e10vq
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
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þ |
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2010
OR
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o |
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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)
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DELAWARE
(State or other jurisdiction of
incorporation or organization)
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36-4144905
(I.R.S. Employer
Identification No.) |
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333 S. WABASH AVE., CHICAGO, ILLINOIS
(Address of principal executive offices)
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60604
(Zip Code) |
(312) 822-5000
(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 the definitions of large accelerated
filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
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Large accelerated filer o
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Accelerated filer þ
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Non-accelerated filer o
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Smaller Reporting Company o |
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(Do not check if a smaller reporting company) |
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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:
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:
44,317,755 shares of Common Stock, $.01 par value as of July 22, 2010.
CNA SURETY CORPORATION AND SUBSIDIARIES
INDEX
2
CNA SURETY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
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June 30, |
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December 31, |
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2010 |
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2009 |
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|
(Amounts in thousands, except per |
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share data) |
|
Assets |
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|
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Invested assets: |
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|
|
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Fixed income securities, at fair value (amortized cost: $1,252,987 and $1,219,270) |
|
$ |
1,324,980 |
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$ |
1,266,223 |
|
Equity securities, at fair value (cost: $1,687 and $1,429) |
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1,830 |
|
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|
1,610 |
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Short-term investments, at amortized cost (approximates fair value) |
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77,514 |
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48,999 |
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|
|
|
|
|
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Total invested assets |
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1,404,324 |
|
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|
1,316,832 |
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Cash |
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|
4,875 |
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|
5,822 |
|
Deferred policy acquisition costs |
|
|
103,748 |
|
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|
99,836 |
|
Insurance receivables: |
|
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|
|
|
|
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|
Premiums, including $10,256 and $9,753 from affiliates, (net of allowance for doubtful
accounts: $1,407 and $1,110) |
|
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47,224 |
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33,392 |
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Reinsurance |
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51,044 |
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|
48,645 |
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Deposit with affiliated ceding company |
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23,404 |
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|
26,878 |
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Goodwill and other intangible assets (net of accumulated amortization: $25,523 and $25,523) |
|
|
138,785 |
|
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|
138,785 |
|
Property and equipment, at cost (less accumulated depreciation and amortization: $38,525
and $37,514) |
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17,915 |
|
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19,681 |
|
Prepaid reinsurance premiums |
|
|
202 |
|
|
|
210 |
|
Accrued investment income |
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16,239 |
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|
15,832 |
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Other assets |
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2,258 |
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|
3,122 |
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Total assets |
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$ |
1,810,018 |
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$ |
1,709,035 |
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Liabilities |
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Reserves: |
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Unpaid losses and loss adjustment expenses |
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$ |
439,344 |
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$ |
406,123 |
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Unearned premiums |
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259,706 |
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|
247,776 |
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|
|
|
|
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Total reserves |
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|
699,050 |
|
|
|
653,899 |
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Long-term debt |
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|
30,930 |
|
|
|
30,930 |
|
Deferred income taxes, net |
|
|
37,111 |
|
|
|
28,065 |
|
Reinsurance and other payables to affiliates |
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|
104 |
|
|
|
548 |
|
Accrued expenses |
|
|
14,525 |
|
|
|
18,586 |
|
Liability for postretirement benefits |
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|
11,092 |
|
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|
10,718 |
|
Payable for securities purchased |
|
|
|
|
|
|
1,356 |
|
Income tax payable |
|
|
3,481 |
|
|
|
13,389 |
|
Other liabilities |
|
|
23,555 |
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28,460 |
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|
|
|
|
|
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Total liabilities |
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819,848 |
|
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|
785,951 |
|
Commitments and contingencies (See Notes 3, 5, & 8) |
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Stockholders Equity |
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Common stock, par value $.01 per share, 100,000 shares authorized; 45,674 shares issued and
44,313 shares outstanding at June 30, 2010 and 45,635 shares issued and 44,268 shares
outstanding at December 31, 2009 |
|
|
457 |
|
|
|
456 |
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Additional paid-in capital |
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|
280,761 |
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|
279,388 |
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Retained earnings |
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676,935 |
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|
627,505 |
|
Accumulated other comprehensive income |
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|
46,623 |
|
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|
30,406 |
|
Treasury stock, 1,361 and 1,367 shares, at cost |
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(14,606 |
) |
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(14,671 |
) |
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|
|
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Total stockholders equity |
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990,170 |
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|
923,084 |
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Total liabilities and stockholders equity |
|
$ |
1,810,018 |
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|
$ |
1,709,035 |
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|
The accompanying notes are an integral part of these condensed consolidated financial statements.
3
CNA SURETY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
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Three Months Ended |
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Six Months Ended |
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June 30, |
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June 30, |
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2010 |
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2009 |
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2010 |
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2009 |
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(Amount in thousands, except per share data) |
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Revenues: |
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|
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|
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Net earned premium |
|
$ |
105,214 |
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$ |
105,695 |
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$ |
203,466 |
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$ |
206,846 |
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Net investment income |
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|
12,787 |
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|
12,577 |
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|
26,164 |
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|
24,823 |
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Net realized investment gains (losses): |
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|
|
|
|
|
|
|
|
|
|
|
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Other-than-temporary impairment losses |
|
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|
|
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|
(1,824 |
) |
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|
|
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|
(1,870 |
) |
Portion of other-than-temporary impairment losses
recognized in other comprehensive income (before
taxes) |
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(28 |
) |
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1,708 |
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(122 |
) |
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1,708 |
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|
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Net impairment losses recognized in earnings |
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|
(28 |
) |
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|
(116 |
) |
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|
(122 |
) |
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|
(162 |
) |
Net realized investment gains, excluding impairment
losses on available-for-sale securities |
|
|
766 |
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|
69 |
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|
1,183 |
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|
49 |
|
|
|
|
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|
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Total net realized investment gains (losses) |
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|
738 |
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|
(47 |
) |
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1,061 |
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|
(113 |
) |
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|
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Total revenues |
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118,739 |
|
|
|
118,225 |
|
|
|
230,691 |
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|
231,556 |
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|
|
|
|
|
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|
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Expenses: |
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|
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|
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|
|
|
|
|
|
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Net losses and loss adjustment expenses |
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|
21,596 |
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|
|
30,975 |
|
|
|
50,177 |
|
|
|
60,563 |
|
Net commissions, brokerage and other underwriting expenses |
|
|
55,805 |
|
|
|
55,917 |
|
|
|
108,593 |
|
|
|
110,195 |
|
Interest expense |
|
|
291 |
|
|
|
359 |
|
|
|
572 |
|
|
|
777 |
|
|
|
|
|
|
|
|
|
|
|
|
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|
Total expenses |
|
|
77,692 |
|
|
|
87,251 |
|
|
|
159,342 |
|
|
|
171,535 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes |
|
|
41,047 |
|
|
|
30,974 |
|
|
|
71,349 |
|
|
|
60,021 |
|
Income tax expense |
|
|
12,422 |
|
|
|
8,807 |
|
|
|
21,919 |
|
|
|
16,990 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
28,625 |
|
|
$ |
22,167 |
|
|
$ |
49,430 |
|
|
$ |
43,031 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings per common share |
|
$ |
0.65 |
|
|
$ |
0.50 |
|
|
$ |
1.12 |
|
|
$ |
0.97 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings per common share, assuming dilution |
|
$ |
0.64 |
|
|
$ |
0.50 |
|
|
$ |
1.11 |
|
|
$ |
0.97 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding |
|
|
44,307 |
|
|
|
44,251 |
|
|
|
44,294 |
|
|
|
44,229 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding, assuming dilution |
|
|
44,477 |
|
|
|
44,412 |
|
|
|
44,447 |
|
|
|
44,394 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these condensed consolidated financial statements.
4
CNA SURETY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
(UNAUDITED)
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|
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|
|
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Common |
|
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|
|
|
|
|
|
|
|
|
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|
Accumulated |
|
|
|
|
|
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|
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, 2009 |
|
|
44,168 |
|
|
$ |
455 |
|
|
$ |
276,255 |
|
|
|
|
|
|
$ |
509,644 |
|
|
$ |
(4,286 |
) |
|
$ |
(14,773 |
) |
|
$ |
767,295 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
|
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
43,031 |
|
|
$ |
43,031 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
43,031 |
|
Other comprehensive income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in unrealized gains on
securities, after income tax
expense of $9,368 (net of
reclassification adjustment
of ($1,380), after income tax
benefit of $743) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
17,396 |
|
|
|
|
|
|
|
17,396 |
|
|
|
|
|
|
|
17,396 |
|
Other-than-temporary losses
not recognized in the
Condensed Consolidated
Statements of Income, after
income tax benefit of $598 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,110 |
) |
|
|
|
|
|
|
(1,110 |
) |
|
|
|
|
|
|
(1,110 |
) |
Net change related to
postretirement benefits, after
income tax benefit of $25 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(56 |
) |
|
|
|
|
|
|
(56 |
) |
|
|
|
|
|
|
(56 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive income |
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
59,261 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock-based compensation |
|
|
|
|
|
|
|
|
|
|
1,022 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,022 |
|
Stock options exercised and other |
|
|
86 |
|
|
|
1 |
|
|
|
1,056 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
42 |
|
|
|
1,099 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, June 30, 2009 |
|
|
44,254 |
|
|
$ |
456 |
|
|
$ |
278,333 |
|
|
|
|
|
|
$ |
552,675 |
|
|
$ |
11,944 |
|
|
$ |
(14,731 |
) |
|
$ |
828,677 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, January 1, 2010 |
|
|
44,268 |
|
|
$ |
456 |
|
|
$ |
279,388 |
|
|
|
|
|
|
$ |
627,505 |
|
|
$ |
30,406 |
|
|
$ |
(14,671 |
) |
|
$ |
923,084 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
|
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
49,430 |
|
|
$ |
49,430 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
49,430 |
|
Other comprehensive income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in unrealized gains on
securities, after income tax
expense of $8,664 (net of
reclassification adjustment
of $828, after income tax
expense of $446) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
16,090 |
|
|
|
|
|
|
|
16,090 |
|
|
|
|
|
|
|
16,090 |
|
Change in other-than-temporary
impairment losses not
recognized in the Condensed
Consolidated Statements of
Income, after income tax
expense of $87 (net of
reclassification adjustment of
($79), after income tax
benefit of $43) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
161 |
|
|
|
|
|
|
|
161 |
|
|
|
|
|
|
|
161 |
|
Net change related to
postretirement benefits, after
income tax benefit of $19 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(34 |
) |
|
|
|
|
|
|
(34 |
) |
|
|
|
|
|
|
(34 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive income |
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
65,647 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock-based compensation |
|
|
|
|
|
|
|
|
|
|
885 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
885 |
|
Stock options exercised and other |
|
|
45 |
|
|
|
1 |
|
|
|
488 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
65 |
|
|
|
554 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, June 30, 2010 |
|
|
44,313 |
|
|
$ |
457 |
|
|
$ |
280,761 |
|
|
|
|
|
|
$ |
676,935 |
|
|
$ |
46,623 |
|
|
$ |
(14,606 |
) |
|
$ |
990,170 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these condensed consolidated financial statements.
5
CNA SURETY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
|
2010 |
|
|
2009 |
|
|
|
(Amounts in thousands) |
|
Cash Flows from Operating Activities: |
|
|
|
|
|
|
|
|
Net income |
|
$ |
49,430 |
|
|
$ |
43,031 |
|
Adjustments to reconcile net income to net cash provided by operating activities: |
|
|
|
|
|
|
|
|
Provision for doubtful accounts |
|
|
381 |
|
|
|
112 |
|
Depreciation and amortization |
|
|
3,013 |
|
|
|
3,050 |
|
Amortization of bond premium, net |
|
|
3,611 |
|
|
|
2,138 |
|
Gain on disposal of property and equipment |
|
|
(78 |
) |
|
|
(15 |
) |
Net realized investment (gains) losses |
|
|
(1,061 |
) |
|
|
113 |
|
Stock-based compensation |
|
|
885 |
|
|
|
1,022 |
|
Deferred income tax expense |
|
|
247 |
|
|
|
|
|
Changes in: |
|
|
|
|
|
|
|
|
Insurance receivables |
|
|
(16,612 |
) |
|
|
34,484 |
|
Reserve for unearned premiums |
|
|
11,930 |
|
|
|
7,196 |
|
Reserve for unpaid losses and loss adjustment expenses |
|
|
33,221 |
|
|
|
(8,912 |
) |
Deposit with affiliated ceding company |
|
|
3,474 |
|
|
|
2,268 |
|
Deferred policy acquisition costs |
|
|
(3,912 |
) |
|
|
(3,097 |
) |
Reinsurance and other payables to affiliates |
|
|
(444 |
) |
|
|
(1,402 |
) |
Prepaid reinsurance premiums |
|
|
8 |
|
|
|
92 |
|
Accrued expenses |
|
|
(4,061 |
) |
|
|
(6,738 |
) |
Other assets and liabilities |
|
|
(13,969 |
) |
|
|
(8,177 |
) |
|
|
|
|
|
|
|
Net cash provided by operating activities |
|
|
66,063 |
|
|
|
65,165 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash Flows from Investing Activities: |
|
|
|
|
|
|
|
|
Fixed income securities: |
|
|
|
|
|
|
|
|
Purchases |
|
|
(90,421 |
) |
|
|
(128,846 |
) |
Maturities |
|
|
28,824 |
|
|
|
56,806 |
|
Sales |
|
|
25,295 |
|
|
|
2,581 |
|
Purchases of equity securities |
|
|
(311 |
) |
|
|
(677 |
) |
Proceeds from the sale of equity securities |
|
|
65 |
|
|
|
525 |
|
Changes in short-term investments |
|
|
(28,491 |
) |
|
|
12,415 |
|
Purchases of property and equipment, net |
|
|
(1,170 |
) |
|
|
(2,763 |
) |
Changes in receivables/payables for securities sold/purchased |
|
|
(1,355 |
) |
|
|
(8,398 |
) |
|
|
|
|
|
|
|
Net cash (used in) investing activities |
|
|
(67,564 |
) |
|
|
(68,357 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash Flows from Financing Activities: |
|
|
|
|
|
|
|
|
Employee stock option exercises and other |
|
|
554 |
|
|
|
1,099 |
|
|
|
|
|
|
|
|
Net cash provided by financing activities |
|
|
554 |
|
|
|
1,099 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Decrease in cash |
|
|
(947 |
) |
|
|
(2,093 |
) |
Cash at beginning of period |
|
|
5,822 |
|
|
|
9,596 |
|
|
|
|
|
|
|
|
Cash at end of period |
|
$ |
4,875 |
|
|
$ |
7,503 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental Disclosure of Cash Flow Information: |
|
|
|
|
|
|
|
|
Cash paid during the period for: |
|
|
|
|
|
|
|
|
Interest |
|
$ |
565 |
|
|
$ |
789 |
|
Income taxes |
|
$ |
31,518 |
|
|
$ |
18,824 |
|
The accompanying notes are an integral part of these condensed consolidated financial statements.
