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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended MARCH 31, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number: 1-13277
CNA SURETY CORPORATION
(Exact name of Registrant as specified in its Charter)
DELAWARE 36-4144905
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
CNA PLAZA, CHICAGO, ILLINOIS 60685
(Address of principal executive offices) (Zip Code)
(312) 822-5000
(Registrant's 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 X No
--- ---
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
42,733,958 shares of Common Stock, $.01 par value as of May 4, 2001.
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CNA SURETY CORPORATION AND SUBSIDIARIES
INDEX
Page
Part I. Financial Information (Unaudited):
Item 1. Condensed Consolidated Financial Statements:
Independent Accountants' Report.................................................. 3
Condensed Consolidated Balance Sheets at March 31, 2001 and
at December 31, 2000............................................................. 4
Condensed Consolidated Statements of Income for the Three Months Ended
March 31, 2001 and 2000.......................................................... 5
Condensed Consolidated Statements of Stockholders' Equity for the Three
Months Ended March 31, 2001 and 2000............................................. 6
Condensed Consolidated Statements of Cash Flows for the Three Months Ended
March 31, 2001 and 2000.......................................................... 7
Notes to Condensed Consolidated Financial Statements at March 31, 2001 .......... 8
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................................ 12
Part II. Other Information:
Item 1. Legal Proceedings................................................................ 19
Item 2. Changes in the Rights of the Company's Security Holders.......................... 19
Item 3. Defaults Upon Senior Securities.................................................. 19
Item 4. Submission of Matters to a Vote of Security Holders.............................. 19
Item 5. Other Information................................................................ 19
Item 6. Exhibits and Reports on Form 8-K ................................................ 19
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INDEPENDENT ACCOUNTANTS' REPORT
To the Board of Directors and Stockholders of
CNA Surety Corporation
Chicago, Illinois
We have reviewed the accompanying condensed consolidated balance sheet of CNA
Surety Corporation and subsidiaries as of March 31, 2001, and the related
condensed consolidated statements of income, stockholders' equity and cash flows
for the three-month periods ended March 31, 2001 and 2000. These financial
statements are the responsibility of the Corporation's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and of making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with auditing standards generally accepted in the United States of America, the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to such condensed consolidated financial statements for them to be in
conformity with accounting principles generally accepted in the United States of
America.
We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the consolidated balance sheet of CNA
Surety Corporation and subsidiaries as of December 31, 2000, and the related
consolidated statements of income, stockholders' equity, and cash flows for the
year then ended (not presented herein); and in our report dated February 12,
2001, we expressed an unqualified opinion on those consolidated financial
statements. In our opinion, the information set forth in the accompanying
condensed consolidated balance sheet as of December 31, 2000 is fairly stated,
in all material respects, in relation to the consolidated balance sheet from
which it has been derived.
Deloitte & Touche LLP
Chicago, Illinois
April 30, 2001
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CNA SURETY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
(Unaudited)
March 31, December 31,
2001 2000
---------------- ---------------
ASSETS Invested assets and cash:
Fixed income securities, at fair value (amortized cost: $452,025 and $453,570) $ 462,080 $ 458,284
Equity securities, at fair value (cost: $41,655 and $37,761)................... 33,918 33,927
Short-term investments, at cost (approximates fair value)...................... 49,874 52,660
Other investments, at fair value............................................... 5,268 5,154
Cash........................................................................... 4,529 5,950
---------- ----------
Total invested assets and cash.............................................. 555,669 555,975
Deferred policy acquisition costs................................................ 91,993 91,403
Insurance receivables:
Premiums, including $32,547 and $31,607 from affiliates........................ 42,599 41,207
Reinsurance, including $11,951 and $13,349 from affiliates..................... 80,611 75,330
Intangible assets (net of accumulated amortization: $20,950 and $19,426)....... 148,358 149,882
Property and equipment, at cost (less accumulated
depreciation: $14,353 and $13,677)............................................. 15,437 15,332
Prepaid reinsurance premiums..................................................... 2,932 2,532
Receivables for securities sold.................................................. -- 10,406
Other assets..................................................................... 7,424 8,501
---------- ----------
Total assets.............................................................. $ 945,023 $ 950,568
========== ==========
LIABILITIES
Reserves:
Unpaid losses and loss adjustment expenses..................................... $ 212,014 $ 204,457
Unearned premiums.............................................................. 198,456 202,179
---------- ----------
Total reserves.............................................................. 410,470 406,636
