Board issued Accounting Standards Update
No. 2010-26, Financial Services Insurance (Topic 944) Accounting for Costs Associated with
Acquiring or Renewing Insurance Contracts. This
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updated accounting guidance modifies the definition of the types of costs incurred to acquire
or renew insurance contracts that may be capitalized. Under the new guidance, these costs include
those costs that are incremental direct costs and certain costs that are directly related to
successful contract acquisitions. This accounting guidance is effective for fiscal years, and
interim periods within those fiscal years, beginning after December 15, 2011 with prospective or
retrospective application allowed. The Company is currently assessing the available application
methods as well as the impact this accounting guidance will have on its financial condition and
results of operations.
FORWARD-LOOKING STATEMENTS
This report includes a number of statements, which relate to anticipated future events
(forward-looking statements) rather than actual present conditions or historical events.
Forward-looking statements generally include words such as believes, expects, intends,
anticipates, estimates and similar expressions. Forward-looking statements in this report
include expected developments in the Companys insurance business, including losses and loss
reserves; the impact of routine ongoing insurance reserve reviews being conducted by the Company;
the routine state regulatory examinations of the Companys primary insurance company subsidiaries,
and the Companys responses to the results of those reviews and examinations; the Companys
expectations concerning its revenues, earnings, expenses and investment activities; expected cost
savings and other results from the Companys expense reduction and restructuring activities; and
the Companys proposed actions in response to trends in its business.
Forward-looking statements, by their nature, are subject to a variety of inherent risks and
uncertainties that could cause actual results to differ materially from the results projected. Many
of these risks and uncertainties cannot be controlled by the Company.
Some examples of these risks and uncertainties are:
| general economic and business conditions; | ||
| changes in financial markets such as fluctuations in interest rates, long-term periods of low interest rates, credit conditions and currency, commodity and stock prices; | ||
| the ability of the Companys contract principals to fulfill their bonded obligations; | ||
| the effects of corporate bankruptcies on surety bond claims, as well as on capital markets; | ||
| changes in foreign or domestic political, social and economic conditions; | ||
| regulatory initiatives and compliance with governmental regulations, judicial decisions, including interpretation of policy provisions, decisions regarding coverage, trends in litigation and the outcome of any litigation involving the Company, and rulings and changes in tax laws and regulations; | ||
| regulatory limitations, impositions and restrictions upon the Company, including the effects of assessments and other surcharges for guaranty funds and other mandatory pooling arrangements; | ||
| the impact of competitive products, policies and pricing and the competitive environment in which the Company operates, including changes in the Companys books of business; | ||
| product and policy availability and demand and market responses, including the level of ability to obtain rate increases and decline or non-renew underpriced accounts, to achieve premium targets and profitability and to realize growth and retention estimates; | ||
| development of claims and the impact on loss reserves, including changes in claim settlement practices; | ||
| the performance of reinsurance companies under reinsurance contracts with the Company; | ||
| results of financing efforts, including the Companys ability to access capital markets; |
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| changes in the Companys composition of operating segments; | ||
| the actual closing of contemplated transactions and agreements; | ||
| the sufficiency of the Companys loss reserves and the possibility of future increases in reserves; | ||
| the risks and uncertainties associated with the Companys loss reserves; and, | ||
| the possibility of changes in the Companys ratings by ratings agencies, including the inability to access certain markets or distribution channels and the required collateralization of future payment obligations as a result of such changes, and changes in rating agency policies and practices. |
Any forward-looking statements made in this report are made by the Company as of the date of
this report. The Company does not have any obligation to update or revise any forward-looking
statement contained in this report, even if the Companys expectations or any related events,
conditions or circumstances change.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
CNA Suretys investment portfolio is subject to economic losses due to adverse changes in the
fair value of its financial instruments, or market risk. Interest rate risk represents the largest
market risk factor affecting the Companys consolidated financial condition due to its significant
level of investments in fixed income securities. Increases and decreases in prevailing interest
rates generally translate into decreases and increases in the fair value of the Companys fixed
income portfolio. The fair value of these interest rate sensitive instruments may also be affected
by the credit-worthiness of the issuer, prepayment options, relative value of alternative
investments, the liquidity of the instrument, income tax considerations and general market
conditions. The Company manages its exposure to interest rate risk primarily through an
asset/liability matching strategy. The Companys exposure to interest rate risk is mitigated by the
relative short-term nature of its insurance and other liabilities. The targeted effective duration
of the Companys investment portfolio is approximately 5, consistent with the expected duration of
its insurance and other liabilities.