6
CNA SURETY CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2010
(UNAUDITED)
1. Significant Accounting Policies
Formation of CNA Surety Corporation and Merger
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 62%
of the outstanding common stock of CNA Surety. Loews Corporation owns approximately 90% of the
outstanding common stock of CNAF.
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.
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 2009 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. 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 is computed using the treasury stock
method.
7
The computation of earnings per common share is as follows (amounts in thousands, except for
per share data):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
|
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Net income |
|
$ |
28,625 |
|
|
$ |
22,167 |
|
|
$ |
49,430 |
|
|
$ |
43,031 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding |
|
|
44,298 |
|
|
|
44,240 |
|
|
|
44,268 |
|
|
|
44,168 |
|
Weighted average shares of options exercised and
additional stock issuance |
|
|
9 |
|
|
|
11 |
|
|
|
26 |
|
|
|
61 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total weighted average shares outstanding |
|
|
44,307 |
|
|
|
44,251 |
|
|
|
44,294 |
|
|
|
44,229 |
|
Effect of dilutive options |
|
|
170 |
|
|
|
161 |
|
|
|
153 |
|
|
|
165 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total weighted average shares outstanding, assuming dilution |
|
|
44,477 |
|
|
|
44,412 |
|
|
|
44,447 |
|
|
|
44,394 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings per share |
|
$ |
0.65 |
|
|
$ |
0.50 |
|
|
$ |
1.12 |
|
|
$ |
0.97 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings per share, assuming dilution |
|
$ |
0.64 |
|
|
$ |
0.50 |
|
|
$ |
1.11 |
|
|
$ |
0.97 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
No adjustments were made to reported net income in the computation of earnings per share.
Options to purchase shares of common stock of 0.5 million and 0.8 million were excluded from the
calculation of diluted earnings per share for the three months ended June 30, 2010 and June 30,
2009, respectively, because the exercise price of these options was greater than the average market
price of CNA Suretys common stock. Options to purchase shares of common stock of 0.7 million and
0.8 million were excluded from the calculation of diluted earnings per share for the six months
ended June 30, 2010 and June 30, 2009, respectively, because the exercise price of these options
was greater than the average market price of CNA Suretys common stock.
Adopted Accounting Pronouncements
In June 2009, the Financial Accounting Standards Board (FASB) issued Accounting Standards
Update (ASU) No. 2009-16, Transfers and Servicing (Topic 860) Accounting for Transfers of
Financial Assets. This guidance removed the concept of a qualifying special-purpose entity and
eliminated it from exceptions under the guidance for consolidation of variable interest entities.
It also modified the de-recognition conditions related to legal isolation and effective control and
added additional disclosure requirements for transfers of financial assets. This guidance was
effective for annual reporting periods beginning after November 15, 2009. The adoption of this
guidance did not have an impact on the Companys financial condition or results of operations.
In June 2009, the FASB issued ASU No. 2009-17, Consolidations (Topic 810) Improvements to
Financial Reporting by Enterprises Involved with Variable Interest Entities. This guidance amended
existing consolidation guidance applicable for variable interest entities as well as requirements
for determination of the primary beneficiary of a variable interest entity, required an ongoing
assessment of whether an entity is the primary beneficiary and required enhanced disclosures that
will provide users of financial statements information regarding an enterprises involvement in a
variable interest entity. This guidance was effective for annual reporting periods beginning after
November 15, 2009. The Company evaluated its trust preferred security arrangement discussed further
in Note 6., Debt, to these Condensed Consolidated Financial Statements and determined the issuer
trust should remain unconsolidated under this guidance. As such, the adoption of this guidance did
not have an impact on the Companys financial condition or results of operations.
In April 2009, the FASB issued updated accounting guidance, which amended the
other-than-temporary impairment (OTTI) loss model for fixed income securities. A fixed income
security is impaired if the fair value of the security is less than its amortized cost basis, which
is its cost adjusted for accretion, amortization and previously recorded OTTI losses. The updated
accounting guidance requires an OTTI loss equal to the difference between fair value and amortized
cost to be recognized in earnings if the Company intends to sell the fixed income security or if it
is more likely than not the Company will be required to sell the fixed income security before
recovery of its amortized cost basis.
The remaining fixed income securities in an unrealized loss position are evaluated to
determine if a credit loss exists. If the Company does not expect to recover the entire amortized
cost basis of a fixed income security, the security is deemed to be other-than-temporarily impaired
for credit reasons. For these securities, the bifurcation of OTTI losses into a credit component
and a non-credit component is required by the updated accounting guidance. The credit component is
recognized in earnings and represents the difference between the present value of the future cash
flows that the Company expects to collect and a fixed income securitys amortized cost basis. The
non-credit component is recognized in other comprehensive income and represents the difference
between fair value and the present value of the future cash flows that the Company expects to
collect.
8
Prior to the adoption of the updated accounting guidance, OTTI losses were not bifurcated
between credit and non-credit components. The difference between fair value and amortized cost was
recognized in earnings for all securities for which the Company did not expect to recover the
amortized cost basis, or for which the Company did not have the ability and intent to hold until
recovery of fair value to amortized cost.
2. Investments
Major categories of net investment income were as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30 |
|
|
Six Months Ended June 30 |
|
|
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Investment income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed income securities |
|
$ |
13,067 |
|
|
$ |
12,724 |
|
|
$ |
26,733 |
|
|
$ |
25,027 |
|
Equity securities |
|
|
10 |
|
|
|
10 |
|
|
|
18 |
|
|
|
19 |
|
Short-term investments |
|
|
21 |
|
|
|
36 |
|
|
|
36 |
|
|
|
84 |
|
Other |
|
|
11 |
|
|
|
15 |
|
|
|
24 |
|
|
|
34 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total investment income on available-for-sale securities |
|
|
13,109 |
|
|
|
12,785 |
|
|
|
26,811 |
|
|
|
25,164 |
|
Investment income on deposit with affiliated ceding company |
|
|
25 |
|
|
|
115 |
|
|
|
51 |
|
|
|
272 |
|
Investment expenses |
|
|
(347 |
) |
|
|
(323 |
) |
|
|
(698 |
) |
|
|
(613 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net investment income |
|
$ |
12,787 |
|
|
$ |
12,577 |
|
|
$ |
26,164 |
|
|
$ |
24,823 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 June 30, |
|
|
Six Months Ended June 30, |
|
|
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Net realized investment gains (losses): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed income securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross realized investment gains |
|
$ |
768 |
|
|
$ |
43 |
|
|
$ |
1,193 |
|
|
$ |
43 |
|
Gross realized investment losses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other-than-temporary impairment losses |
|
|
(28 |
) |
|
|
(116 |
) |
|
|
(122 |
) |
|
|
(116 |
) |
Realized losses from sales |
|
|
(2 |
) |
|
|
|
|
|
|
(21 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total gross realized investment losses |
|
|
(30 |
) |
|
|
(116 |
) |
|
|
(143 |
) |
|
|
(116 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net realized investment gains (losses) on fixed income securities |
|
|
738 |
|
|
|
(73 |
) |
|
|
1,050 |
|
|
|
(73 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross realized investment gains |
|
|
1 |
|
|
|
27 |
|
|
|
12 |
|
|
|
27 |
|
Gross realized investment losses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other-than-temporary impairment losses |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(46 |
) |
Realized losses from sales |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(20 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total gross realized investment losses |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(66 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net realized investment gains (losses) on equity securities |
|
|
1 |
|
|
|
27 |
|
|
|
12 |
|
|
|
(39 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other |
|
|
(1 |
) |
|
|
(1 |
) |
|
|
(1 |
) |
|
|
(1 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net realized investment gains (losses) |
|
$ |
738 |
|
|
$ |
(47 |
) |
|
$ |
1,061 |
|
|
$ |
(113 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net change in unrealized gains (losses): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed income securities |
|
$ |
22,471 |
|
|
$ |
12,248 |
|
|
$ |
25,040 |
|
|
$ |
24,975 |
|
Equity securities |
|
|
(59 |
) |
|
|
81 |
|
|
|
(38 |
) |
|
|
81 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net change in unrealized gains (losses) |
|
$ |
22,412 |
|
|
$ |
12,329 |
|
|
$ |
25,002 |
|
|
$ |
25,056 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net realized gains (losses) and change in unrealized gains (losses) |
|
$ |
23,150 |
|
|
$ |
12,282 |
|
|
$ |
26,063 |
|
|
$ |
24,943 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 (bonds) and equity securities as available-for-sale, and as such, they are
carried at fair value.
9
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 June 30,
2010, by investment category, were as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross |
|
|
Gross Unrealized Losses |
|
|
|
|
|
|
|
|
|
Amortized Cost |
|
|
Unrealized |
|
|
Less Than |
|
|
More Than |
|
|
Estimated |
|
|
Unrealized |
|
June 30, 2010 |
|
or Cost |
|
|
Gains |
|
|
12 Months |
|
|
12 Months |
|
|
Fair Value |
|
|
OTTI Losses(a) |
|
Fixed income securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury securities and obligations of U.S.
Government and agencies: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury |
|
$ |
17,286 |
|
|
$ |
1,101 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
18,387 |
|
|
$ |
|
|
U.S. Agencies |
|
|
6,525 |
|
|
|
332 |
|
|
|
|
|
|
|
|
|
|
|
6,857 |
|
|
|
|
|
Collateralized mortgage obligations residential |
|
|
27,039 |
|
|
|
1,926 |
|
|
|
|
|
|
|
|
|
|
|
28,965 |
|
|
|
|
|
Mortgage pass-through securities residential |
|
|
81,617 |
|
|
|
4,096 |
|
|
|
|
|
|
|
|
|
|
|
85,713 |
|
|
|
|
|
Obligations of states and political subdivisions |
|
|
719,868 |
|
|
|
43,021 |
|
|
|
(408 |
) |
|
|
(2,285 |
) |
|
|
760,196 |
|
|
|
|
|
Corporate bonds |
|
|
366,333 |
|
|
|
23,276 |
|
|
|
(148 |
) |
|
|
(147 |
) |
|
|
389,314 |
|
|
|
|
|
Collateralized mortgage obligations commercial |
|
|
10,021 |
|
|
|
421 |
|
|
|
|
|
|
|
|
|
|
|
10,442 |
|
|
|
|
|
Other asset-backed securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Second mortgages/home equity loans residential |
|
|
4,606 |
|
|
|
|
|
|
|
|
|
|
|
(301 |
) |
|
|
4,305 |
|
|
|
(1,113 |
) |
Consumer credit receivables |
|
|
9,996 |
|
|
|
371 |
|
|
|
|
|
|
|
|
|
|
|
10,367 |
|
|
|
|
|
Other |
|
|
9,696 |
|
|
|
738 |
|
|
|
|
|
|
|
|
|
|
|
10,434 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed income securities |
|
|
1,252,987 |
|
|
|
75,282 |
|
|
|
(556 |
) |
|
|
(2,733 |
) |
|
|
1,324,980 |
|
|
$ |
(1,113 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity securities |
|
|
1,687 |
|
|
|
143 |
|
|
|
|
|
|
|
|
|
|
|
1,830 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
1,254,674 |
|
|
$ |
75,425 |
|
|
$ |
(556 |
) |
|
$ |
(2,733 |
) |
|
$ |
1,326,810 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a) |
|
The unrealized loss position of this security was $0.3 million at June 30, 2010. |
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,
2009, by investment category, were as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross |
|
|
Gross Unrealized Losses |
|
|
|
|
|
|
|
|
|
Amortized Cost |
|
|
Unrealized |
|
|
Less Than |
|
|
More Than |
|
|
Estimated |
|
|
Unrealized |
|
December 31, 2009 |
|
or Cost |
|
|
Gains |
|
|
12 Months |
|
|
12 Months |
|
|
Fair Value |
|
|
OTTI Losses(a) |
|
Fixed income securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury securities and obligations of U.S.