Debt............................................................................. 81,556 101,556
Deferred income taxes, net....................................................... 20,657 19,700
Payable for securities purchased................................................. 2,897 --
Current income taxes payable..................................................... 11,988 6,820
Reinsurance and other payables to affiliates..................................... 9,237 8,117
Other liabilities................................................................ 24,980 33,707
---------- ----------
Total liabilities........................................................... $ 561,785 $ 576,536
---------- ----------
Commitments and contingencies (See Note 4)
STOCKHOLDERS' EQUITY
Preferred stock, par value $.01 per share, 20,000 shares authorized; none issued
and outstanding................................................................ -- --
Common stock, par value $.01 per share, 100,000 shares authorized; 44,168 shares
issued and 42,725 shares outstanding at March 31, 2001 and 44,146 shares
issued and 42,702 shares outstanding at December 31, 2000 ..................... 442 441
Additional paid-in capital....................................................... 253,658 253,497
Retained earnings................................................................ 143,406 135,308
Accumulated other comprehensive income........................................... 1,213 267
Treasury stock, at cost.......................................................... (15,481) (15,481)
--------- ---------
Total stockholders' equity.................................................. 383,238 374,032
---------- ----------
Total liabilities and stockholders' equity.................................. $ 945,023 $ 950,568
========== ==========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
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CNA SURETY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
Three Months Ended
March 31,
----------------------------------
2001 2000
----------------- ----------------
Revenues:
Net earned premiums......................................... $ 76,749 $ 75,687
Net investment income....................................... 7,735 7,201
Net realized investment losses.............................. (29) (4)
----------- -----------
84,455 82,884
---------- ----------
Expenses:
Net losses and loss adjustment expenses..................... 16,086 13,572
Net commissions, brokerage and other underwriting........... 46,837 44,808
Interest expense............................................ 1,588 1,621
Amortization of intangible assets........................... 1,524 1,525
---------- ----------
66,035 61,526
---------- ----------
Income before income taxes.................................... 18,420 21,358
Income taxes.................................................. 6,476 7,245
---------- ----------
Net income.................................................... $ 11,944 $ 14,113
========== ==========
Earnings per share............................................ $ 0.28 $ 0.33
========== ==========
Earnings per share, assuming dilution......................... $ 0.28 $ 0.33
========== ==========
Weighted average shares outstanding........................... 42,713 42,962
========== ==========
Weighted average shares outstanding, assuming dilution........ 42,917 43,065
========== ==========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
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CNA SURETY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(AMOUNTS IN THOUSANDS)
(UNAUDITED)
Common
Stock Additional
Shares Common Paid-In Comprehensive Retained
Outstanding Stock Capital Income Earnings
------------------------ --------------------------- --------------
Balance, December 31, 1999................................... 43,006 $ 441 $ 253,366 $ 95,419
Comprehensive income:
Net income................................................. -- -- -- $ 14,113 14,113
Other comprehensive income:
Change in unrealized gains on securities (after income
taxes), net of reclassification adjustment of $135......... -- -- -- 2,183 --
---------
Total comprehensive income.............................. $ 16,296
=========
Purchase of treasury stock................................... (110) -- -- --
Stock options exercised and other............................ -- -- 1 --
Dividends paid to stockholders............................... -- -- -- (3,432)
------- ------- --------- --------
Balance, March 31, 2000...................................... 42,896 $ 441 $ 253,367 $106,100
======= ======= ========= ========
Balance, December 31, 2000................................... 42,702 $ 441 $ 253,497 $135,308
Comprehensive income:
Net income................................................. -- -- -- $ 11,944 11,944
Other comprehensive income:
Change in unrealized gains on securities (after income
taxes), net of reclassification adjustment of $209......... -- -- -- 946 --
---------
Total comprehensive income.............................. $ 12,890
=========
Stock options exercised and other............................ 23 1 161 --
Dividends paid to stockholders............................... -- -- -- (3,846)
------- ------- --------- --------
Balance, March 31, 2001...................................... 42,725 $ 442 $ 253,658 $143,406
======= ======= ========= ========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
Accumulated
Other Treasury Total
Comprehensive Stock Stockholders'
Income (Loss) (at cost) Equity
-------------------------------------------
Balance, December 31, 1999................................... $ (11,150) $(11,772) $ 326,304
Comprehensive income:
Net income................................................. -- -- 14,113
Other comprehensive income:
Change in unrealized gains on securities (after income
taxes), net of reclassification adjustment of $135......... 2,183 -- 2,183
Total comprehensive income..............................
