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 SEPTEMBER 30, 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 of (I.R.S. Employer
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:
42,754,856 shares of Common Stock, $.01 par value as of November 2, 2001.
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 September 30, 2001 and
at December 31, 2000........................................................................... 4
Condensed Consolidated Statements of Income for the Three- and Nine- Months
Ended September 30, 2001 and 2000.............................................................. 5
Condensed Consolidated Statements of Stockholders' Equity for the Nine
Months Ended September 30, 2001 and 2000....................................................... 6
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended
September 30, 2001 and 2000.................................................................... 7
Notes to Condensed Consolidated Financial Statements at September 30, 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.............................................................................. 21
Item 2. Changes in the Rights of the Company's Security Holders........................................ 21
Item 3. Defaults Upon Senior Securities................................................................ 21
Item 4. Submission of Matters to a Vote of Security Holders............................................ 21
Item 5. Other Information.............................................................................. 21
Item 6. Exhibits and Reports on Form 8-K .............................................................. 21
2
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 September 30, 2001, and the related
condensed consolidated statements of income for the three-month and nine-month
periods ended September 30, 2001 and 2000 and the related condensed consolidated
statements of stockholders' equity and of cash flows for the nine-month periods
ended September 30, 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
October 29, 2001
3
CNA SURETY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
(Unaudited)
September 30, December 31,
2001 2000
----------------- -----------------
ASSETS Invested assets and cash:
Fixed income securities, at fair value (amortized cost: $447,415 and $453,570) $ 463,620 $ 458,284
Equity securities, at fair value (cost: $41,649 and $37,761)................... 30,731 33,927
Short-term investments, at cost (approximates fair value)...................... 52,025 52,660
Other investments, at fair value............................................... 5,212 5,154
Cash 9,348 5,950
---------- ----------
Total invested assets and cash.............................................. 560,936 555,975
Deferred policy acquisition costs................................................ 93,365 91,403
Insurance receivables:
Premiums, including $33,165 and $31,607 from affiliates........................ 43,254 41,207
Reinsurance, including $14,703 and $13,349 from affiliates..................... 98,402 75,330
Intangible assets (net of accumulated amortization: $23,999 and $19,426)......... 145,310 149,882
Property and equipment, at cost (less accumulated
depreciation: $14,156 and $13,677)............................................. 16,341 15,332
Prepaid reinsurance premiums..................................................... 3,895 2,532
Receivables for securities sold.................................................. 90 10,406
Other assets..................................................................... 7,136 8,501
---------- ----------
Total assets................................................................ $ 968,729 $ 950,568
========== ==========
LIABILITIES
Reserves:
Unpaid losses and loss adjustment expenses..................................... $ 219,425 $ 204,457
Unearned premiums.............................................................. 203,521 202,179
---------- ----------
Total reserves.............................................................. 422,946 406,636
Debt ............................................................................ 76,195 101,556
Deferred income taxes, net....................................................... 22,413 19,700
Current income taxes payable..................................................... 11,659 6,820
Reinsurance and other payables to affiliates..................................... 5,369 8,117
Other liabilities................................................................ 33,279 33,707
---------- ----------
Total liabilities........................................................... $ 571,861 $ 576,536
---------- ----------
Commitments and contingencies (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; 44,202 shares
issued and 42,753 shares outstanding at September 30, 2001 and 44,146 shares
issued and 42,702 shares outstanding at December 31, 2000........................ 442 441
Additional paid-in capital....................................................... 253,898 253,497
Retained earnings................................................................ 154,938 135,308
Accumulated other comprehensive income........................................... 3,143 267
Treasury stock, at cost.......................................................... (15,553) (15,481)
---------- ----------
Total stockholders' equity.................................................. 396,868 374,032
---------- ----------
Total liabilities and stockholders' equity.................................. $ 968,729 $ 950,568
========== ==========
The accompanying notes are an integral part of these
condensed consolidated financial statements.