Government and agencies: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury |
|
$ |
17,378 |
|
|
$ |
970 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
18,348 |
|
|
$ |
|
|
U.S. Agencies |
|
|
9,794 |
|
|
|
337 |
|
|
|
|
|
|
|
|
|
|
|
10,131 |
|
|
|
|
|
Collateralized mortgage obligations residential |
|
|
30,709 |
|
|
|
1,383 |
|
|
|
|
|
|
|
|
|
|
|
32,092 |
|
|
|
|
|
Mortgage pass-through securities residential |
|
|
94,453 |
|
|
|
2,336 |
|
|
|
(232 |
) |
|
|
|
|
|
|
96,557 |
|
|
|
|
|
Obligations of states and political subdivisions |
|
|
696,505 |
|
|
|
35,847 |
|
|
|
(882 |
) |
|
|
(2,902 |
) |
|
|
728,568 |
|
|
|
|
|
Corporate bonds |
|
|
334,136 |
|
|
|
11,478 |
|
|
|
(1,248 |
) |
|
|
(257 |
) |
|
|
344,109 |
|
|
|
|
|
Collateralized mortgage obligations commercial |
|
|
10,024 |
|
|
|
|
|
|
|
|
|
|
|
(351 |
) |
|
|
9,673 |
|
|
|
|
|
Other asset-backed securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Second mortgages/home equity loans residential |
|
|
5,501 |
|
|
|
|
|
|
|
|
|
|
|
(740 |
) |
|
|
4,761 |
|
|
|
(1,399 |
) |
Consumer credit receivables |
|
|
11,055 |
|
|
|
528 |
|
|
|
|
|
|
|
|
|
|
|
11,583 |
|
|
|
|
|
Other |
|
|
9,715 |
|
|
|
686 |
|
|
|
|
|
|
|
|
|
|
|
10,401 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed income securities |
|
|
1,219,270 |
|
|
|
53,565 |
|
|
|
(2,362 |
) |
|
|
(4,250 |
) |
|
|
1,266,223 |
|
|
$ |
(1,399 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity securities |
|
|
1,429 |
|
|
|
181 |
|
|
|
|
|
|
|
|
|
|
|
1,610 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
1,220,699 |
|
|
$ |
53,746 |
|
|
$ |
(2,362 |
) |
|
$ |
(4,250 |
) |
|
$ |
1,267,833 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a) |
|
The unrealized loss position of this security was $0.5 million at December 31, 2009. |
A security is in an unrealized loss position, or impaired, if the fair value of the security
is less than its amortized cost or 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
10
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 an 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 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.
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 an 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
during the three months ended June 30, 2010, the Company recorded credit-related OTTI losses of
$28,000 in earnings on a security collateralized by sub-prime home loans. The Company initially
recorded credit-related OTTI losses on this security in the three months ended June 30, 2009 as
well as
additional credit-related losses of $0.1 million in the three months ended March 31, 2010.
This security is rated below investment grade by Standard & Poors (S&P).
11
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 June 30, 2010 (in thousands of dollars):
|
|
|
|
|
|
|
|
|
|
|
Three Months |
|
|
Six Months |
|
|
|
Ended June 30 |
|
|
Ended June 30 |
|
Beginning balance |
|
$ |
210 |
|
|
$ |
116 |
|
Credit losses for which an OTTI loss was not previously recognized |
|
|
|
|
|
|
|
|
Credit losses for which an OTTI loss was previously recognized |
|
|
28 |
|
|
|
122 |
|
|
|
|
|
|
|
|
Ending balance |
|
$ |
238 |
|
|
$ |
238 |
|
|
|
|
|
|
|
|
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 June 30, 2009 (in thousands of dollars):
|
|
|
|
|
|
|
Three Months |
|
|
|
Ended June 30 |
|
Beginning balance |
|
$ |
|
|
Credit losses for which an OTTI loss was not previously recognized |
|
|
116 |
|
Credit losses for which an OTTI loss was previously recognized |
|
|
|
|
|
|
|
|
Ending balance |
|
$ |
116 |
|
|
|
|
|
For the three and six months ended June 30, 2010, the Company has recorded no OTTI losses on
equity securities. For the three months ended June 30, 2009, the Company did not record OTTI
losses on equity securities; however, the Company recorded OTTI losses of less than $0.1 million on
the equity securities that are related to the Companys nonqualified deferred compensation plan for
the six months ended June 30, 2009.
The amortized cost and estimated fair value of fixed income securities, by contractual
maturity, at June 30, 2010 and December 31, 2009 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):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2010 |
|
|
December 31, 2009 |
|
|
|
Amortized |
|
|
Estimated Fair |
|
|
Amortized |
|
|
Estimated Fair |
|
|
|
Cost |
|
|
Value |
|
|
Cost |
|
|
Value |
|
Fixed income securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Due within one year |
|
$ |
36,616 |
|
|
$ |
37,571 |
|
|
$ |
13,006 |
|
|
$ |
13,224 |
|
Due after one year but within five years |
|
|
355,530 |
|
|
|
376,347 |
|
|
|
304,654 |
|
|
|
321,144 |
|
Due after five years but within ten years |
|
|
417,573 |
|
|
|
451,951 |
|
|
|
447,485 |
|
|
|
468,254 |
|
Due after ten years |
|
|
300,293 |
|
|
|
308,885 |
|
|
|
292,668 |
|
|
|
298,534 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,110,012 |
|
|
|
1,174,754 |
|
|
|
1,057,813 |
|
|
|
1,101,156 |
|
Mortgage pass-through securities,
collateralized mortgage obligations and
asset-backed securities |
|
|
142,975 |
|
|
|
150,226 |
|
|
|
161,457 |
|
|
|
165,067 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
1,252,987 |
|
|
$ |
1,324,980 |
|
|
$ |
1,219,270 |
|
|
$ |
1,266,223 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The following table provides the composition of fixed income securities with an unrealized
loss at June 30, 2010 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 |
|
|
13 |
% |
|
|
9 |
% |
Due after ten years |
|
|
81 |
|
|
|
82 |
|
Asset-backed securities |
|
|
6 |
|
|
|
9 |
|
|
|
|
|
|
|
|
Total |
|
|
100 |
% |
|
|
100 |
% |
|
|
|
|
|
|
|
12
The following table summarizes for fixed income securities in an unrealized loss position at
June 30, 2010 and December 31, 2009, 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):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2010 |
|
|
December 31, 2009 |
|
|
|
|
|
|
|
Gross |
|
|
|
|
|
|
Gross |
|
|
|
Estimated |
|
|
Unrealized |
|
|
Estimated |
|
|
Unrealized |
|
Unrealized Loss Aging |
|
Fair Value |
|
|
Loss |
|
|
Fair Value |
|
|
Loss |
|
Fixed income securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment grade (a): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
0-6 months |
|
$ |
6,912 |
|
|
$ |
148 |
|
|
$ |
162,087 |
|
|
$ |
2,362 |
|
7-12 months |
|
|
23,809 |
|
|
|
408 |
|
|
|
|
|
|
|
|
|
13-24 months |
|
|
|
|
|
|
|
|
|
|
11,176 |
|
|
|
469 |
|
Greater than 24 months |
|
|
25,847 |
|
|
|
1,172 |
|
|
|
32,932 |
|
|
|
2,065 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total investment grade |
|
|
56,568 |
|
|
|
1,728 |
|
|
|
206,195 |
|
|
|
4,896 |
|
Non-investment grade: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Greater than 24 months |
|
|
17,019 |
|
|
|
1,561 |
|
|
|
17,346 |
|
|
|
1,716 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
73,587 |
|
|
$ |
3,289 |
|
|
$ |
223,541 |
|
|
$ |
6,612 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(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 June 30, 2010
and December 31, 2009, all of the Companys fixed income
securities were rated by S&P or Moodys. |
At June 30, 2010, the Company holds 294 fixed income securities in an unrealized gain position
with a total estimated fair value of $1,251.4 million and an aggregate gross unrealized gain of
$75.3 million.
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 |
|
June 30, 2010 |
|
AAA |
|
|
AA |
|
|
A |
|
|
BBB |
|
|
Total |
|
|
Count |
|
|
Fair Value |
|
Fixed income securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment grade(a): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Obligations of states and political subdivisions |
|
$ |
166 |
|
|
$ |
555 |
|
|
$ |
706 |
|
|
$ |
|
|
|
$ |
1,427 |
|
|
|
7 |
|
|
$ |
44,597 |
|
Corporate bonds |
|
|
|
|
|
|
|
|
|
|
148 |
|
|
|
147 |
|
|
|
295 |
|
|
|
2 |
|
|
|
9,780 |
|
Other asset-backed securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Second mortgages/home equity loans residential |
|
|
6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6 |
|
|
|
1 |
|
|
|
2,191 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total investment grade |
|
|
172 |
|
|
|
555 |
|
|
|
854 |
|
|
|
147 |
|
|
|
1,728 |
|
|
|
10 |
|
|
|
56,568 |
|
Non-investment grade: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Obligations of states and political subdivisions |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,266 |
|
|
|
2 |
|
|
|
14,906 |
|
Other asset-backed securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Second mortgages/home equity loans residential |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
295 |
|
|
|
1 |
|
|
|
2,113 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total non-investment grade |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,561 |
|
|
|
3 |
|
|
|
17,019 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
172 |
|
|
$ |
555 |
|
|
$ |
854 |
|
|
$ |
147 |
|
|
$ |
3,289 |
|
|
|
13 |
|
|
$ |
73,587 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a) |
|
Securities are categorized using the S&P rating. If a security is not rated by
S&P, the Moodys rating is used. At June 30, 2010, 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. Of the seven investment grade obligations of
states and political subdivisions that were in an unrealized loss position at June 30, 2010, only
one was in an unrealized loss position exceeding 5% of the securitys amortized cost. This
security, issued by a governmental utility authority, had an unrealized loss of $0.7 million, which
was 12.7% of the securitys amortized cost. The unrealized loss on this security deteriorated
slightly from $0.6 million, or 11.3% of the securitiys amortized cost, compared to December 31,
2009. Improving market conditions resulted in an improvement of $1.3 million in the unrealized
losses on the Companys other investment grade obligations of states and political subdivisions at
June 30, 2010 compared to December 31, 2009. 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 June
30, 2010.
13
The Companys investments in two other obligations of states and political subdivisions,
issued by governmental utility authorities, are below investment grade. At June 30, 2010, one of
these securities had an unrealized loss of $0.3 million, or 5.4% of its amortized cost, and the
other had an unrealized loss of $1.0 million, or 9.0% of its amortized cost. The unrealized loss
position of each of these securities deteriorated slightly, less than $0.1 million in total, at
June 30, 2010 compared to December 31, 2009. Based on the underlying fundamentals of these
securities, 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. As such,
the Company has not recorded an OTTI loss on these securities at June 30, 2010.
The two corporate bond investments in an unrealized loss position at June 30, 2010 had
unrealized losses which represented 2.1% and 4.9% of each securitys amortized cost,
respectively. The overall unrealized loss position on the Companys corporate bond holdings
improved $1.2 million at June 30, 2010 compared to December 31, 2009. The unrealized losses on the
Companys corporate bond investments are primarily attributable to increases in interest rates
beginning in the fourth quarter of 2009. 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
June 30, 2010.
At June 30, 2010 the Companys exposure to sub-prime home loans is limited to two asset-backed
securities collateralized by sub-prime home loans originated prior to 2005. Both of these
securities are in an unrealized loss position. One of these securities, which is rated investment
grade, has an amortized cost of $2.2 million and is in an unrealized loss position of less than
0.3% of its amortized cost at June 30, 2010. The Company believes the unrealized loss on this
security is primarily attributable to broader economic conditions 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 amortized cost.
The other security with sub-prime exposure is rated below investment grade. During the six
months ended June 30, 2010, the Company received repayments on this security of $0.3 million, or
approximately 12% of the par value outstanding at December 31, 2009. As discussed previously, this
security was determined to have additional credit losses totaling $122,000 during the six months
ended June 30, 2010. The non-credit component of this securitys OTTI recognized in accumulated
other comprehensive income at June 30, 2010 was $0.3 million. The Company also recognized a
credit-related loss of $0.1 million on this security in the three months ended June 30, 2009. The
Company believes the non-credit component of the unrealized loss on this security is primarily
attributable to broader economic conditions and liquidity concerns 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 June 30, 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.