45
Table of Contents
The tables below summarize the estimated effects of certain hypothetical changes in interest
rates. It is assumed that the changes occur immediately and uniformly across each investment
category. The selected hypothetical changes in market interest rates reflect the Companys
expectations of the reasonably possible scenarios over a one-year period and the hypothetical fair
values are based upon the same prepayment assumptions that were utilized in computing fair values
at March 31, 2011 and December 31, 2010. Significant variations in market interest rates could
produce changes in the timing of repayments due to prepayment options available. The fair value of
such instruments could be affected and therefore actual results might differ from those reflected
in the following tables.
Estimated Fair | Hypothetical | |||||||||||||||
Hypothetical | Value After | Percentage | ||||||||||||||
Fair Value at | Change in | Hypothetical | Decrease in | |||||||||||||
March 31, | Interest Rate | Change in | Stockholders | |||||||||||||
2011 | (bp=basis points) | Interest Rate | Equity | |||||||||||||
(Dollars in thousands) | ||||||||||||||||
U.S. Government and government agencies and
authorities |
$ | 110,814 | ||||||||||||||
200 bp increase | $ | 102,644 | (0.5 | )% | ||||||||||||
150 bp increase | 104,855 | (0.4 | ) | |||||||||||||
100 bp increase | 107,004 | (0.2 | ) | |||||||||||||
50 bp increase | 109,021 | (0.1 | ) | |||||||||||||
States, municipalities and political subdivisions |
763,618 | |||||||||||||||
200 bp increase | 678,213 | (5.1 | ) | |||||||||||||
150 bp increase | 698,418 | (3.9 | ) | |||||||||||||
100 bp increase | 719,395 | (2.6 | ) | |||||||||||||
50 bp increase | 741,128 | (1.3 | ) | |||||||||||||
Corporate bonds |
512,361 | |||||||||||||||
200 bp increase | 468,782 | (2.6 | ) | |||||||||||||
150 bp increase | 479,193 | (2.0 | ) | |||||||||||||
100 bp increase | 489,925 | (1.3 | ) | |||||||||||||
50 bp increase | 500,984 | (0.7 | ) | |||||||||||||
Mortgage-backed and asset-backed |
42,941 | |||||||||||||||
200 bp increase | 41,264 | (0.1 | ) | |||||||||||||
150 bp increase | 41,672 | (0.1 | ) | |||||||||||||
100 bp increase | 42,087 | (0.1 | ) | |||||||||||||
50 bp increase | 42,510 | | ||||||||||||||
Total fixed income securities available-for-sale |
$ | 1,429,734 | ||||||||||||||
200 bp increase | 1,290,903 | (8.3 | ) | |||||||||||||
150 bp increase | 1,324,138 | (6.3 | ) | |||||||||||||
100 bp increase | 1,358,411 | (4.3 | ) | |||||||||||||
50 bp increase | 1,393,643 | (2.2 | ) |
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Estimated Fair | Hypothetical | |||||||||||||||
Hypothetical | Value After | Percentage | ||||||||||||||
Fair Value at | Change in | Hypothetical | Decrease in | |||||||||||||
December 31, | Interest Rate | Change in | Stockholders | |||||||||||||
2010 | (bp=basis points) | Interest Rate | Equity | |||||||||||||
(Dollars in thousands) | ||||||||||||||||
U.S. Government and government agencies and
authorities |
$ | 119,344 | ||||||||||||||
200 bp increase | $ | 111,034 | (0.5 | )% | ||||||||||||
150 bp increase | 113,329 | (0.4 | ) | |||||||||||||
100 bp increase | 115,538 | (0.2 | ) | |||||||||||||
50 bp increase | 117,578 | (0.1 | ) | |||||||||||||
States, municipalities and political subdivisions |
770,608 | |||||||||||||||
200 bp increase | 682,531 | (5.4 | ) | |||||||||||||
150 bp increase | 703,332 | (4.1 | ) | |||||||||||||
100 bp increase | 724,944 | (2.8 | ) | |||||||||||||
50 bp increase | 747,360 | (1.4 | ) | |||||||||||||
Corporate bonds |
476,873 | |||||||||||||||
200 bp increase | 436,507 | (2.5 | ) | |||||||||||||
150 bp increase | 446,132 | (1.9 | ) | |||||||||||||
100 bp increase | 456,064 | (1.3 | ) | |||||||||||||
50 bp increase | 466,309 | (0.6 | ) | |||||||||||||
Mortgage-backed and asset-backed |
37,550 | |||||||||||||||
200 bp increase | 36,031 | (0.1 | ) | |||||||||||||
150 bp increase | 36,400 | (0.1 | ) | |||||||||||||
100 bp increase | 36,776 | | ||||||||||||||
50 bp increase | 37,159 | | ||||||||||||||
Total fixed income securities available-for-sale |
$ | 1,404,375 | ||||||||||||||
200 bp increase | 1,266,103 | (8.4 | ) | |||||||||||||
150 bp increase | 1,299,193 | (6.4 | ) | |||||||||||||