4
CNA SURETY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------ -------------------------------
2001 2000 2001 2000
--------------- -------------- --------------- ---------------
Revenues:
Net earned premiums......................................... $ 81,931 $ 73,541 $ 237,530 $ 224,782
Net investment income....................................... 7,088 7,428 22,303 21,896
Net realized investment gains (losses)...................... 367 (39) 530 191
---------- ----------- ---------- ----------
89,386 80,930 260,363 246,869
---------- ---------- ---------- ----------
Expenses:
Net losses and loss adjustment expenses..................... 17,068 11,683 49,967 38,943
Net commissions, brokerage and other underwriting........... 51,748 46,325 146,769 135,158
Interest expense............................................ 803 1,809 3,348 5,159
Non-recurring charge........................................ -- -- -- 500
Amortization of intangible assets........................... 1,525 1,525 4,573 4,573
---------- ---------- ---------- ----------
71,144 61,342 204,657 184,333
---------- ---------- ---------- ----------
Income before income taxes.................................... 18,242 19,588 55,706 62,536
Income taxes.................................................. 6,228 6,250 19,405 20,978
---------- ---------- ---------- ----------
Net income.................................................... $ 12,014 $ 13,338 $ 36,301 $ 41,558
========== ========== ========== ==========
Earnings per share............................................ $ 0.28 $ 0.31 $ 0.85 $ 0.97
========== ========== ========== ==========
Earnings per share, assuming dilution......................... $ 0.28 $ 0.31 $ 0.85 $ 0.97
========== ========== ========== ==========
Weighted average shares outstanding........................... 42,758 42,909 42,736 42,922
========== ========== ========== ==========
Weighted average shares outstanding, assuming dilution........ 42,945 43,001 42,939 43,056
========== ========== ========== ==========
The accompanying notes are an integral part of these
condensed consolidated financial statements.
5
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................................................. -- -- -- $ 41,558 41,558
Other comprehensive income:
Change in unrealized gains (losses) on securities (after
income taxes), net of reclassification adjustment
of $520.................................................... -- -- -- 5,202 --
---------
Total comprehensive income.............................. $ 46,760
=========
Purchase of treasury stock................................... (110) -- -- --
Stock options exercised...................................... 20 -- 114 --
Dividends paid to stockholders............................... -- -- -- (10,297)
------- ------- --------- --------
Balance, September 30, 2000.................................. 42,916 $ 441 $ 253,480 $126,680
======= ======= ========= ========
Balance, December 31, 2000................................... 42,702 $ 441 $ 253,497 $135,308
Comprehensive income:
Net income................................................. -- -- -- $ 36,301 36,301
Other comprehensive income:
Change in unrealized gains (losses) on securities (after
income taxes), net of reclassification adjustment
of $(130).................................................. -- -- -- 2,876 --
---------
Total comprehensive income.............................. $ 39,177
=========
Purchase of treasury stock................................... (10) -- -- --
Employee Stock Purchase Program issuance from treasury stock. 5 -- -- --
Stock options exercised and other............................ 56 1 401 --
Dividends paid to stockholders............................... -- -- -- (16,671)
------- ------- --------- --------
Balance, September 30, 2001.................................. 42,753 $ 442 $ 253,898 $154,938
======= ======= ========= ========
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................................................. -- -- 41,558
Other comprehensive income:
Change in unrealized gains (losses) on securities (after
income taxes), net of reclassification adjustment
of $520.................................................... 5,202 -- 5,202
Total comprehensive income..............................
Purchase of treasury stock................................... -- (1,210) (1,210)
Stock options exercised...................................... -- -- 114
Dividends paid to stockholders............................... -- -- (10,297)
--------- -------- ---------
Balance, September 30, 2000.................................. $ (5,948) $(12,982) $ 361,671
========== ========= =========
Balance, December 31, 2000................................... $ 267 $(15,481) $ 374,032
Comprehensive income:
Net income................................................. -- -- 36,301
Other comprehensive income:
Change in unrealized gains (losses) on securities (after
income taxes), net of reclassification adjustment
of $(130).................................................. 2,876 -- 2,876
Total comprehensive income..............................