14
3. Reinsurance
The effect of reinsurance on the Companys written and earned premium was as follows (dollars
in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30, |
|
|
|
2010 |
|
|
2009 |
|
|
|
Written |
|
|
Earned |
|
|
Written |
|
|
Earned |
|
Direct |
|
$ |
91,316 |
|
|
$ |
87,982 |
|
|
$ |
92,019 |
|
|
$ |
87,293 |
|
Assumed |
|
|
23,631 |
|
|
|
23,430 |
|
|
|
24,815 |
|
|
|
25,252 |
|
Ceded |
|
|
(6,203 |
) |
|
|
(6,198 |
) |
|
|
(6,719 |
) |
|
|
(6,850 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
108,744 |
|
|
$ |
105,214 |
|
|
$ |
110,115 |
|
|
$ |
105,695 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30, |
|
|
|
2010 |
|
|
2009 |
|
|
|
Written |
|
|
Earned |
|
|
Written |
|
|
Earned |
|
Direct |
|
$ |
183,279 |
|
|
$ |
169,861 |
|
|
$ |
181,147 |
|
|
$ |
170,634 |
|
Assumed |
|
|
44,195 |
|
|
|
45,683 |
|
|
|
46,812 |
|
|
|
50,128 |
|
Ceded |
|
|
(12,070 |
) |
|
|
(12,078 |
) |
|
|
(13,825 |
) |
|
|
(13,916 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
215,404 |
|
|
$ |
203,466 |
|
|
$ |
214,134 |
|
|
$ |
206,846 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 discussed below. 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 this 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
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 the three and six month periods ended June 30, 2010 and 2009.
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
June 30, 2010 and 2009, assumed premiums written under such arrangements were $1.3 million and $0.5
million, respectively. For the six month periods ended June 30, 2010 and 2009, assumed premiums
written under such arrangements were $2.6 million and $1.0 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 June 30, |
|
|
2010 |
|
2009 |
|
|
$ |
|
Ratio |
|
$ |
|
Ratio |
|
|
|
|
|
|
|
|
|
|
|
Gross losses and loss adjustment expenses |
|
$ |
23,307 |
|
|
|
20.9 |
% |
|
$ |
32,745 |
|
|
|
29.1 |
% |
Ceded amounts |
|
|
(1,711 |
) |
|
|
27.6 |
% |
|
|
(1,770 |
) |
|
|
25.8 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net losses and loss adjustment expenses |
|
$ |
21,596 |
|
|
|
20.5 |
% |
|
$ |
30,975 |
|
|
|
29.3 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30, |
|
|
2010 |
|
2009 |
|
|
$ |
|
|
Ratio |
|
$ |
|
|
Ratio |
Gross losses and loss adjustment expenses |
|
$ |
51,122 |
|
|
|
23.7 |
% |
|
$ |
64,053 |
|
|
|
29.0 |
% |
Ceded amounts |
|
|
(945 |
) |
|
|
7.8 |
% |
|
|
(3,490 |
) |
|
|
25.1 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net losses and loss adjustment expenses |
|
$ |
50,177 |
|
|
|
24.7 |
% |
|
$ |
60,563 |
|
|
|
29.3 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
15
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. Only the large national contractor
discussed below was excluded from the third party reinsurance agreements effective for the treaty
periods discussed; however, as discussed below, the Company has no further exposure to this
principal.
2009 Third Party Reinsurance
Effective January 1, 2009, CNA Surety entered into an excess of loss treaty (2009 Excess of
Loss Treaty) with a group of third party reinsurers on terms similar to the excess of loss treaty
effective in 2008. Under the 2009 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 $13.8 million based on losses ceded under the
contract. The actual ceded premiums for the 2009 Excess of Loss Treaty were $26.6 million.
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 2009 Excess of Loss
Treaty. Under the 2010 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 2010 on bonds that were in force during 2010. The contract also
includes a provision for additional premiums of up to $12.3 million based on losses ceded under the
contract. The base annual premium for the 2010 Excess of Loss Treaty is $24.6 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. Many of
these agreements originally were entered into on September 30, 1997 (the Merger Date) and
include: (i) the Surety Quota Share Treaty (the Quota Share Treaty); (ii) the Aggregate Stop Loss
Reinsurance Contract (the Stop Loss Contract) and (iii) the Surety Excess of Loss Reinsurance
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,
2010 and expires on December 31, 2010 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 2009 this resulted in an override commission on their actual direct acquisition costs
of 4.8% 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 June 30, 2010.
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
16
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 June 30, 2010 and
December 31, 2009, losses incurred under the Stop Loss Contract were $47.2 million and $49.1
million, respectively. The decrease is due to favorable development on claims subject to the Stop
Loss Contract during the three months ended March 31, 2010. At June 30, 2010, 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. In 2009, this agreement was amended so that the Companys authority to
conduct administrative, management, underwriting and claim functions for bonds written for the
large national contractor discussed below shall continue until CCCs bonds for such contractor have
expired and claims have been settled or closed. This agreement was renewed on January 1, 2010 and
expires on December 31, 2010 and is annually renewable thereafter. As of June 30, 2010 there were
no amounts due to the CNA Surety insurance subsidiaries under this agreement.
From January 1, 2005 to June 30, 2009, the Company and CCC were parties to an excess of loss
contract, and extensions to that contract, that provided unlimited reinsurance coverage in excess
of $60 million retention for the life of bonds either in force or written during the contract
periods exclusively for the one large national contractor excluded from the Companys third party
reinsurance. Premiums for these contracts totaled $8.6 million and included an initial premium of
$7.0 million and premiums of $1.6 million based on the level of premiums written on bonds for the
large national contractor.
In 2009, the Company and CCC terminated the excess of loss contract discussed in the preceding
paragraph. Related to the termination of this contract, the Company and CCC also commuted the
Quota Share Treaty as regards the premium and losses for the large national contractor. The impact
of this commutation was a decrease of gross loss reserves of $51.8 million. Under the terms of
the agreements effecting this commutation, the Company paid CCC $1.8 million. This settlement
reflected the difference between the Companys $60.0 million retention under the excess of loss
contract and the $58.2 million paid by the Company for losses of the large national contractor
through 2009.
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. These agreements expire on December 31,
2010 and are annually renewable thereafter. As of June 30, 2010,
Western Surety had a payable of
$0.1 million to CCC under the Canadian Services and Indemnity Agreement.
As of June 30, 2010 and December 31, 2009, CNA Surety had an insurance receivable balance from
CCC and CIC of $10.3 million and $9.8 million, respectively, comprised of premiums receivable.
The Companys Condensed Consolidated Balance Sheets also include a Deposit with affiliated
ceding company of $23.4 million and $26.9 million at June 30, 2010 and December 31, 2009,
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.
17
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 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 or 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.
18
Assets measured at fair value on a recurring basis as of June 30, 2010 and December 31, 2009
are summarized below (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 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 |
|
$ |
18,387 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
18,387 |
|
U.S. Agencies |
|
|
|
|
|
|
6,857 |
|
|
|
|
|
|
|
6,857 |
|
Collateralized mortgage obligations residential |
|
|
|
|
|
|
28,965 |
|
|
|
|
|
|
|
28,965 |
|
Mortgage pass-through securities residential |
|
|
|
|
|
|
85,713 |
|
|
|
|
|
|
|
85,713 |
|
Obligations of states and political subdivisions |
|
|
|
|
|
|
760,196 |
|
|
|
|
|
|
|
760,196 |
|
Corporate bonds |
|
|
|
|
|
|
389,314 |
|
|
|
|
|
|
|
389,314 |
|
Collateralized mortgage obligations commercial |
|
|
|
|
|
|
10,442 |
|
|
|
|
|
|
|
10,442 |
|
Other asset-backed securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Second mortgages/home equity loans residential |
|
|
|
|
|
|
4,305 |
|
|
|
|
|
|
|
4,305 |
|
Consumer credit receivables |
|
|
|
|
|
|
10,367 |
|
|
|
|
|
|
|
10,367 |
|
Other |
|
|
|
|
|
|
10,434 |
|
|
|
|
|
|
|
10,434 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed income securities |
|
|
18,387 |
|
|
|
1,306,593 |
|
|
|
|
|
|
|
1,324,980 |
|
Equity securities at fair value |
|
|
1,830 |
|
|
|
|
|
|
|
|
|
|
|
1,830 |
|
Short-term investments at fair value (a) |
|
|
29,544 |
|
|
|
47,970 |
|
|
|
|
|
|
|
77,514 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets |
|
$ |
49,761 |
|
|
$ |
1,354,563 |
|
|
$ |
|
|
|
$ |
1,404,324 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a) |
|
Includes commercial paper, U.S. Government agency discount notes and money market
funds. |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2009 |
|
|
|
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 |
|
$ |
18,348 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
18,348 |
|
U.S. Agencies |
|
|
|
|
|
|
10,131 |
|
|
|
|
|
|
|
10,131 |
|
Collateralized mortgage obligations residential |
|
|
|
|
|
|
32,092 |
|
|
|
|
|
|
|
32,092 |
|
Mortgage pass-through securities residential |
|
|
|
|
|
|
96,557 |
|
|
|
|
|
|
|
96,557 |
|
Obligations of states and political subdivisions |
|
|
|
|
|
|
728,568 |
|
|
|
|
|
|
|
728,568 |
|
Corporate bonds |
|
|
|
|
|
|
344,109 |
|
|
|
|
|
|
|
344,109 |
|
Collateralized mortgage obligations commercial |
|
|
|
|
|
|
9,673 |
|
|
|
|
|
|
|
9,673 |
|
Other asset-backed securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Second mortgages/home equity loans residential. |
|
|
|
|
|
|
4,761 |
|
|
|
|
|
|
|
4,761 |
|
Consumer credit receivables |
|
|
|
|
|
|
11,583 |
|
|
|
|
|
|
|
11,583 |
|
Other |
|
|
|
|
|
|
10,401 |
|
|
|
|
|
|
|
10,401 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed income securities |
|
|
18,348 |
|
|
|
1,247,875 |
|
|
|
|
|
|
|
1,266,223 |
|
Equity securities at fair value |
|
|
1,610 |
|
|
|
|
|
|
|
|
|
|
|
1,610 |
|
Short-term investments at fair value (a) |
|
|
15,412 |
|
|
|
33,587 |
|
|
|
|
|
|
|
48,999 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets |
|
$ |
35,370 |
|
|
$ |
1,281,462 |
|
|
$ |
|
|
|
$ |
1,316,832 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a) |
|
Includes commercial paper, U.S. Government agency discount notes and money
market funds. |
The Company had no transfers between levels in the fair value hierarchy requiring additional
disclosure.
19
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 |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
|
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Reserves at beginning of period: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross |
|
$ |
426,458 |
|
|
$ |
453,724 |
|
|
$ |
406,123 |
|
|
$ |
428,724 |
|
Ceded reinsurance |
|
|
51,430 |
|
|
|
91,659 |
|
|
|
50,968 |
|
|
|
83,691 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net reserves at beginning of period |
|
|
375,028 |
|
|
|
362,065 |
|
|
|
355,155 |
|
|
|
345,033 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net incurred loss and loss adjustment expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision for insured events of current year |
|
|
30,596 |
|
|
|
30,979 |
|
|
|
59,177 |
|
|
|
60,616 |
|
(Decrease) in provision for insured events of prior years |
|
|
(9,000 |
) |
|
|
(4 |
) |
|
|
(9,000 |
) |
|
|
(53 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net incurred |
|
|
21,596 |
|
|
|
30,975 |
|
|
|
50,177 |
|
|
|
60,563 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net payments attributable to: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current year events |
|
|
3,403 |
|
|
|
2,825 |
|
|
|
4,093 |
|
|
|
3,606 |
|
Prior year events |
|
|
6,823 |
|
|
|
11,199 |
|
|
|
14,915 |
|
|
|
22,974 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net payments |
|
|
10,226 |
|
|
|
14,024 |
|
|
|
19,008 |
|
|
|
26,580 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign currency transaction adjustments |
|
|
(94 |
) |
|
|
|
|
|
|
(20 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net reserves at end of period |
|
|
386,304 |
|
|
|
379,016 |
|
|
|
386,304 |
|
|
|
379,016 |
|
Ceded reinsurance at end of period |
|
|
53,040 |
|
|
|
40,796 |
|
|
|
53,040 |
|
|
|
40,796 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross reserves at end of period |
|
$ |
439,344 |
|
|
$ |
419,812 |
|
|
$ |
439,344 |
|
|
$ |
419,812 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Company recorded net loss reserve development for prior accident years which resulted in a
decrease of the estimated liability of $9.0 million for the three and six-month periods ended June
30, 2010 compared to nominal decreases for the three and six-month periods ended June 30, 2009.
The favorable development in 2010 resulted primarily from a level of loss activity that
continues to be substantially below expectations for accident year 2006. This level of loss
activity was particularly influenced by a lower than expected emergence of large claims. The
Companys initial estimates of losses for accident year 2010 and the estimates for accident years
2008 and 2009 continue to reflect the impact of less favorable economic conditions.
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. Beginning in May 2009, these securities may be
redeemed, in whole or in part, at par value at any scheduled quarterly interest payment date. As
of June 30, 2010, 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 $57.4 million, consisting of annual
dividend payments of approximately $1.2 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 June 30, 2010 and 2009, the interest rate on the junior
subordinated debenture was 3.811% and 4.258%, respectively.