Purchase of treasury stock................................... -- (1,213) (1,213)
Stock options exercised and other............................ -- -- 1
Dividends paid to stockholders............................... -- -- (3,432)
--------- -------- ---------
Balance, March 31, 2000...................................... $ (8,967) $(12,985) $ 337,956
========== ========= =========
Balance, December 31, 2000................................... $ 267 $(15,481) $374,032
Comprehensive income:
Net income................................................. -- -- 11,944
Other comprehensive income:
Change in unrealized gains on securities (after income
taxes), net of reclassification adjustment of $209......... 946 -- 946
Total comprehensive income..............................
Stock options exercised and other............................ -- -- 162
Dividends paid to stockholders............................... -- -- (3,846)
--------- -------- ---------
Balance, March 31, 2001...................................... $ 1,213 $(15,481) $ 383,238
========= ========= =========
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CNA SURETY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
(UNAUDITED)
Three Months Ended
March 31,
--------------------------------------
2001 2000
----------------- -----------------
OPERATING ACTIVITIES:
Net income........................................................................ $ 11,944 $ 14,113
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization.................................................. 2,381 2,284
Accretion of bond discount, net................................................ 247 319
Net realized investment losses................................................. 29 4
Changes in:
Insurance receivables.......................................................... (6,673) (11,040)
Reserve for unearned premiums.................................................. (3,723) 3,289
Reserve for unpaid losses and loss adjustment expenses......................... 7,557 5,015
Deferred policy acquisition costs.............................................. (590) (3,839)
Deferred income taxes, net..................................................... 421 591
Reinsurance and other payables to affiliates................................... 1,120 29,337
Other assets and liabilities................................................... (2,689) 346
----------- ----------
Net cash provided by operating activities.................................... 10,024 40,419
---------- ----------
INVESTING ACTIVITIES:
Fixed income securities:
Purchases...................................................................... (31,673) (29,302)
Maturities..................................................................... 25,533 12,864
Sales.......................................................................... 7,408 3,119
Purchases of equity securities.................................................... (4,303) (868)
Proceeds from the sale of equity securities....................................... 409 967
Changes in short-term investments................................................. 2,787 (17,742)
Purchases of property and equipment............................................... (1,043) (2,300)
Changes in receivables/payables for securities sold/purchased..................... 13,303 (1,596)
Other, net........................................................................ (88) 269
---------- ----------
Net cash provided by (used in) investing activities.......................... 12,333 (34,589)
---------- -----------
FINANCING ACTIVITIES:
Principal payments on long-term debt.............................................. (20,000) --
Dividends to stockholders......................................................... (3,846) (3,432)
Purchase of treasury stock........................................................ -- (1,213)
Other............................................................................. 68 --
---------- ----------
Net cash used in financing activities........................................ (23,778) (4,645)
----------- -----------
Increase (decrease) in cash........................................................ (1,421) 1,185
Cash at beginning of period......................................................... 5,950 7,237
---------- ----------
Cash at end of period............................................................... $ 4,529 $ 8,422
========== ==========
Supplemental Disclosure of Cash Flow Information:
Cash paid during the period for:
Interest....................................................................... $ 1,561 $ 2,127
Income taxes................................................................... $ 750 $ 750
The accompanying notes are an integral part of these condensed consolidated
financial statements.
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CNA SURETY CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2000
(UNAUDITED)
1. SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of CNA Surety
Corporation and all majority-owned subsidiaries.
Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles 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 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 Company's 2000 Annual Report to Shareholders. Certain financial
information that is normally included in annual financial statements prepared in
accordance with accounting principles generally accepted in the United States of
America, that is not required for interim reporting 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. Certain reclassifications
have been made to the 2000 Financial Statements to conform with the presentation
in the 2001 Condensed Consolidated Financial Statements.
Accounting Changes
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 133 entitled "Accounting for
Derivative Instruments and Hedging Activities" ("SFAS No. 133"). SFAS No. 133
was subsequently amended by SFAS No. 137, which delayed the effective date by
one year, and SFAS No. 138, which clarified four areas which were causing
difficulties in implementation. SFAS No. 133 requires the recognition of all
derivative financial instruments, including embedded derivative instruments, as
either assets or liabilities in the statement of financial position and
measurement of those instruments at fair value. The accounting for gains and
losses associated with changes in the fair value of a derivative and the effect
on the consolidated financial statements will depend on its hedge designation
and whether the hedge is highly effective in achieving offsetting changes in the
fair value or cash flows of the asset or liability hedged. If the derivative is
designated in a fair value hedge, the changes in the fair value of the
derivative and the hedged item will be recognized in earnings. If the derivative
is designated as a cash flow hedge, changes in the fair value of the derivative
will be recorded in other comprehensive income and will be recognized in the
income statement when the hedged item affects earnings. A derivative that does
not qualify as a hedge will be marked to fair value through earnings. The
transition adjustments resulting from adoption must be reported in net income or
other comprehensive income, as appropriate, as the cumulative effect of a change
in accounting principle. The Company has adopted this standard effective January
1, 2001, such adoption did not have an impact on the Company's financial
position or results of operations.