Purchase of treasury stock................................... -- (125) (125)
Employee Stock Purchase Program issuance from treasury stock. -- 53 53
Stock options exercised and other............................ -- -- 402
Dividends paid to stockholders............................... -- -- (16,671)
--------- -------- ---------
Balance, September 30, 2001.................................. $ 3,143 $(15,553) $ 396,868
========= ========= =========
The accompanying notes are an integral part of these
condensed consolidated financial statements.
6
CNA SURETY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
(UNAUDITED)
Nine Months Ended
September 30,
--------------------------------------
2001 2000
----------------- -----------------
OPERATING ACTIVITIES:
Net income..................................................................... $ 36,301 $ 41,558
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization............................................... 7,159 6,933
Accretion of bond discount, net............................................. 556 822
Net realized investment (gains)............................................. (530) (191)
Changes in:
Insurance receivables....................................................... (25,119) 3,058
Reserve for unearned premiums............................................... 1,342 9,805
Reserve for unpaid losses and loss adjustment expenses...................... 14,968 11,312
Deferred policy acquisition costs........................................... (1,962) (8,433)
Deferred income taxes, net.................................................. 1,102 2,009
Reinsurance and other payables to affiliates................................ (2,748) 3,734
Other assets and liabilities................................................ 4,949 (1,811)
---------- -----------
Net cash provided by operating activities................................. 36,018 68,796
---------- ----------
INVESTING ACTIVITIES:
Fixed income securities:
Purchases................................................................... (94,242) (92,226)
Maturities.................................................................. 56,265 56,783
Sales....................................................................... 44,236 16,461
Purchases of equity securities................................................. (5,457) (15,809)
Proceeds from the sale of equity securities.................................... 1,436 7,203
Changes in short-term investments.............................................. 635 (13,967)
Purchases of property and equipment............................................ (3,943) (3,635)
Changes in receivables/payables for securities sold/purchased, net............. 10,316 (5,418)
Other, net..................................................................... (23) 65
----------- ----------
Net cash provided by (used in) investing activities....................... 9,223 (50,543)
---------- ----------
FINANCING ACTIVITIES:
Principal payments on long-term debt........................................... (25,361) (344)
Dividends to stockholders...................................................... (16,671) (10,297)
Purchase of treasury stock..................................................... (125) (1,210)
Other.......................................................................... 314 91
---------- ----------
Net cash used in financing activities..................................... (41,843) (11,760)
----------- -----------
Increase in cash................................................................. 3,398 6,493
Cash at beginning of period...................................................... 5,950 7,237
---------- ----------
Cash at end of period............................................................ $ 9,348 $ 13,730
========== ==========
Supplemental Disclosure of Cash Flow Information:
Cash paid during the period for:
Interest.................................................................... $ 3,344 $ 5,604
Income taxes................................................................ 12,650 17,250
The accompanying notes are an integral part of these
condensed consolidated financial statements.
7
CNA SURETY CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2001
(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 accounting
principles generally accepted in the United States of America ("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 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 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 statement 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 Pronouncements
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 balance sheet 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 statement of income
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.
8
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.
On April 1, 2001, the Company adopted Emerging Issues Task Force ("EITF")
Issue No. 99-20, "Recognition of Interest Income and Impairment on Purchased and
Retained Beneficial Interests in Securitized Financial Assets" ("EITF 99-20").
EITF 99-20 establishes how a transferor that retains an interest in securitized
financial assets or an enterprise that purchases a beneficial interest in
securitized financial assets should account for interest income and impairment.
This issue did not have a significant impact on the results of operations or
equity of the Company.
In June 2001, the FASB issued Statements of Financial Accounting Standards
No. 141 and No. 142 entitled "Business Combinations" ("SFAS No. 141") and
"Goodwill and Other Intangible Assets" ("SFAS No. 142"), respectively. SFAS No.