20
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 June 30, 2010 or December 31, 2009.
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 (MMA) has been recognized in the accounting for that plan. Also, as further
described in Note 9., Income Taxes, to these Condensed Consolidated Financial Statements, enactment
of the Patient Protection and Affordable Care Act (the Act) and the Healthcare and Education
Affordability Reconciliation Act (the Reconciliation Measure), which modifies certain provisions
of the Act, repeal the current 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.
The plans combined net periodic postretirement benefit cost included the following components
(amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30, |
|
|
Six Months Ended June 30, |
|
|
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Net periodic benefit cost: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service cost |
|
$ |
61 |
|
|
$ |
53 |
|
|
$ |
122 |
|
|
$ |
106 |
|
Interest cost |
|
|
158 |
|
|
|
135 |
|
|
|
316 |
|
|
|
269 |
|
Amortization of prior service cost |
|
|
(27 |
) |
|
|
(41 |
) |
|
|
(55 |
) |
|
|
(81 |
) |
Net amortization of actuarial loss |
|
|
|
|
|
|
|
|
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net periodic benefit cost |
|
$ |
192 |
|
|
$ |
147 |
|
|
$ |
384 |
|
|
$ |
294 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Company expects to contribute $0.2 million to the postretirement benefit plans to pay
benefits in 2010. As of June 30, 2010 less than $0.1 million of contributions have been made to
the postretirement benefit plans.
8. Commitments and Contingencies
The Company is party 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
As previously discussed, the enactment of the Act and the related Reconciliation Measure
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. Under the Act and the Reconciliation Measure, the subsidy remains tax-free through 2012.
As of March 31, 2010, the impact of these provisions was recognized in the accounting for this
postretirement benefit plan. No additional income tax expense was recognized for the three months
ended June 30, 2010. However, as a result of the provisions of the Act and the Reconciliation
Measure, the Company recognized additional income tax expense of $0.5 million for the six months
ended June 30, 2010.
The Company is subject to taxation in the United States and various state jurisdictions. In
2009, the Internal Revenue Service notified the Company that the examination of the Companys tax
return for the year 2006 was completed and no changes were made to the Companys reported income
taxes. However, the Companys tax year 2006, as well as tax years 2007 through 2009, 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 June 30, 2010
or December 31, 2009, 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.
21
10. Stockholders Equity
The compensation expense recorded for the Companys stock-based compensation plan was $0.5
million and $0.4 million for the three months ended June 30, 2010 and 2009, respectively, and $0.9
million and $1.0 million for the six months ended June 30, 2010 and 2009, respectively. The total
income tax benefit recognized in the Condensed Consolidated Statements of Income for stock-based
compensation arrangements was $0.1 million for both the three months ended June 30, 2010 and 2009,
respectively. The total income tax benefit recognized in the Condensed Consolidated Statements of
Income for stock-based compensation was $0.3 million for both the six months ended June 30, 2010
and 2009, respectively. The amount of cash received from the exercise of stock options was $0.2
million for both the three months ended June 30, 2010 and 2009. For the six months
ended June 30, 2010 and 2009, the amount of cash received was $0.5 million and $1.1 million,
respectively.
Equity Compensation Plans
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 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 options may be granted under the 2006
Plan was 3,000,000. Option exercises under the 2006 Plan are settled in newly issued common shares.
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 option exercise prices. Exercise prices 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.
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.
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
estimated the expected option life of the 2010 grant based on its analysis of past exercise
patterns for similar options. As of June 30, 2010, the number of shares available for granting of
options under the 2006 Plan was 1,982,345.
On February 6, 2009, 217,960 options were granted under the 2006 Plan. The fair market value
(at grant date) per option granted was $8.95 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 1.95%; dividend yield of 0.0%; expected option life
of 5.3 years and volatility of 51.8%, which was based on historical volatility. The Company
estimated the expected option life of the 2009 grant based on its analysis of past exercise
patterns for similar options. As of June 30, 2009, the number of shares available for granting of
options under the 2006 Plan was 2,238,255.
22
A summary of option activity for the six months ended June 30, 2010 and 2009 is presented
below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
|
Average |
|
|
|
Shares |
|
|
Exercise |
|
|
|
Subject |
|
|
Price Per |
|
|
|
To Option |
|
|
Share |
|
Outstanding options at January 1, 2009 |
|
|
1,221,118 |
|
|
$ |
14.93 |
|
Options granted |
|
|
217,960 |
|
|
$ |
18.85 |
|
Options forfeited |
|
|
(4,030 |
) |
|
$ |
17.74 |
|
Options expired |
|
|
(1,690 |
) |
|
$ |
15.79 |
|
Options exercised |
|
|
(81,680 |
) |
|
$ |
11.54 |
|
|
|
|
|
|
|
|
|
Outstanding options at June 30, 2009 |
|
|
1,351,678 |
|
|
$ |
15.76 |
|
|
|
|
|
|
|
|
|
Outstanding options at January 1, 2010 |
|
|
1,318,288 |
|
|
$ |
15.78 |
|
Options granted |
|
|
281,260 |
|
|
$ |
14.32 |
|
Options forfeited |
|
|
(7,755 |
) |
|
$ |
17.98 |
|
Options expired |
|
|
(2,555 |
) |
|
$ |
19.98 |
|
Options exercised |
|
|
(38,920 |
) |
|
$ |
12.50 |
|
|
|
|
|
|
|
|
|
Outstanding options at June 30, 2010 |
|
|
1,550,318 |
|
|
$ |
15.58 |
|
|
|
|
|
|
|
|
|
A summary of the status of the Companys non-vested options as of June 30, 2010 and 2009 and
changes during the six months then ended is presented below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
|
Shares |
|
|
Average |
|
|
|
Subject |
|
|
Grant Date |
|
|
|
To Option |
|
|
Fair Value |
|
Non-vested options at January 1, 2009 |
|
|
545,095 |
|
|
$ |
7.29 |
|
Options granted |
|
|
217,960 |
|
|
$ |
8.95 |
|
Options vested |
|
|
(136,849 |
) |
|
$ |
7.82 |
|
Options forfeited |
|
|
(4,030 |
) |
|
$ |
7.57 |
|
|
|
|
|
|
|
|
|
Non-vested options at June 30, 2009 |
|
|
622,176 |
|
|
$ |
7.76 |
|
|
|
|
|
|
|
|
|
Non-vested options at January 1, 2010 |
|
|
539,396 |
|
|
$ |
8.10 |
|
Options granted |
|
|
281,260 |
|
|
$ |
7.25 |
|
Options vested |
|
|
(185,202 |
) |
|
$ |
8.14 |
|
Options forfeited |
|
|
(7,755 |
) |
|
$ |
7.96 |
|
|
|
|
|
|
|
|
|
Non-vested options at June 30, 2010 |
|
|
627,699 |
|
|
$ |
7.71 |
|
|
|
|
|
|
|
|
|
A summary of the options vested or expected to vest and options exercisable as of June 30,
2010 is presented below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Vested or Expected to Vest |
|
|
|
|
|
|
Weighted |
|
|
|
|
|
Weighted Average |
|
|
|
|
|
|
Average |
|
Aggregate |
|
Remaining |
|
|
Number |
|
Exercise Price |
|
Intrinsic Value |
|
Contractual Life |
June 30, 2010
|
|
|
1,474,102 |
|
|
$ |
15.53 |
|
|
$ |
2,694,992 |
|
|
6.6 years |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Exercisable |
|
|
|
|
|
|
Weighted |
|
|
|
|
|
Weighted Average |
|
|
|
|
|
|
Average |
|
Aggregate |
|
Remaining |
|
|
Number |
|
Exercise Price |
|
Intrinsic Value |
|
Contractual Life |
June 30, 2010
|
|
|
922,619 |
|
|
$ |
14.90 |
|
|
$ |
2,264,314 |
|
|
5.4 years |
The total intrinsic value of options exercised was $0.1 million for both the three months
ended June 30, 2010 and 2009 and $0.2 million and $0.5 million for the six months
ended June 30, 2010 and 2009, respectively. The tax benefits recognized by the Company for these exercises were
less than $0.1 million for both the three and six months ended June 30, 2010. The tax benefits
recognized by the Company for these exercises were $0.1 million and $0.2 million for the three and
six months ended June 30, 2009, respectively.
As of June 30, 2010, there was $2.3 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: 2010 $0.9 million; 2011 $0.9 million;
2012 $0.4 million; and 2013 $0.1 million.
23
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, 2009.
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 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).
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.
24
The following table shows the estimated liability as of June 30, 2010 for unpaid claims
applicable to reported claims and to IBNR for each sub-line of business (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross Case Loss |
|
|
Gross IBNR Loss |
|
|
Total Gross |
|
|
|
and LAE Reserves |
|
|
and LAE Reserves |
|
|
Reserves |
|
Contract |
|
$ |
71,048 |
|
|
$ |
248,146 |
|
|
$ |
319,194 |
|
Commercial |
|
|
53,400 |
|
|
|
55,224 |
|
|
|
108,624 |
|
Fidelity and other |
|
|
4,047 |
|
|
|
7,479 |
|
|
|
11,526 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
128,495 |
|
|
$ |
310,849 |
|
|
$ |
439,344 |
|
|
|
|
|
|
|
|
|
|
|
Periodic actuarial analyses of the Companys loss reserves are performed. These analyses
previously included a comprehensive review performed in the third quarter based on data as of June
30 and an update of the comprehensive review performed in January based on data as of December 31.
In 2009, the Company changed the timing of the comprehensive review to occur in the fourth quarter
using data as of September 30. 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.
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,
25
liquidity or regulatory capital requirements, or other similar factors. As a result, the
Company considers all of its fixed income securities (bonds) 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.
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 cash flows and
the fixed income securitys amortized cost, is recognized in earnings and the non-credit component
is recognized in other comprehensive income. 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.
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.
Goodwill and Other Intangible Assets
CNA Suretys Condensed Consolidated Balance Sheets as of June 30, 2010 and December 31, 2009
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
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
26
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 are presented net of an estimated allowance for doubtful
accounts, which is based on a periodic evaluation of the aging and collectability of premium
receivables.
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.
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.
27
Comparison of CNA Surety Actual Results for the Three and Six Months Ended June 30, 2010 and 2009
Analysis of Net Income
Net income for the three months ended June 30, 2010 was $28.6 million, or $0.64 per diluted
share, compared to $22.2 million, or $0.50 per diluted share, for the same period in 2009. The
results for the three months ended June 30, 2010 include favorable loss reserve development on prior accident years of $9.0 million.
Net income for the six months ended June 30, 2010 was $49.4 million, or $1.11 per diluted
share, compared to $43.0 million, or $0.97 per diluted share, in 2009. In addition to the favorable
loss reserve development of $9.0 million, the results for the six months ended June 30, 2010 also
include an income tax charge of $0.5 million related to tax code changes contained within the
health care reform legislation enacted during the first quarter of 2010.
The components of net income are discussed in the following sections.
Results of Insurance Operations
Underwriting components for the Company for the three and six months ended June 30, 2010 and
2009 are summarized in the following table (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30, |
|
|
Six Months Ended June 30, |
|
|
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Gross written premiums |
|
$ |
114,947 |
|
|
$ |
116,834 |
|
|
$ |
227,474 |
|
|
$ |
227,959 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net written premiums |
|
$ |
108,744 |
|
|
$ |
110,115 |
|
|
$ |
215,404 |
|
|
$ |
214,134 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earned premiums |
|
$ |
105,214 |
|
|
$ |
105,695 |
|
|
$ |
203,466 |
|
|
$ |
206,846 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net losses and loss adjustment expenses |
|
$ |
21,596 |
|
|
$ |
30,975 |
|
|
$ |
50,177 |
|
|
$ |
60,563 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
commissions, brokerage and other underwriting expenses |
|
$ |
55,805 |
|
|
$ |
55,917 |
|
|
$ |
108,593 |
|
|
$ |
110,195 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss ratio |
|
|
20.5 |
% |
|
|
29.3 |
% |
|
|
24.7 |
% |
|
|
29.3 |
% |
Expense ratio |
|
|
53.0 |
|
|
|
52.9 |
|
|
|
53.4 |
|
|
|
53.3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Combined ratio |
|
|
73.5 |
% |
|
|
82.2 |
% |
|
|
78.1 |
% |
|
|
82.6 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
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 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 month periods ended
June 30, 2010 and 2009, premiums assumed under such arrangements were $1.3 million and $0.5
million, respectively. For the six months ended June 30, 2010 and 2009, premiums assumed under
such arrangements were $2.6 million and $0.5 million, respectively.