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In March of 1998, the National Association of Insurance Commissioners
adopted the Codification of Statutory Accounting Principles ("Codification").
Codification, which intends to standardize regulatory accounting and reporting
to state insurance departments, became effective on January 1, 2001. However,
statutory accounting principles will continue to be established by individual
state laws and permitted practices. The states in which CNA Surety's insurance
subsidiaries conduct business required adoption of Codification for the
preparation of statutory financial statements effective January 1, 2001. The
adoption of Codification increased the Company's statutory capital and surplus
as of January 1, 2001 by approximately $21.9 million.
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2. INVESTMENTS
The estimated amortized cost and fair value of fixed income securities held
by CNA Surety at March 31, 2001 and December 31, 2000, by investment category,
were as follows (dollars in thousands):
Gross Gross
Amortized Cost Unrealized Unrealized Estimated Fair
March 31, 2001 or Cost Gains Losses Value
--------------------------------------------------- -------------------------------------- ------------------ -------------------
Fixed income securities:
U.S. Treasury securities and obligations of
U.S. Government and agencies:
U.S. Treasury............................. $ 17,893 $ 382 $ -- $ 18,275
U.S. Agencies............................. 55,573 2,019 (685) 56,907
Collateralized mortgage obligations....... 1,000 4 (4) 1,000
Mortgage pass-through securities.......... 40,920 466 (38) 41,348
Obligations of states and political subdivisions 186,734 6,653 (111) 193,276
Corporate bonds................................ 79,970 1,690 (1,459) 80,201
Non-agency collateralized mortgage obligations 11,714 135 (59) 11,790
Other asset-backed securities:
Second mortgages/home equity loans........... 19,637 343 (45) 19,935
Credit card receivables...................... 10,462 203 (30) 10,635
Manufactured housing......................... 7,663 219 (64) 7,818
Other........................................ 6,038 92 -- 6,130
Redeemable preferred stock..................... 14,421 344 -- 14,765
---------- ---------- ---------- ----------
Total fixed income securities............. 452,025 12,550 (2,495) 462,080
Equity securities.............................. 41,655 1,992 (9,729) 33,918
---------- ---------- ---------- ----------
Total..................................... $ 493,680 $ 14,542 $ (12,224) $ 495,998
========== ========== =========== ==========
Gross Gross
Amortized Cost Unrealized Unrealized Estimated Fair
December 31, 2000 or Cost Gains Losses Value
--------------------------------------------------- -------------------------------------- ------------------ -------------------
Fixed income securities:
U.S. Treasury securities and obligations of
U.S. Government and agencies:
U.S. Treasury............................. $ 19,727 $ 279 $ (8) $ 19,998
U.S. Agencies............................. 52,760 1,835 (212) 54,383
Collateralized mortgage obligations....... 1,098 1 (9) 1,090
Mortgage pass-through securities.......... 42,054 149 (189) 42,014
Obligations of states and political subdivisions 208,423 5,136 (929) 212,630
Corporate bonds................................ 62,055 675 (2,011) 60,719
Non-agency collateralized mortgage obligations 12,319 70 (132) 12,257
Other asset-backed securities:
Second mortgages/home equity loans........... 18,043 160 (210) 17,993
Credit card receivables...................... 10,490 106 (5) 10,591
Manufactured housing......................... 12,967 143 (235) 12,875
Other........................................ 1,272 69 (3) 1,338
Redeemable preferred stock..................... 12,362 89 (55) 12,396
---------- ---------- ----------- ----------
Total fixed income securities............. 453,570 8,712 (3,998) 458,284
Equity securities.............................. 37,761 3,562 (7,396) 33,927
---------- ---------- ---------- ----------
Total..................................... $ 491,331 $ 12,274 $ (11,394) $ 492,211
========== ========== =========== ==========
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3. REINSURANCE
The effect of reinsurance on the Company's written and earned premium was
as follows (dollars in thousands):
Three Months Ended March 31,
---------------------------------------------
2001 2000
--------------------- ---------------------
Written Earned Written Earned
--------- --------- --------- ---------
Direct.......................... $ 32,657 $ 27,620 $ 30,297 $ 25,880
Assumed from affiliates......... 42,827 51,622 50,358 52,994
Ceded........................... (2,857) (2,493) (1,476) (3,187)
--------- --------- --------- ---------
$ 72,627 $ 76,749 $ 79,179 $ 75,687
========= ========= ========= =========
The effect of reinsurance on the Company's provision for loss and loss
adjustment expenses was as follows (dollars in thousands):
Three Months Ended March 31,
--------------------------
2001 2000
--------- ---------
Gross losses and loss adjustment expenses.......... $ 25,062 $ 36,704
Ceded amounts...................................... (8,976) (23,132)
--------- ---------
Net losses and loss adjustment expenses............ $ 16,086 $ 13,572
========= =========
4. COMMITMENTS AND CONTINGENCIES
The Company and its subsidiaries are parties to various lawsuits arising in
the normal course of business, some seeking material damages. The Company
believes the resolution of these lawsuits will not have a material adverse
effect on its financial condition or its results of operations.