141 requires that the purchase method of accounting be used for all business
combinations subsequent to June 30, 2001 and specifies criteria for recognizing
intangible assets acquired in a business combination. SFAS No. 142 requires that
goodwill and intangible assets with indefinite useful lives no longer be
amortized, but instead be tested for impairment at least annually. Any
impairment loss for the excess of the carrying amount of an intangible asset
over its fair value would be recognized as a charge to operations. Intangible
assets with definite useful lives will continue to be amortized over their
respective estimated useful lives. The Company plans to adopt the provisions of
Statement No. 142 effective January 1, 2002. The Company has not completed a
full analysis of the impact of SFAS No. 142, but anticipates the adoption of
SFAS No. 142 will increase the Company's reported net income as amortization of
goodwill, currently $5.1 million annually, is expected to cease. The Company is
currently reviewing its accounting for intangible assets and the related $1.0
million in annual amortization expense under SFAS No. 142.
In August 2001, the FASB issued Statement of Financial Accounting Standards
No. 143 entitled "Accounting for Asset Retirement Obligations" ("SFAS No 143").
SFAS No. 143 addresses accounting and reporting for obligations associated with
the retirement of tangible long-lived assets and the associated asset retirement
costs. The provisions of this standard are effective for CNA Surety beginning
January 1, 2003. The Company is in the process of quantifying the impact this
new standard will have on the results of operations or equity of the Company.
In October 2001, the FASB issued Statement of Financial Accounting
Standards No. 144 entitled "Accounting for the Impairment or Disposal of
Long-Lived Assets" ("SFAS No. 144"). SFAS No. 144 addresses accounting and
reporting for the impairment or disposal of long-lived assets. This statement
supersedes FASB Statement No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of." The provisions of this
statement are effective for CNA Surety beginning January 1, 2002. The Company is
in the process of quantifying the impact this new standard will have on the
results of operations or equity of the Company.
9
2. INVESTMENTS
The estimated amortized cost and estimated fair value of fixed income and
equity securities held by CNA Surety at September 30, 2001 and December 31,
2000, by investment category, were as follows (dollars in thousands):
Gross Gross
Amortized Cost or Unrealized Unrealized Estimated Fair
September 30, 2001 Cost Gains Losses Value
--------------------------------------------------- -------------------------------------- ------------------ -------------------
Fixed income securities:
U.S. Treasury securities and obligations of U.S.
Government and agencies:
U.S. Treasury............................. $ 15,422 $ 858 $ -- $ 16,280
U.S. Agencies............................. 57,443 2,953 (706) 59,690
Collateralized mortgage obligations....... 475 4 (2) 477
Mortgage pass-through securities.......... 26,734 741 -- 27,475
Obligations of states and political subdivisions 199,514 8,672 (29) 208,157
Corporate bonds................................ 81,896 2,721 (1,023) 83,594
Non-agency collateralized mortgage obligations 13,516 139 (42) 13,613
Other asset-backed securities:
Second mortgages/home equity loans........... 16,098 733 -- 16,831
Credit card receivables...................... 10,426 528 -- 10,954
Manufactured housing......................... 7,427 373 (3) 7,797
Other........................................ 1,024 140 -- 1,164
Redeemable preferred stock..................... 17,440 196 (48) 17,588
---------- ---------- ----------- ----------
Total fixed income securities............. 447,415 18,058 (1,853) 463,620
Equity securities.............................. 41,649 1,540 (12,458) 30,731
---------- ---------- ---------- ----------
Total..................................... $ 489,064 $ 19,598 $ (14,311) $ 494,351
========== ========== =========== ==========
Gross Gross
Amortized Cost or Unrealized Unrealized Estimated Fair
December 31, 2000 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
========== ========== =========== ==========
10
3. REINSURANCE
The effect of reinsurance on the Company's written and earned premium was
as follows (dollars in thousands):
Three Months Ended September 30,
--------------------------------
2001 2000
------------------------- --------------------------
Written Earned Written Earned
----------- ----------- ----------- ------------
Direct........................................................ $ 32,342 $ 31,281 $ 28,573 $ 28,054
Assumed from affiliates....................................... 55,649 55,617 50,820 49,980
Ceded......................................................... (3,933) (4,967) (4,267) (4,493)
----------- ----------- ----------- -----------