28
Gross written premium, which is the aggregate of direct written premiums and assumed written
premiums, for the three months and six months ended June 30, 2010 and 2009 is shown in the table
below (dollars in thousands) for each sub-line of business:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30, |
|
|
Six Months Ended June 30, |
|
|
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Contract |
|
$ |
74,892 |
|
|
$ |
76,129 |
|
|
$ |
143,349 |
|
|
$ |
143,484 |
|
Commercial |
|
|
32,622 |
|
|
|
33,438 |
|
|
|
67,843 |
|
|
|
68,416 |
|
Fidelity and other |
|
|
7,433 |
|
|
|
7,267 |
|
|
|
16,282 |
|
|
|
16,059 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
114,947 |
|
|
$ |
116,834 |
|
|
$ |
227,474 |
|
|
$ |
227,959 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the three months ended June 30, 2010, gross written premiums decreased 1.6 percent to
$114.9 million compared to $116.8 million for the three months ended June 30, 2009. Contract surety
gross written premiums decreased 1.6 percent to $74.9 million due to lower demand resulting from
fewer new construction projects, partially offset by an increase in premiums assumed under
international reinsurance contracts. Commercial surety gross written premiums decreased 2.4 percent
to $32.6 million due to a modest decline in the small commercial
market, partially offset by selective growth
opportunities in the corporate commercial market.
For the six months ended June 30, 2010, gross written premiums decreased 0.2 percent to $227.5
million compared to $228.0 million for the six-month period ended June 30, 2009. Contract surety
gross written premiums remained relatively flat compared to the same period in 2009.
Commercial surety gross written premiums decreased 0.8 percent to $67.8 million due to the
market conditions discussed above.
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 $0.5 million and $1.8 million
for the three and six months ended June 30, 2010, respectively, compared to the same periods in 2009 due to the
lower cost of the Companys 2010 third party excess of loss reinsurance treaty.
Net written premium, which is gross written premiums less ceded written premiums, for the
three and six months ended June 30, 2010 and 2009 are shown in the table below (dollars in
thousands) for each sub-line of business:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30, |
|
|
Six Months Ended June 30, |
|
|
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Contract |
|
$ |
69,424 |
|
|
$ |
70,127 |
|
|
$ |
132,737 |
|
|
$ |
131,152 |
|
Commercial |
|
|
31,887 |
|
|
|
32,721 |
|
|
|
66,385 |
|
|
|
66,923 |
|
Fidelity and other |
|
|
7,433 |
|
|
|
7,267 |
|
|
|
16,282 |
|
|
|
16,059 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
108,744 |
|
|
$ |
110,115 |
|
|
$ |
215,404 |
|
|
$ |
214,134 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the three months ended June 30, 2010, net written premiums decreased 1.2 percent to $108.7
million compared to $110.1 million for the three months ended June 30, 2009 reflecting the decrease
in gross written premium, partially offset by lower ceded written premium.
Net written premiums for the six months ended June 30, 2010 increased 0.6 percent to $215.4
million compared to $214.1 million for the six months ended June 30, 2009 reflecting lower ceded
written premium partially offset by the decrease in gross written premium discussed above.
Net written premiums are recognized as revenue over the policy term as net earned premiums.
Net earned premiums for the three months and six months ended June 30, 2010 and 2009 are shown in
the table below (dollars in thousands) for each sub-line of business:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30, |
|
|
Six Months Ended June 30, |
|
|
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Contract |
|
$ |
65,010 |
|
|
$ |
65,207 |
|
|
$ |
123,536 |
|
|
$ |
126,499 |
|
Commercial |
|
|
32,642 |
|
|
|
32,821 |
|
|
|
64,918 |
|
|
|
65,038 |
|
Fidelity and other |
|
|
7,562 |
|
|
|
7,667 |
|
|
|
15,012 |
|
|
|
15,309 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
105,214 |
|
|
$ |
105,695 |
|
|
$ |
203,466 |
|
|
$ |
206,846 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the three months ended June 30, 2010, net earned premiums decreased by $0.5 million to
$105.2 million as compared to the same period of 2009 reflecting the impact of adverse economic
conditions on gross written premiums in prior periods, partially offset
29
by the decrease in ceded written premiums discussed above. Ceded earned premiums decreased
$0.6 million to $6.2 million for the three months ended June 30, 2010 compared to the three months
ended June 30, 2009. Net earned premiums for contract surety business decreased 0.3 percent to
$65.0 million for the three months ended June 30, 2010 compared to the three months ended June 30,
2009. Net earned premiums for commercial surety decreased 0.5 percent to $32.6 million for the
three months ended June 30, 2010 compared to the three months ended June 30, 2009. Net earned
premiums for fidelity and other premiums decreased 1.4 percent to $7.6 million for the three months
ended June 30, 2010 compared to the three months ended June 30, 2009.
For the six months ended June 30, 2010, net earned premiums decreased by $3.4 million to
$203.5 million as compared to the same period of 2009 reflecting the impact of adverse economic
conditions on gross written premiums in prior periods, partially offset by the decrease in ceded
written premiums discussed above. Ceded earned premiums decreased $1.8 million to $12.1 million for
the six months ended June 30, 2010 compared to the same period in 2009. Net earned premiums for
contract surety business decreased 2.3 percent to $123.5 million for the six months ended June 30,
2010 compared to the same period in 2009. Net earned premiums for commercial surety business
decreased slightly while net earned premiums for fidelity and other net earned premiums decreased
1.9 percent to $15.0 million for the six months ended June 30, 2010 compared to the same period in
2009.
Net Loss Ratio
The net loss ratio was 20.5% for the three months ended June 30, 2010 compared with 29.3% for
the same period in 2009. The net loss ratio was 24.7% for the six months ended June 30, 2010
compared with 29.3% for the same period in 2009. These loss ratios include re-estimates of prior
accident year reserves, known as reserve development. The decrease in the ratios reflect favorable
loss reserve development on prior accident years of $9.0 million, an impact of 8.6 and 4.4
percentage points on the net loss ratios for the three and six months ended June 30, 2010,
respectively. Nominal revisions of prior year loss reserves had no impact on the loss ratios for
the three and six months ended June 30, 2009.
Expense Ratio
The expense ratio was 53.0% for the three months ended June 30, 2010 as compared with 52.9%
for the same period in 2009. The expense ratio was 53.4% for the six months ended June 30, 2010 as
compared with 53.3% for the same period in 2009. Expected upward pressure on the expense ratio
resulting from the impact on earned premiums of lower written premiums in prior periods was offset
by the impact of lower ceded written premium and the Companys continued expense management.
Investment Income and Realized Investment Gains/Losses
Net investment income for the quarter ended June 30, 2010 was $12.8 million compared to $12.6
million during the second quarter of 2009 due to an increase in invested assets, partially offset
by lower yields. The annualized pre-tax yields were 3.9% and 4.3% for the three months ended June
30, 2010 and 2009, respectively. The annualized after-tax yield was 3.1% and 3.6% for the three
months ended June 30, 2010 and 2009, respectively.
Net investment income for the six months ended June 30, 2010 was $26.2 million compared to
$24.8 million for the same period in 2009. The increase reflects the impact of higher overall
invested assets, partially offset by lower yields. The annualized pre-tax yields were 4.0% and 4.3%
for the six months ended June 30, 2010 and 2009, respectively. The annualized after-tax yield was
3.3% and 3.6% for the six months ended June 30, 2010 and 2009, respectively.
30
The following summarizes net realized investment gains (losses) activity (dollars in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30, |
|
|
Six Months Ended June 30, |
|
|
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Net realized investment gains (losses): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed income securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross realized investment gains |
|
$ |
768 |
|
|
$ |
43 |
|
|
$ |
1,193 |
|
|
$ |
43 |
|
Gross realized investment losses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other-than-temporary impairment losses |
|
|
(28 |
) |
|
|
(116 |
) |
|
|
(122 |
) |
|
|
(116 |
) |
Realized losses from sales |
|
|
(2 |
) |
|
|
|
|
|
|
(21 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total gross realized investment losses |
|
|
(30 |
) |
|
|
(116 |
) |
|
|
(143 |
) |
|
|
(116 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net realized investment gains (losses) on fixed income securities |
|
|
738 |
|
|
|
(73 |
) |
|
|
1,050 |
|
|
|
(73 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross realized investment gains |
|
|
1 |
|
|
|
27 |
|
|
|
12 |
|
|
|
27 |
|
Gross realized investment losses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other-than-temporary impairment losses |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(46 |
) |
Realized losses from sales |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(20 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total gross realized investment losses |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(66 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net realized investment gains (losses) on equity securities |
|
|
1 |
|
|
|
27 |
|
|
|
12 |
|
|
|
(39 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Other |
|
|
(1 |
) |
|
|
(1 |
) |
|
|
(1 |
) |
|
|
(1 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net realized investment gains (losses) |
|
$ |
738 |
|
|
$ |
(47 |
) |
|
$ |
1,061 |
|
|
$ |
(113 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
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
The benchmark interest rate for the Companys variable interest rate debt is the London
Interbank Offered Rate (LIBOR). Due to lower three-month LIBOR rates, interest expense decreased
by 18.9 percent and 26.4 percent for the three and six months ended June 30, 2010, respectively, as
compared with the same periods in 2009. Weighted average debt outstanding was $30.9 million for
each of these periods. The weighted average interest rate for the three months ended June 30, 2010
was 3.7% as compared with 4.4% for the same period in 2009. The weighted average interest rate for
the six months ended June 30, 2010 was 3.7% as compared with 4.8% for the same period in 2009.
Income Taxes
The Companys income tax expense was $12.4 million and $21.9 million for the three and six
months ended June 30, 2010, respectively. The Companys income tax expense was $8.8 million and
$17.0 million for the three and six months ended June 30, 2009, respectively. The effective income
tax rates for the three and six months ended June 30, 2010 were 30.2% and 30.7%, respectively. The
effective income tax rates for the three and six months ended June 30, 2009 were 28.4% and 28.3%,
respectively. The Companys effective tax rate differs from the statutory tax rate due primarily to
tax-exempt investment income. Tax-exempt investment income was $5.8 million and $12.1 million for
the three and six months ended June 30, 2010, respectively. Tax-exempt investment income was $6.5
million and $13.1 million for the three and six months ended June 30, 2009, respectively.
As previously discussed, the Company recorded an additional income tax expense of $0.5 million
in the first three months of 2010 as the result of health care reform legislation. The Patient
Protection and Affordable Care Act (the Act) and the Healthcare and Education Affordability
Reconciliation Act (the Reconciliation Measure) 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.
31
Under the Act and the Reconciliation Measure, the subsidy remains tax-free through 2012.
The impact of these provisions was recognized in the accounting for this postretirement benefit
plan during the three months ended March 31, 2010. No additional income tax expense was recognized
for the three months ended June 30, 2010.
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 management initiatives. With respect to
risks on large commercial accounts, the Company generally limits its exposure to $25.0 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 does have accounts
with bonded backlogs greater than $30.0 million.
The Company manages its exposure to any one contract credit 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. Only the large national contractor
discussed below was excluded from the third party reinsurance agreements effective for the treaty
periods discussed; however, as discussed below, the Company has no further exposure to this
principal.
2009 Third Party Reinsurance
Effective January 1, 2009, CNA Surety entered into an excess of loss treaty (2009 Excess of
Loss Treaty) with a group of third party reinsurers on terms similar to the excess of loss treaty
effective in 2008. Under the 2009 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 $13.8 million based on losses ceded under the
contract. The actual ceded premiums for the 2009 Excess of Loss Treaty were $26.6 million.
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 2009 Excess of Loss
Treaty. Under the 2010 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 2010 on bonds that were in force during 2010. The contract also
includes a provision for additional premiums of up to $12.3 million based on losses ceded under the
contract. The base annual premium for the 2010 Excess of Loss Treaty is $24.6 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. Many of
these agreements originally were entered into on September 30, 1997 (the Merger Date) and
include: (i) the Surety Quota Share Treaty (the Quota Share Treaty); (ii) the Aggregate Stop Loss
Reinsurance Contract (the Stop Loss Contract) and (iii) the Surety Excess of Loss Reinsurance
Contract. Although the contracts entered on the Merger Date have expired, some have been renewed on
different terms as described below.
32
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,
2010 and expires on December 31, 2010 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 2009 this resulted in an override commission on their actual direct acquisition costs
of 4.8% 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 June 30, 2010.
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 June 30, 2010 and December 31, 2009, losses incurred
under the Stop Loss Contract were $47.2 million and $49.1 million, respectively. The decrease is
due to favorable development on claims subject to the Stop Loss
Contract during the three months ended March 31, 2010. At June 30, 2010, 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. In 2009, this agreement was amended so that the Companys authority to
conduct administrative, management, underwriting and claim functions for bonds written for the
large national contractor discussed below shall continue until CCCs bonds for such contractor have
expired and claims have been settled or closed. This agreement was renewed on January 1, 2010 and
expires on December 31, 2010 and is annually renewable thereafter. As of June 30, 2010 there were
no amounts due to the CNA Surety insurance subsidiaries under this agreement.
From January 1, 2005 to June 30, 2009, the Company and CCC were parties to an excess of loss
contract, and extensions to that contract, that provided unlimited reinsurance coverage in excess
of $60 million retention for the life of bonds either in force or written during the contract
periods exclusively for the one large national contractor excluded from the Companys third party
reinsurance. Premiums for these contracts totaled $8.6 million and included an initial premium of
$7.0 million and premiums of $1.6 million based on the level of premiums written on bonds for the
large national contractor.