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CNA SURETY CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
GENERAL
The following is a discussion and analysis of CNA Surety Corporation ("CNA
Surety" or the "Company") and its insurance subsidiaries' operating results,
liquidity and capital resources, and financial condition. This discussion should
be read in conjunction with the Consolidated Financial Statements of CNA Surety
and notes thereto.
FORMATION OF CNA SURETY 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 Capsure's insurance subsidiaries, Western Surety Company ("Western Surety")
and Universal Surety of America ("USA"), 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. CNAF owns approximately 64% of the
outstanding common stock of CNA Surety. Loews Corporation owns approximately 87%
of the outstanding common stock of CNAF. 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"). CIC was acquired by CNAF
on May 10, 1995.
Pursuant to a reorganization agreement, CCC Surety Operations and Capsure
merged their respective operations at the close of business on September 30,
1997 ("Merger Date"). CNAF, through its property and casualty subsidiaries, CCC
and CIC, contributed $52.25 million of capital to CNA Surety. Through
reinsurance agreements, CCC and CIC ceded to Western Surety all of their net
unearned premiums and loss and loss adjustment expense reserves, as of the
Merger Date, and will cede to Western Surety all surety business written or
renewed by CCC and CIC for a period of five years thereafter. Further, CCC and
CIC have agreed to assume the obligation for any adverse development on recorded
reserves for CCC Surety Operations as of the Merger Date, to limit the loss
ratio on certain defined business written by CNA Surety through December 31,
2000 and to provide certain additional excess of loss reinsurance.
BUSINESS
CNA Surety's insurance subsidiaries write surety and fidelity bonds in all
50 states through a combined network of approximately 37,000 independent
agencies. CNA Surety's principal insurance subsidiaries are Western Surety and
USA. The insurance subsidiaries write, on a direct basis or as business assumed
from CCC and CIC, small fidelity and non-contract surety bonds, referred to as
commercial bonds; small, medium and large contract bonds; international surety
and credit insurance; and errors and omissions ("E&O") liability insurance.
Western Surety is a licensed insurer in all 50 states and the District of
Columbia. USA is licensed in 44 states and the District of Columbia. Western
Surety's affiliated company, Surety Bonding Company of America ("SBCA"), is
licensed in 25 states and the District of Columbia.
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"SAFE HARBOR" STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995
The statements which are not historical facts contained in this Form 10-Q are
forward-looking statements that involve risks and uncertainties, including, but
not limited to, product and policy demand and market response risks, the effect
of economic conditions, the impact of competitive products, policies and
pricing, product and policy development, regulatory changes and conditions,
rating agency policies and practices, development of claims and the effect on
loss reserves, the performance of reinsurance companies under reinsurance
contracts with the Company, investment portfolio developments and reaction to
market conditions, the results of financing efforts, the actual closing of
contemplated transactions and agreements, the effect of the Company's accounting
policies, and other risks detailed in the Company's Securities and Exchange
Commission filings. No assurance can be given that the actual results of
operations and financial condition will conform to the forward-looking
statements contained herein.