$ 84,058 $ 81,931 $ 75,126 $ 73,541
=========== =========== =========== ===========
Nine Months Ended September 30,
-------------------------------
2001 2000
------------------------- --------------------------
Written Earned Written Earned
----------- ----------- ----------- ------------
Direct........................................................ $ 96,498 $ 88,287 $ 87,174 $ 80,740
Assumed from affiliates....................................... 152,759 159,703 155,250 154,611
Ceded......................................................... (11,748) (10,460) (9,709) (10,569)
----------- ----------- ----------- -----------
$ 237,509 $ 237,530 $ 232,715 $ 224,782
=========== =========== =========== ===========
The effect of reinsurance on the Company's provision for loss and loss
adjustment expenses was as follows (dollars in thousands):
Three Months Ended
September 30,
------------------
2001 2000
----------- -----------
Gross loss and loss adjustment expenses................................................. $ 38,559 $ 23,230
Ceded amounts........................................................................... (21,491) (11,547)
----------- -----------
Net loss and loss adjustment expenses................................................... $ 17,068 $ 11,683
=========== ===========
Nine Months Ended
September 30,
-------------------
2001 2000
----------- -----------
Gross loss and loss adjustment expenses................................................. $ 89,243 $ 77,126
Ceded amounts........................................................................... (39,276) (38,183)
----------- -----------
Net loss and loss adjustment expenses................................................... $ 49,967 $ 38,943
=========== ===========
4. Legal Proceedings
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.
11
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 Condensed 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. 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 89% 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.
12
"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- AND NINE- MONTHS ENDED SEPTEMBER 30, 2001 AND
2000
The components of net income for the Company for the three and nine months
ended September 30, 2001 and 2000 are summarized as follows (dollars in
thousands, except per share amounts):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------ -------------------------------
2001 2000 2001 2000
------------------------------ --------------- ---------------
Total revenues................................ $ 89,386 $ 80,930 $ 260,363 $ 246,869
========== ========== ========== ==========
Underwriting income........................... $ 13,115 $ 15,533 $ 40,794 $ 50,681
Net investment income......................... 7,088 7,428 22,303 21,896
Net realized investment gains (losses)........ 367 (39) 530 191
Interest expense.............................. 803 1,809 3,348 5,159
Non-recurring charge.......................... -- -- -- 500
Amortization of intangible assets............. 1,525 1,525 4,573 4,573
---------- ---------- ---------- ----------
Income before income taxes.................... 18,242 19,588 55,706 62,536
Income taxes.................................. 6,228 6,250 19,405 20,978
---------- ---------- ---------- ----------
Net income.................................... $ 12,014 $ 13,338 $ 36,301 $ 41,558
========== ========== ========== ==========
Net income per share.......................... $ 0.28 $ 0.31 $ 0.85 $ 0.97
========== ========== ========== ==========
13
Insurance Underwriting
Underwriting results for the Company for the three and nine months ended
September 30, 2001 and 2000 are summarized in the following table (dollars in
thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------ -------------------------------
2001 2000 2001 2000
------------------------------ --------------- ---------------
Gross written premiums........................ $ 87,991 $ 79,393 $ 249,257 $ 242,424
========= ========= ========= =========
Net written premiums.......................... $ 84,058 $ 75,126 $ 237,509 $ 232,715
========= ========= ========= =========
Net earned premiums........................... $ 81,931 $ 73,541 $ 237,530 $ 224,782
Net losses and loss adjustment expenses....... 17,068 11,683 49,967 38,943
Net commissions, brokerage and other.......... 51,748 46,325 146,769 135,158
--------- --------- --------- ---------
Underwriting income........................... $ 13,115 $ 15,533 $ 40,794 $ 50,681
========= ========= ========= =========
Loss ratio.................................... 20.8% 15.9% 21.0% 17.3%
Expense ratio................................. 63.2 63.0 61.8 60.2
--------- --------- --------- ---------
Combined ratio................................ 84.0% 78.9% 82.8% 77.5%
========= ========= ========= =========
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.