In 2009, the Company and CCC terminated the excess of loss contract discussed in the preceding
paragraph. Related to the termination of this contract, the Company and CCC also commuted the
Quota Share Treaty as regards the premium and losses for the large national contractor. The impact
of this commutation was a decrease of gross loss reserves of $51.8 million. Under the terms of
the agreements effecting this commutation, the Company paid CCC $1.8 million. This settlement
reflected the difference between the Companys $60.0 million retention under the excess of loss
contract and the $58.2 million paid by the Company for losses of the large national contractor
through 2009.
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,
33
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. These agreements expire on December 31, 2010 and are
annually renewable thereafter. As of June 30, 2010, Western
Surety had a payable of $0.1 million to
CCC under the Canadian Services and Indemnity Agreement.
As of June 30, 2010 and December 31, 2009, CNA Surety had an insurance receivable balance from
CCC and CIC of $10.3 million and $9.8 million, respectively, comprised of premiums receivable.
The Companys Condensed Consolidated Balance Sheets also include a Deposit with affiliated
ceding company of $23.4 million and $26.9 million at June 30, 2010 and December 31, 2009,
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, 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 June 30, 2010, the carrying value of the Companys insurance subsidiaries invested assets
was comprised of $1,325.0 million of fixed income securities and $73.9 million of short-term
investments and cash. At December 31, 2009, the carrying value of the Companys insurance
subsidiaries invested assets was comprised of $1,266.2 million of fixed income securities and
$39.8 million of short-term investments and 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. The principal
obligations at the parent company level are to service debt and pay operating expenses, including
income taxes. At June 30, 2010, the parent companys invested assets consisted of $1.8 million of
equity securities and $7.9 million of short-term investments and cash. At December 31, 2009, the
parent companys invested assets consisted of $1.6 million of equity securities and $14.0 million
of short-term investments and cash. At June 30, 2010 and December 31, 2009, parent company
short-term investments and cash included $6.3 million and $11.1 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 $66.1 million
for the six months ended June 30, 2010 compared to net cash flow provided by operating activities
of $65.2 million for the comparable period in 2009. This increase results from lower net loss and
loss adjustment expense payments, higher investment income received and lower commissions,
brokerage and other underwriting expenses paid, largely offset by lower collected premiums and
higher federal income tax payments.
The Companys consolidated net cash flow provided by operating activities was $39.8 million
for the three months ended June 30, 2010 compared to net cash flow provided by operating activities
of $31.5 million for the comparable period in 2009. This increase is due to the factors described
above for the six-month period ended June 30, 2010; however, the impact of higher federal income
tax payments was significantly less for the three-month period.
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
34
basis points with a 30-year term. Beginning in May 2009, these securities may be redeemed, in whole or in part, at par value at
any scheduled quarterly interest payment date. As of June 30, 2010, 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 $57.4 million, consisting of annual
dividend payments of approximately $1.2 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 June 30, 2010 and 2009, the interest rate on the junior
subordinated debenture was 3.811% and 4.258%, 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.
A summary of the Companys commitments as of June 30, 2010 is presented in the following table
(in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contractual Obligations as of June 30, 2010 |
|
2010 |
|
|
2011 |
|
|
2012 |
|
|
2013 |
|
|
2014 |
|
|
Thereafter |
|
|
Total |
|
Debt (a) |
|
$ |
0.6 |
|
|
$ |
1.2 |
|
|
$ |
1.2 |
|
|
$ |
1.2 |
|
|
$ |
1.2 |
|
|
$ |
53.7 |
|
|
$ |
59.1 |
|
Operating leases |
|
|
1.0 |
|
|
|
1.9 |
|
|
|
1.0 |
|
|
|
0.1 |
|
|
|
0.1 |
|
|
|
|
|
|
|
4.1 |
|
Loss and loss adjustment expense reserves |
|
|
49.6 |
|
|
|
121.5 |
|
|
|
85.0 |
|
|
|
58.8 |
|
|
|
49.7 |
|
|
|
74.7 |
|
|
|
439.3 |
|
Other long-term liabilities (b) |
|
|
0.2 |
|
|
|
1.4 |
|
|
|
1.1 |
|
|
|
0.5 |
|
|
|
0.4 |
|
|
|
10.4 |
|
|
|
14.0 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
51.4 |
|
|
$ |
126.0 |
|
|
$ |
88.3 |
|
|
$ |
60.6 |
|
|
$ |
51.4 |
|
|
$ |
138.8 |
|
|
$ |
516.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a) |
|
Reflects expected principal and interest payments. |
|
(b) |
|
Reflects unfunded postretirement benefit plans and long-term incentive plan payments
to certain executives. |
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 states 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 2010 is based on
statutory surplus and income at and for the year ended December 31, 2009. Without prior regulatory
approval in 2010, Western Surety may pay dividends of $122.9 million to CNA Surety. CNA Surety
received dividends of $0.5 million from its non-insurance subsidiary and no dividends from its
insurance subsidiaries during the first six months of 2010. CNA Surety received no dividends from
its subsidiaries during the first six months of 2009.
Combined statutory surplus totaled $729.0 million at June 30, 2010, resulting in a net written
premium to statutory surplus ratio of to 0.6 to 1. Insurance regulations restrict Western Suretys
maximum net retention on a single surety bond to 10 percent of statutory surplus. Under the 2010
Excess of Loss Treaty, the Companys net retention on new bonds would generally be $15 million plus
a 5%
35
co-participation in the $90 million layer of excess reinsurance above the Companys retention.
Based on statutory surplus as of June 30, 2010, this regulation would limit Western Suretys
largest gross risk to $158.4 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 $31.8 million and $19.5 million from its subsidiaries for the six months ended
June 30, 2010 and June 30, 2009, 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, 2009 through June 30, 2010, the underwriting
limitations of Western Surety and Surety Bonding were $54.7 million and $0.7 million, respectively.
Effective July 1, 2010 through June 30, 2011, the 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. During 2008, the South Dakota Division of Insurance began its financial
examination of Western Surety, Surety Bonding and Universal Surety as of and for the period January
1, 2004 through December 31, 2008. The final financial examination report was filed with the South
Dakota Division of Insurance on December 11, 2009. On January 13, 2010, the Company was notified
that the final examination report was adopted by the Director of the South Dakota Division of
Insurance as filed. No adverse findings were included in the final examination report.
36
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 June 30,
2010, by investment category, were as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross |
|
|
Gross Unrealized Losses |
|
|
|
|
|
|
|
|
|
Amortized Cost |
|
|
Unrealized |
|
|
Less Than |
|
|
More Than |
|
|
Estimated |
|
|
Unrealized |
|
June 30, 2010 |
|
or Cost |
|
|
Gains |
|
|
12 Months |
|
|
12 Months |
|
|
Fair Value |
|
|
OTTI Losses(a) |
|
Fixed income securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury securities and obligations of U.S.
Government and agencies: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury |
|
$ |
17,286 |
|
|
$ |
1,101 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
18,387 |
|
|
$ |
|
|
U.S. Agencies |
|
|
6,525 |
|
|
|
332 |
|
|
|
|
|
|
|
|
|
|
|
6,857 |
|
|
|
|
|
Collateralized mortgage obligations residential |
|
|
27,039 |
|
|
|
1,926 |
|
|
|
|
|
|
|
|
|
|
|
28,965 |
|
|
|
|
|
Mortgage pass-through securities residential |
|
|
81,617 |
|
|
|
4,096 |
|
|
|
|
|
|
|
|
|
|
|
85,713 |
|
|
|
|
|
Obligations of states and political subdivisions |
|
|
719,868 |
|
|
|
43,021 |
|
|
|
(408 |
) |
|
|
(2,285 |
) |
|
|
760,196 |
|
|
|
|
|
Corporate bonds |
|
|
366,333 |
|
|
|
23,276 |
|
|
|
(148 |
) |
|
|
(147 |
) |
|
|
389,314 |
|
|
|
|
|
Collateralized mortgage obligations commercial |
|
|
10,021 |
|
|
|
421 |
|
|
|
|
|
|
|
|
|
|
|
10,442 |
|
|
|
|
|
Other asset-backed securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Second mortgages/home equity loans residential |
|
|
4,606 |
|
|
|
|
|
|
|
|
|
|
|
(301 |
) |
|
|
4,305 |
|
|
|
(1,113 |
) |
Consumer credit receivables |
|
|
9,996 |
|
|
|
371 |
|
|
|
|
|
|
|
|
|
|
|
10,367 |
|
|
|
|
|
Other |
|
|
9,696 |
|
|
|
738 |
|
|
|
|
|
|
|
|
|
|
|
10,434 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed income securities |
|
|
1,252,987 |
|
|
|
75,282 |
|
|
|
(556 |
) |
|
|
(2,733 |
) |
|
|
1,324,980 |
|
|
$ |
(1,113 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity securities |
|
|
1,687 |
|
|
|
143 |
|
|
|
|
|
|
|
|
|
|
|
1,830 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
1,254,674 |
|
|
$ |
75,425 |
|
|
$ |
(556 |
) |
|
$ |
(2,733 |
) |
|
$ |
1,326,810 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a) |
|
The unrealized loss position of this security was $0.3 million at June 30, 2010. |
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,
2009, by investment category, were as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross |
|
|
Gross Unrealized Losses |
|
|
|
|
|
|
|
|
|
Amortized Cost |
|
|
Unrealized |
|
|
Less Than |
|
|
More Than |
|
|
Estimated |
|
|
Unrealized |
|
December 31, 2009 |
|
or Cost |
|
|
Gains |
|
|
12 Months |
|
|
12 Months |
|
|
Fair Value |
|
|
OTTI Losses(a) |
|
Fixed income securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury securities and obligations of U.S.
Government and agencies: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury |
|
$ |
17,378 |
|
|
$ |
970 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
18,348 |
|
|
$ |
|
|
U.S. Agencies |
|
|
9,794 |
|
|
|
337 |
|
|
|
|
|
|
|
|
|
|
|
10,131 |
|
|
|
|
|
Collateralized mortgage obligations residential |
|
|
30,709 |
|
|
|
1,383 |
|
|
|
|
|
|
|
|
|
|
|
32,092 |
|
|
|
|
|
Mortgage pass-through securities residential |
|
|
94,453 |
|
|
|
2,336 |
|
|
|
(232 |
) |
|
|
|
|
|
|
96,557 |
|
|
|
|
|
Obligations of states and political subdivisions |
|
|
696,505 |
|
|
|
35,847 |
|
|
|
(882 |
) |
|
|
(2,902 |
) |
|
|
728,568 |
|
|
|
|
|
Corporate bonds |
|
|
334,136 |
|
|
|
11,478 |
|
|
|
(1,248 |
) |
|
|
(257 |
) |
|
|
344,109 |
|
|
|
|
|
Collateralized mortgage obligations commercial |
|
|
10,024 |
|
|
|
|
|
|
|
|
|
|
|
(351 |
) |
|
|
9,673 |
|
|
|
|
|
Other asset-backed securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Second mortgages/home equity loans residential |
|
|
5,501 |
|
|
|
|
|
|
|
|
|
|
|
(740 |
) |
|
|
4,761 |
|
|
|
(1,399 |
) |
Consumer credit receivables |
|
|
11,055 |
|
|
|
528 |
|
|
|
|
|
|
|
|
|
|
|
11,583 |
|
|
|
|
|
Other |
|
|
9,715 |
|
|
|
686 |
|
|
|
|
|
|
|
|
|
|
|
10,401 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed income securities |
|
|
1,219,270 |
|
|
|
53,565 |
|
|
|
(2,362 |
) |
|
|
(4,250 |
) |
|
|
1,266,223 |
|
|
$ |
(1,399 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity securities |
|
|
1,429 |
|
|
|
181 |
|
|
|
|
|
|
|
|
|
|
|
1,610 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
1,220,699 |
|
|
$ |
53,746 |
|
|
$ |
(2,362 |
) |
|
$ |
(4,250 |
) |
|
$ |
1,267,833 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a) |
|
The unrealized loss position of this security was $0.5 million at December 31, 2009. |
37
The following table provides the composition of fixed income securities with an unrealized
loss at June 30, 2010 in relation to the total of all fixed income securities by contractual
maturities:
|
|
|
|
|
|
|
|
|
|
|
% of |
|
|
|
|
|
|
Estimated |
|
|
% of |
|
|
|
Fair |
|
|
Unrealized |
|
Contractual Maturity |
|
Value |
|
|
Loss |
|
Due after one year through five years |
|
|
13 |
% |
|
|
9 |
% |
Due after ten years |
|
|
81 |
|
|
|
82 |
|
Asset-backed securities |
|
|
6 |
|
|
|
9 |
|
|
|
|
|
|
|
|
Total |
|
|
100 |
% |
|
|
100 |
% |
|
|
|
|
|
|
|
The following table summarizes for fixed income securities in an unrealized loss position at
June 30, 2010 and December 31, 2009, 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):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2010 |
|
|
December 31, 2009 |
|
|
|
|
|
|
|
Gross |
|
|
|
|
|
|
Gross |
|
|
|
Estimated |
|
|
Unrealized |
|
|
Estimated |
|
|
Unrealized |
|
Unrealized Loss Aging |
|
Fair Value |
|
|
Loss |
|
|
Fair Value |
|
|
Loss |
|
Fixed income securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment grade (a): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
0-6 months |
|
$ |
6,912 |
|
|
$ |
148 |
|
|
$ |
162,087 |
|
|
$ |
2,362 |
|
7-12 months |
|
|
23,809 |
|
|
|
408 |
|
|
|
|
|
|
|
|
|
13-24 months |
|
|
|
|
|
|
|
|
|
|
11,176 |
|
|
|
469 |
|
Greater than 24 months |
|
|
25,847 |
|
|
|
1,172 |
|
|
|
32,932 |
|
|
|
2,065 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total investment grade |
|
|
56,568 |
|
|
|
1,728 |
|
|
|
206,195 |
|
|
|
4,896 |
|
Non-investment grade: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Greater than 24 months |
|
|
17,019 |
|
|
|
1,561 |
|
|
|
17,346 |
|
|
|
1,716 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
73,587 |
|
|
$ |
3,289 |
|
|
$ |
223,541 |
|
|
$ |
6,612 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a) |
|
Investment grade is determined by using the S&P rating. If
a security is not rated by Standard & Poors (S&P), the
Moodys Investor Services (Moodys) rating is used. As of
June 30, 2010 and December 31, 2009, all of the Companys
fixed income securities were rated by S&P or Moodys. |
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 (bonds) 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 adjusted 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 an anticipated
recovery in value and (d) general market conditions and industry or sector specific
38
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 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. 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.