RESULTS OF OPERATIONS
CNA SURETY RESULTS FOR THREE MONTHS ENDED MARCH 31, 2001 AND 2000
The components of income for the Company for the three months ended March
31, 2001 and 2000 are summarized as follows (dollars in thousands):
Three Months Ended March 31,
2001 2000
---------- ----------
Total revenues........................... $ 84,455 $ 82,884
========== ==========
Underwriting income...................... $ 13,826 $ 17,307
Net investment income.................... 7,735 7,201
Net realized investment losses........... (29) (4)
Interest expense......................... 1,588 1,621
Amortization of intangible assets........ 1,524 1,525
---------- ----------
Income before income taxes............... 18,420 21,358
Income taxes............................. 6,476 7,245
---------- ----------
Net income............................... $ 11,944 $ 14,113
========== ==========
Net income per share..................... $ 0.28 $ 0.33
========== ==========
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Insurance Underwriting
Underwriting results for the Company for the three months ended March 31,
2001 and 2000 are summarized in the following table (dollars in thousands):
Three Months Ended March 31,
2001 2000
---------- ----------
Gross written premiums.................... $ 75,484 $ 80,655
========== ==========
Net written premiums...................... $ 72,627 $ 79,179
========== ==========
Net earned premiums....................... $ 76,749 $ 75,687
Net losses and loss adjustment expenses... 16,086 13,572
Net commissions, brokerage and other...... 46,837 44,808
---------- ----------
Underwriting income....................... $ 13,826 $ 17,307
========== ==========
Loss ratio................................ 21.0% 17.9%
Expense ratio............................. 61.0 59.2
---------- ----------
Combined ratio............................ 82.0% 77.1%
========== ==========
Premiums Written
CNA Surety primarily markets contract and commercial surety bonds. Contract
surety bonds generally secure a contractor's 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 which cover losses arising from employee dishonesty and other insurance
products.
Gross written premiums are shown in the table below (dollars in thousands):
Three Months Ended March 31,
2001 2000
---------- ----------
Contract................................ $ 38,332 $ 37,415
Commercial.............................. 28,991 35,747
Fidelity and other...................... 8,161 7,493
---------- ----------
$ 75,484 $ 80,655
========== ==========
Effective January 1, 2001, the Company began delaying the recording of
written premium until the effective date of the bond, rather than recording on
the date the bond is processed ("processed premium"). The change did not impact
the recognition of net earned premium but did impact gross written premiums.
Gross written premiums decreased 6.4% to $75.5 million for the three months
ended March 31, 2001 over the comparable period in 2000. First quarter gross
written premium reflects a decrease associated with the change in the timing of
recording written premiums of $7.9 million and the discontinuance of the CNA
Reinsurance Company, Limited (London) ("CNA Re") assumed international credit
and surety business of $3.0 million. Gross written premiums for core direct
commercial surety (excluding international reinsurance business assumed from CNA
Re) decreased 11.5% to $29.0 million, for the three months ended March 31, 2001.
Gross processed premiums for core direct commercial surety increased 8.4% to
$35.5 million, but this increase was primarily attributable to fluctuations in
large account activity.
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Absent this fluctuation in large account activity, the commercial business would
have grown 3.8%. Gross written premiums for contract surety increased 2.5% to
$38.3 million. Gross processed premiums for contract surety increased 6.0% to
$39.7 million. This increase is primarily due to continued strength in public
construction spending. Fidelity and other products increased 8.9% to $8.2
million for the three months ended March 31, 2001 as compared to the same period
in 2000.
Net written premiums are shown in the table below (dollars in thousands):
Three Months Ended March 31,
2001 2000
---------- ----------
Contract............................... $ 35,767 $ 35,930
Commercial............................. 28,699 35,315
Fidelity and other..................... 8,161 7,934
---------- ----------
$ 72,627 $ 79,179
========== ==========
For the three months ended March 31, 2001, net written premiums decreased
8.3% to $72.6 million as compared to the same period in 2000, reflecting the
aforementioned gross production variances and the effects of higher reinsurance
costs. The reinsurance costs reflected in ceded premiums are based upon
reinsurers' loss experience under the Company's surety excess of loss
reinsurance contract. Due primarily to increased large losses reported to the
Company's excess of loss reinsurers, ceded written premiums increased $1.4
million to $2.9 million for the three months ended March 31, 2001. Net written
premiums for contract surety business decreased 0.5% to $35.8 million. Net
written premiums for commercial surety, excluding international reinsurance
business assumed, decreased 11.2% to $28.7 million for the first three months in
2001. The fidelity and other products increased 2.9% to $8.2 million, for the
first three months in 2001 as compared to the same period in 2000.
Since the second half of calendar year 1999, the Company has experienced an
increase in claim severity in the most recent accident years, primarily with
respect to large commercial risks. As a result of this increase in large loss
activity where the Company cedes loss amounts in excess of $5 million per
principal under its excess of loss reinsurance program, CNA Surety is paying
higher costs for reinsurance. Given the relatively unfavorable economic outlook
for at least the first half of 2001, the Company's reinsurance costs are
unlikely to return to historical levels in 2001. The higher reinsurance costs
will have an adverse impact on the Company's future results of operations.