Effective January 1, 2001, the Company began recording written premium on
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 are shown in the table below (dollars in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------ -------------------------------
2001 2000 2001 2000
------------------------------ --------------- ---------------
Contract...................................... $ 48,655 $ 43,512 $ 134,999 $ 123,079
Commercial.................................... 32,510 29,446 92,933 98,932
Fidelity and other............................ 6,826 6,435 21,325 20,413
---------- ---------- ---------- ----------
$ 87,991 $ 79,393 $ 249,257 $ 242,424
========== ========== ========== ==========
Gross written premiums increased 10.8%, or $8.6 million, for the three
months ended September 30, 2001 over the comparable period in 2000. Gross
written premium included an increase associated with the change in the timing of
recording written premiums of $2.6 million. Gross processed premiums increased
7.6%, or $6.0 million, to $85.4 million with contract surety and commercial
surety up 10.6% and 3.3%, respectively.
14
Gross written premiums for contract surety increased 11.8%, or $5.2
million, to $48.7 million in gross written premiums as compared to 2000. This
increase is primarily attributable to continued strength in public construction
nationwide particularly highway and road, airport and school related projects.
Gross written premiums for commercial surety increased 10.4%, or $3.0 million,
to $32.5 million, for the three months ended September 30, 2001 primarily due to
increases in the large commercial segment which benefited from pricing actions.
Fidelity and other products increased 6.1%, or $0.4 million, to $6.8 million for
the three months ended September 30, 2001 as compared to the same period in
2000.
Gross written premiums increased 2.8%, or $6.9 million, to $249.3 million
for the nine months ended September 30, 2001 over the comparable period in 2000.
Nine month gross written premium increased despite a decrease associated with
the change in the timing of recording written premiums of $7.6 million and the
discontinuance of the CNA Re assumed international credit and surety business of
$6.0 million. Excluding international reinsurance business assumed from CNA Re,
core direct gross processed premiums increased 8.7%, or $20.5 million, to $256.9
million with contract surety and commercial surety up 10.4% and 6.7%,
respectively. These increases were primarily due to continued strength in public
construction spending for contract surety and increased large commercial account
activity.
Gross written premiums for contract surety increased 9.7%, or $11.9
million, to $135.0 million, for the nine months ended September 30, 2001. Gross
written premiums for core direct commercial surety (excluding international
reinsurance business assumed from CNA Re) was unchanged at $92.9 million.
Fidelity and other products increased 4.5%, or $0.9 million, to $21.3 million
for the nine months ended September 30, 2001 as compared to the same period in
2000.
Net written premiums are shown in the table below (dollars in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------ -------------------------------
2001 2000 2001 2000
------------------------------ --------------- ---------------
Contract...................................... $ 45,722 $ 39,630 $ 125,001 $ 114,106
Commercial.................................... 31,510 29,058 91,183 97,727
Fidelity and other............................ 6,826 6,438 21,325 20,882
---------- ---------- ---------- ----------
$ 84,058 $ 75,126 $ 237,509 $ 232,715
========== ========== ========== ==========
For the three months ended September 30, 2001, net written premiums
increased 11.9%, or $9.0 million, to $84.1 million, reflecting the
aforementioned gross production changes. Ceded written premiums decreased $0.3
million to $3.9 million for the third quarter of 2001. Net written premiums
increased 15.4%, or $6.1 million, for the contract surety business. Commercial
surety net written premiums increased 8.4%, or $2.4 million, for the three
months ended September 30, 2001. The fidelity and other products increased 6.0%,
or $0.4 million, to $6.8 million, for the third quarter in 2001 as compared to
the same period in 2000.