100 bp increase | 1,333,322 | (4.3 | ) | |||||||||||||
50 bp increase | 1,368,406 | (2.2 | ) |
ITEM 4. CONTROLS AND PROCEDURES
The Company maintains a system of disclosure controls and procedures which are designed to
ensure that information required to be disclosed by the Company in reports that it files or submits
to the Securities and Exchange Commission under the Securities and Exchange Act of 1934 as amended
(the Exchange Act), including this report, is recorded, processed, summarized and reported on a
timely basis. These disclosure controls and procedures include controls and procedures designed to
ensure that information required to be disclosed under the Exchange Act is accumulated and
communicated to the Companys management on a timely basis to allow decisions regarding required
disclosure.
The Companys principal executive officer and its principal financial officer undertook an
evaluation of the Companys disclosure controls and procedures (as defined in Exchange Act Rules
13a - 15(e) and 15d - 15(e)) as of the end of the period covered by this report and concluded that
the Companys controls and procedures were effective.
There were no changes in the Companys internal control over financial reporting that occurred
during the Companys last fiscal quarter that have materially affected, or are reasonably likely to
materially affect, the Companys internal control over financial reporting.
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PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS Information on the Companys legal proceedings is set forth in Note 8
of the Condensed Consolidated Financial Statements included under Part 1, Item 1.
ITEM 1A. RISK FACTORS Information on the Companys risk factors is set forth in Item 1A Risk
Factors in the Companys Annual Report on Form 10-K for the year ended December 31, 2010.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES None.
ITEM 5. OTHER INFORMATION Reports on Form 8-K:
February 4, 2011; CNA Surety Corporation Earnings Press Release and CNA Surety Corporation
Special Committee Press Release issued on February 4, 2011.
ITEM 6. EXHIBITS
Exhibit Number | ||||
Certification pursuant to Rule 13a-14(a) of the
Securities Exchange Act of 1934, as adopted pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002
Chief Executive Officer.
|
31 | (1) | ||
Certification pursuant to Rule 13a-14(a) of the
Securities Exchange Act of 1934, as adopted pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002
Chief Financial Officer.
|
31 | (2) | ||
Written Statement of the Chief Executive Officer of
CNA Surety Corporation pursuant to 18 U.S.C. 1350 (as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002).
|
32 | (1)* | ||
Written Statement of the Chief Financial Officer of
CNA Surety Corporation pursuant to 18 U.S.C. 1350 (as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002).
|
32 | (2)* |
* | Exhibits 32(1) and 32(2) are being furnished and shall not be deemed filed for the purpose of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liabilities of that Section. These Exhibits shall not be incorporated by reference into any registration statement or other document pursuant to the Securities Act of 1933, as amended. |
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SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has
duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.
CNA SURETY CORPORATION (Registrant) |
||||
/s/ John F. Welch | ||||
John F. Welch | ||||
President and Chief Executive Officer | ||||
/s/ John F. Corcoran | ||||
John F. Corcoran | ||||
Senior Vice President and Chief Financial Officer |
Date: April 29, 2011
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EXHIBIT INDEX
31(1)
|
Certification pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 Chief Executive Officer. | |
31(2)
|
Certification pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 Chief Financial Officer. | |
32(1)
|
Written Statement of the Chief Executive Officer of CNA Surety Corporation pursuant to 18 U.S.C. 1350 (as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002). | |
32(2)
|
Written Statement of the Chief Financial Officer of CNA Surety Corporation pursuant to 18 U.S.C. 1350 (as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002). |
50