Underwriting Income
Underwriting income decreased 20.1% to $13.8 million for the three months
ended March 31, 2001 compared to $17.3 million for the same period in 2000. This
decrease is primarily due to adverse loss experience. Increased claim severity,
primarily in large commercial risks, has reduced underwriting profits by
increasing the estimates of incurred losses for more recent accident years. The
period to period changes in underwriting income reflect an 18.5% increase in net
losses and loss adjustment expenses.
Loss Ratio
The loss ratios for the three months ended March 31, 2001 and 2000 were
21.0% and 17.9%, respectively. The loss ratios included $0.3 million and $2.1
million of net favorable loss reserve development for the three months ended
March 31, 2001 and 2000, respectively. Excluding the impact of net favorable
loss reserve development, the loss ratios would have been 21.4% and 20.7% for
the period ended March 31, 2001 and March 31, 2000, respectively. The increase
in the adjusted loss ratio in 2001 relates primarily to changes in business mix.
The surety business assumed from CCC and CIC is subject
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to an aggregate stop loss reinsurance contract between CCC and the Company that
limits the Company's accident year net loss ratio on this business to 24% for
accident years 1997 (October 1, 1997 to December 31, 1997), 1998, 1999 and 2000.
Expense Ratio
The expense ratio increased to 61.0% for the three months ended March 31,
2001 compared to 59.2% for the same period in 2000. The increase in the expense
ratio for the three months ended March 31, 2001 primarily reflects higher
operating costs and the impact of higher reinsurance costs on net earned
premiums. Net earned premiums increased 1.4% and operating expenses increased at
a higher rate of 4.5%, primarily associated with increased technology related
expenditures.
Investment Income
For the three months ended March 31, 2001, net investment income was $7.7
million compared to net investment income for the three months ended March 31,
2000 of $7.2 million. The increase in investment income primarily reflects
higher average invested assets. The annualized pretax yields for the Company's
equity and fixed income portfolio were 5.7% and 5.5% for the three months ended
March 31, 2001 and 2000, respectively. The annualized after-tax yields for the
Company's equity and fixed income portfolio were 4.2% for the three months ended
March 31, 2001 and 2000.
Net realized investment losses were approximately $29,000 for the three
months ended March 31, 2001 compared to $4,000 of net realized investment losses
for the same period in 2000.
Analysis of Other Operations
Amortization expense was $1.5 million for the three months ended March 31,
2001 and March 31, 2000. Intangible assets primarily represent goodwill and
identified intangibles arising from the acquisition of Capsure. Intangible
assets are generally amortized over 30 years.
Interest expense for the three months ended March 31, 2001 decreased
slightly for the first quarter of 2001 as compared to the first quarter in 2000.
Average debt outstanding was $100.9 million for the first quarter of 2001
compared to $101.9 million in the first quarter of 2000. The weighted average
interest rate for the three months ended March 31, 2001 was 6.1% compared to
6.2% for the same period in 2000.
Income Taxes
Income tax expense was $6.5 million and $7.2 million and the effective
income tax rates were 35.2% and 33.9% for the three months ended March 31, 2001
and 2000, respectively. This increase in the estimated effective tax rate in
first quarter 2001 primarily relates to anticipated decreases in tax exempt
investment income.
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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 sales and maturities of
investments. CNA Surety also may generate funds from additional borrowings under
the credit facility described below. The primary cash flow uses are payments for
claims, operating expenses, federal income taxes, debt service for the credit
facility, as well as dividends to CNA Surety stockholders. 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. At March 31, 2001, the carrying value of the Company's insurance
subsidiaries' invested assets was comprised of $457.0 million of fixed income
securities, $33.9 million of equity securities, $22.4 million of short-term
investments, $5.3 million of other investments and $5.9 million of cash. At
December 31, 2000, the carrying value of the Company's insurance subsidiaries'
invested assets was comprised of $453.2 million of fixed income securities,
$33.9 million of equity securities, $8.7 million of short-term investments, $5.1
million of other investments and $4.0 million of cash.
Cash flow at the parent company level is derived principally from dividend
and tax sharing payments from its insurance subsidiaries. The principal
obligations at the parent company level are to service debt, pay operating
expenses, including income taxes, and pay dividends to stockholders. At March
31, 2001, the parent company's invested assets consisted of $5.1 million of
fixed income securities and $26.1 million of short-term investments and cash. At
December 31, 2000, the parent company's invested assets consisted of $5.1
million of fixed income securities, $44.0 million of short-term investments and
$2.0 million of cash.