At June 30, 2010, the Company holds 294 fixed income securities in an unrealized gain position
with a total estimated fair value of $1,251.4 million and an aggregate gross unrealized gain of
$75.3 million.
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 |
|
June 30, 2010 |
|
AAA |
|
|
AA |
|
|
A |
|
|
BBB |
|
|
Total |
|
|
Count |
|
|
Fair Value |
|
Fixed income securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment grade(a): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Obligations of states and political subdivisions |
|
$ |
166 |
|
|
$ |
555 |
|
|
$ |
706 |
|
|
$ |
|
|
|
$ |
1,427 |
|
|
|
7 |
|
|
$ |
44,597 |
|
Corporate bonds |
|
|
|
|
|
|
|
|
|
|
148 |
|
|
|
147 |
|
|
|
295 |
|
|
|
2 |
|
|
|
9,780 |
|
Other asset-backed securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Second mortgages/home equity loans residential |
|
|
6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6 |
|
|
|
1 |
|
|
|
2,191 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total investment grade |
|
|
172 |
|
|
|
555 |
|
|
|
854 |
|
|
|
147 |
|
|
|
1,728 |
|
|
|
10 |
|
|
|
56,568 |
|
Non-investment grade: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Obligations of states and political subdivisions |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,266 |
|
|
|
2 |
|
|
|
14,906 |
|
Other asset-backed securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Second mortgages/home equity loans residential |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
295 |
|
|
|
1 |
|
|
|
2,113 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total non-investment grade |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,561 |
|
|
|
3 |
|
|
|
17,019 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
172 |
|
|
$ |
555 |
|
|
$ |
854 |
|
|
$ |
147 |
|
|
$ |
3,289 |
|
|
|
13 |
|
|
$ |
73,587 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a) |
|
Securities are categorized using the S&P rating. If a security is not rated by
S&P, the Moodys rating is used. At June 30, 2010, all of the Companys fixed income
securities were rated by S&P or Moodys. |
39
The Company holds three non-investment grade securities in an unrealized loss position at June
30, 2010. Two of these are obligations of states and political subdivisions issued by governmental
utility authorities. At June 30, 2010, one of these securities had an unrealized loss of $0.3
million, or 5.4% of its amortized cost, and the other had an unrealized loss of $1.0 million, or
9.0% of its amortized cost. The unrealized loss position of each of these securities deteriorated
slightly, less than $0.1 million in total, at June 30, 2010 compared to December 31, 2009. Based on
the underlying fundamentals of these securities, 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. As such, the Company has not recorded an OTTI loss on these securities
at June 30, 2010.
The other security rated below investment grade and in an unrealized loss position at June 30,
2010 is an asset-backed security collateralized by sub-prime home loans originated prior to 2005.
During 2010, the Company received repayments on this security of $0.3 million, or approximately 12%
of the par value outstanding at December 31, 2009. As discussed previously, this security was
determined to have additional credit losses totaling $122,000 during the six months ended June 30,
2010. The non-credit component of this securitys OTTI recognized in accumulated other
comprehensive income at June 30, 2010 was $0.3 million. The Company also recognized a
credit-related loss of $0.1 million on this security during the three months ended June 30, 2009. The
Company believes the non-credit component of the unrealized loss on this security is primarily
attributable to broader economic conditions and liquidity concerns 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.
Of the ten investment grade securities in an unrealized loss position at June 30, 2010, only
one was in a unrealized loss position that exceeded 5% of the securitys amortized cost. This
security, issued by a governmental utility authority, had an unrealized loss of $0.7 million, or
12.7% of its amortized cost, which was also the largest unrealized loss in dollars. Gross
unrealized losses on the Companys investment grade fixed income portfolio have improved from $4.9
million at December 31, 2009 to $1.7 million at June 30, 2010. The Company believes that the
unrealized losses are primarily due to credit spread widening, and to a lesser extent, certain
asset classes being out of favor with investors.
As of June 30, 2010, $410.6 million of the Companys investments were guaranteed by one of
three major mono-line bond insurers. This includes $408.5 million of bonds of states and political
obligations, or about 54% of the Companys investments in this type of security. Investments in
obligations of states and political subdivisions represent approximately 57% 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 $410.6 million of bonds that were insured, $90.7 million of
these securities reflect credit rating enhancement due to the guarantee. The underlying ratings of
the enhanced securities are $65.7 million AA, $24.4 million A and $0.6 million BBB. 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
potential ratings downgrades or other difficulties of the mono-line bond insurers would not have a
significant impact on the Companys financial position or results of operations.
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 due to factors
regarding credit-worthiness. 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.
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.
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
40
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; |
|
|
|
|
changes in the Companys composition of operating segments; |
|
|
|
|
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.
41
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 years, consistent with the expected
duration of its insurance and other liabilities.
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. At June 30, 2010 and December 31, 2009, 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. 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 |
|
|
June 30, |
|
|
Interest Rate |
|
Change in |
|
|
Stockholders |
|
|
2010 |
|
|
(bp=basis points) |
|
Interest Rate |
|
|
Equity |
|
|
|
|
|
|
(Dollars in thousands) |
|
|
|
|
U.S. Government and government agencies and
authorities |
|
$ |
139,922 |
|
|
200 bp increase |
|
$ |
131,469 |
|
|
|
(0.6) |
% |
|
|
|
|
|
|
150 bp increase |
|
|
134,016 |
|
|
|
(0.4) |
|
|
|
|
|
|
|
100 bp increase |
|
|
136,351 |
|
|
|
(0.2) |
|
|
|
|
|
|
|
50 bp increase |
|
|
138,345 |
|
|
|
(0.1) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
States, municipalities and political subdivisions |
|
|
760,196 |
|
|
200 bp increase |
|
|
671,913 |
|
|
|
(5.8) |
|
|
|
|
|
|
|
150 bp increase |
|
|
692,761 |
|
|
|
(4.4) |
|
|
|
|
|
|
|
100 bp increase |
|
|
714,412 |
|
|
|
(3.0) |
|
|
|
|
|
|
|
50 bp increase |
|
|
736,891 |
|
|
|
(1.5) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate bonds |
|
|
389,314 |
|
|
200 bp increase |
|
|
354,798 |
|
|
|
(2.3) |
|
|
|
|
|
|
|
150 bp increase |
|
|
363,003 |
|
|
|
(1.7) |
|
|
|
|
|
|
|
100 bp increase |
|
|
371,483 |
|
|
|
(1.2) |
|
|
|
|
|
|
|
50 bp increase |
|
|
380,249 |
|
|
|
(0.6) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mortgage-backed and asset-backed |
|
|
35,548 |
|
|
200 bp increase |
|
|
33,619 |
|
|
|
(0.1) |
|
|
|
|
|
|
|
150 bp increase |
|
|
34,080 |
|
|
|
(0.1) |
|
|
|
|
|
|
|
100 bp increase |
|
|
34,555 |
|
|
|
(0.1) |
|
|
|
|
|
|
|
50 bp increase |
|
|
35,044 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed income securities available-for-sale |
|
$ |
1,324,980 |
|
|
200 bp increase |
|
|
1,191,799 |
|
|
|
(8.8) |
|
|
|
|
|
|
|
150 bp increase |
|
|
1,223,860 |
|
|
|
(6.6) |
|
|
|
|
|
|
|
100 bp increase |
|
|
1,256,801 |
|
|
|
(4.5) |
|
|
|
|
|
|
|
50 bp increase |
|
|
1,290,529 |
|
|
|
(2.2) |
|
42
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Estimated Fair |
|
|
Hypothetical |
|
|
|
|
|
|
Hypothetical |
|
Value After |
|
|
Percentage |
|
|
Fair Value at |
|
|
Change in |
|
Hypothetical |
|
|
Decrease in |
|
|
December 31, |
|
|
Interest Rate |
|
Change in |
|
|
Stockholders |
|
|
2009 |
|
|
(bp=basis points) |
|
Interest Rate |
|
|
Equity |
|
|
|
|
|
|
(Dollars in thousands) |
|
|
|
|
|
U.S. Government and government agencies and
authorities |
|
$ |
157,128 |
|
|
200 bp increase |
|
$ |
144,937 |
|
|
|
(0.9) |
% |
|
|
|
|
|
|
150 bp increase |
|
|
148,310 |
|
|
|
(0.6) |
|
|
|
|
|
|
|
100 bp increase |
|
|
151,570 |
|
|
|
(0.4) |
|
|
|
|
|
|
|
50 bp increase |
|
|
154,580 |
|
|
|
(0.2) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
States, municipalities and political subdivisions |
|
|
728,568 |
|
|
200 bp increase |
|
|
641,122 |
|
|
|
(6.2) |
|
|
|
|
|
|
|
150 bp increase |
|
|
661,735 |
|
|
|
(4.7) |
|
|
|
|
|
|
|
100 bp increase |
|
|
683,176 |
|
|
|
(3.2) |
|
|
|
|
|
|
|
50 bp increase |
|
|
705,453 |
|
|
|
(1.6) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate bonds |
|
|
344,109 |
|
|
200 bp increase |
|
|
310,703 |
|
|
|
(2.4) |
|
|
|
|
|
|
|
150 bp increase |
|
|
318,610 |
|
|
|
(1.8) |
|
|
|
|
|
|
|
100 bp increase |
|
|
326,806 |
|
|
|
(1.2) |
|
|
|
|
|
|
|
50 bp increase |
|
|
335,301 |
|
|
|
(0.6) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mortgage-backed and asset-backed |
|
|
36,418 |
|
|
200 bp increase |
|
|
34,525 |
|
|
|
(0.1) |
|
|
|
|
|
|
|
150 bp increase |
|
|
34,982 |
|
|
|
(0.1) |
|
|
|
|
|
|
|
100 bp increase |
|
|
35,450 |
|
|
|
(0.1) |
|
|
|
|
|
|
|
50 bp increase |
|
|
35,928 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed income securities available-for-sale |
|
$ |
1,266,223 |
|
|
200 bp increase |
|
|
1,131,287 |
|
|
|
(9.6) |
|
|
|
|
|
|
|
150 bp increase |
|
|
1,163,637 |
|
|
|
(7.2) |
|
|
|
|
|
|
|
100 bp increase |
|
|
1,197,002 |
|
|
|
(4.9) |
|
|
|
|
|
|
|
50 bp increase |
|
|
1,231,262 |
|
|
|
(2.4) |
|
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 Exchange Act of 1934 (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.
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, 2009.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS None.
43
ITEM 3. DEFAULTS UPON SENIOR SECURITIES None.
ITEM 4. None.
ITEM 5. OTHER INFORMATION Reports on Form 8-K:
April 30, 2010; CNA Surety Corporation Earnings Press Release issued on April 30, 2010.
ITEM 6. EXHIBITS
|
|
|
|
|
|
|
Exhibit
Number |
Certification pursuant to Rule 13a14(a) of the Securities
Exchange Act of 1934, as adopted pursuant to Section 302 of the
SarbanesOxley Act of 2002 Chief Executive Officer.
|
|
|
31 |
(1) |
|
|
|
|
|
Certification pursuant to Rule 13a14(a) of the Securities
Exchange Act of 1934, as adopted pursuant to Section 302 of the
SarbanesOxley Act of 2002 Chief Financial Officer.
|
|
|
31 |
(2) |
|
|
|
|
|
Certification pursuant to 18 U.S.C. 1350, as adopted pursuant to
Section 906 of the SarbanesOxley Act of 2002 Chief
Executive Officer.
|
|
|
32 |
(1)* |
|
|
|
|
|
Certification pursuant to 18 U.S.C. 1350, as adopted pursuant to
Section 906 of the SarbanesOxley Act of 2002 Chief
Financial Officer.
|
|
|
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. |
44
SIGNATURES
Pursuant to the requirements of the Securities 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: July 30, 2010
45
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)
|
|
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002 Chief Executive Officer. |
|
|
|
32(2)
|
|
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 Chief Financial Officer. |
46