The Company's consolidated net cash flow provided by operating activities
was $10.0 million for the three months ended March 31, 2001 and $40.4 million
for the comparable period in 2000. The decrease in net cash flow provided by
operating activities primarily relates to a large increases in reinsurance and
other payables to affiliates in the prior period.
CNA Surety's bank borrowings are under a five-year unsecured revolving
credit facility (the "Credit Facility") that provides for borrowings of up to
$130 million. As of March 31, 2001, the Company has unused capacity under the
revolver of approximately $50 million.
The interest rate on borrowings under the Credit Facility may be fixed, at
CNA Surety's option, for a period of one, two, three, or six months and is based
on, among other rates, the London Interbank Offered Rate ("LIBOR"), plus the
applicable margin. The margin, including the facility fee, was 0.30% at March
31, 2000 and can vary based on CNA Surety's leverage ratio (debt to total
capitalization) from 0.25% to 0.40%. As of March 31, 2001, the weighted average
interest rate was 5.6% on the $80.0 million of outstanding borrowings. As of
December 31, 2000, the weighted average interest rate was 6.9% on the $100.0
million of outstanding borrowings.
The Credit Facility contains, among other conditions, limitations on CNA
Surety with respect to the incurrence of additional indebtedness and requires
the maintenance of certain financial ratios. As of March 31, 2001, the Company
was in compliance with all restrictions and covenants contained in the
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Credit Facility agreement. The Credit Facility provides for the payment of all
outstanding principal balances by September 30, 2002 with no required principal
payments prior to such time. Principal prepayments, if any, and interest
payments are expected to be funded primarily through dividends from CNA Surety's
insurance subsidiaries.
In 1999 CNA Surety acquired certain assets of Clark Bonding Company, Inc.,
a Charlotte, North Carolina, insurance agency and brokerage doing business as
The Bond Exchange for $5.9 million. As part of this acquisition, the Company
incurred an additional $1.9 million of debt in the form of a promissory note.
The promissory note matures on July 27, 2004 and has an interest rate of 5.0%.
The balance of this promissory note at March 31, 2001 was $1.6 million.
As an insurance holding company, CNA Surety is dependent upon dividends and
other permitted payments from its insurance subsidiaries to pay operating
expenses, meet debt service requirements, as well as to pay cash dividends. The
payment of dividends by the insurance subsidiaries is subject to varying degrees
of supervision by the insurance regulatory authorities in South Dakota and
Texas. In South Dakota, where Western Surety and SBCA are domiciled, insurance
companies may only pay dividends from earned surplus excluding surplus arising
from unrealized capital gains or revaluation of assets. In Texas, where USA is
domiciled, an insurance company may only declare or pay dividends to
stockholders from the insurer's earned surplus. 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 insurer's 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 appropriate insurance department 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 year's ending statutory
surplus and statutory net income. Dividend capacity for 2001 is based on
statutory surplus and income at and for the year ended December 31, 2000.
Without prior regulatory approval in 2001, CNA Surety's insurance subsidiaries
may pay stockholder dividends of $60.2 million in the aggregate. CNA Surety
received $20.0 million in dividends from its insurance subsidiaries during the
first three months of 2001 and 2000.
In accordance with the provisions of intercompany tax sharing agreements
between CNA Surety and its subsidiaries, the tax of each subsidiary shall be
determined based upon each subsidiary's separate return liability. Intercompany
tax payments are made at such times as estimated tax payments would be required
by the Internal Revenue Service ("IRS"). CNA Surety received tax sharing
payments from its subsidiaries of $0.3 million for the three months ended March
31, 2001 and $0.8 million for the same period in 2000.
CNA Surety management believes that it will have sufficient available
resources to meet its present capital needs.
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CNA SURETY CORPORATION AND SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings - None.
ITEM 2. Changes in the Rights of the Company's Security Holders - None.
ITEM 3. Defaults Upon Senior Securities - None.
ITEM 4. Submission of Matters to a Vote of Security Holders - None.
ITEM 5. Other Information - None.
ITEM 6. Exhibits and Reports on Form 8-K:
(a) Exhibits: - None.
(b) Reports on Form 8-K:
March 12, 2001; CNA Surety Corporation Press Release issued on
February 12, 2001.
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SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the Registrant has duly caused this Report to be signed on its behalf by the
undersigned thereunto duly authorized.
CNA SURETY CORPORATION
(Registrant)
/s/ John S. Heneghan
------------------------------------------
John S. Heneghan
Vice President and Chief Financial Officer
Date: May 11, 2001
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