For the first nine months of 2001, net written premiums increased 2.1%, or
$4.8 million, to $237.5 million with contract surety up 9.5% and commercial
surety down 6.7%. The fidelity and other book of business increased 2.1%, or
$0.4 million, to $21.3 million, for the nine months ended September 30, 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. The increase in claim severity in more recent
accident years has generally resulted in higher gross accident year loss ratios
and greater losses ceded to our reinsurers under our $5 million per principal
excess of loss reinsurance contract. CNA Surety is paying higher costs for
reinsurance as a result of this loss experience. Recent discussions
15
with the leading reinsurance companies on our treaty regarding the contract
terms and conditions indicated that sufficient reinsurance capacity will likely
be made available to us to continue operating as we have historically, but the
cost and structure of this support may change. Such changes to our reinsurance
arrangement could have a material adverse impact on the Company's future results
of operations.
Underwriting Income
Underwriting income decreased 15.6% to $13.1 million for the three months
ended September 30, 2001 compared to $15.5 million for the same period in 2000.
This decrease is primarily due to higher incurred losses. 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 a 46.1% increase in
net losses and loss adjustment expenses. Underwriting income decreased 19.5% to
$40.8 million for the nine months ended September 30, 2001 compared to the same
period in 2000. The nine month period to period change in underwriting income
reflects a 28.3% increase in net losses and loss adjustment expenses.
Net Loss Ratio
The net loss ratios for the three months ended September 30, 2001 and 2000
were 20.8% and 15.9%, respectively. The net loss ratios included $0.5 million of
net unfavorable loss reserve development and $2.9 million of net favorable
reserve development for the three months ended September 30, 2001 and 2000,
respectively. Excluding the impact of the reserve development, the net loss
ratios would have been 20.2% and 19.8% for the three month periods ended
September 30, 2001 and 2000, respectively. For the nine months ended September
30, 2001 and 2000, the net loss ratios were 21.0% and 17.3%, respectively. The
net loss ratios included $0.4 million of net unfavorable loss reserve
development and $6.8 million of net favorable reserve development for the nine
months ended September 30, 2001 and 2000, respectively. Excluding the impact of
the reserve development, the net loss ratios would have been 20.8% and 20.3% for
the nine month periods ended September 30, 2001 and 2000, respectively. The
increases in the adjusted net loss ratio for the three and nine month periods in
2001 relate primarily to higher incurred losses. The surety business assumed
from CCC and CIC is subject 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 of 63.2% for the three months ended September 30, 2001
was comparable to a rate of 63.0% for the same period in 2000. For the nine
months ended September 30, 2001, the expense ratio increased to 61.8% from 60.2%
for the same period in 2000. The increase reflects higher reinsurance and
operating costs, primarily technology related expenditures. For the first nine
month of 2001, net earned premiums increased 5.7% and operating expenses
increased at a higher rate of 8.6%.
Investment Income
For the three months ended September 30, 2001, net investment income
decreased 4.6% to $7.1 million from $7.4 million for the same period in 2000.
The decrease in investment income for the three months ended September 30, 2001
reflects the impact of lower investment yields and reduced invested assets
primarily associated with increased dividend payments to shareholders and the
retirement of debt. The average pretax yield was 5.2% and 5.6% for the three
months ended September 30, 2001 and 2000,
16
respectively. Net investment income for the nine months ended September 30, 2001
increased 1.9% to $22.3 million from $21.9 million for the same period in 2000.
The average pretax yields were 5.4% and 5.6% for the nine months ended September
30, 2001 and 2000, respectively.
For the nine months ended September 30, 2001, net realized investment
gains were $0.5 million compared to $0.2 million for the same period in 2000.
Analysis of Other Operations
Amortization expense was $1.5 million for the three months ended September
30, 2001 and 2000. For the nine months ended September 30, 2001 and 2000,
amortization of intangibles was $4.6 million. Intangible assets primarily
represent goodwill and identified intangibles arising from the acquisition of
Capsure. Intangible assets are generally amortized over 30 years.
Interest expense decreased $1.0 million to $0.8 million for the third
quarter of 2001 as compared to the same period in 2000, primarily due to lower
outstanding debt levels and lower interest rates. Average debt outstanding was
$76.3 million for the third quarter in 2001 compared to $101.7 million in the
third quarter of 2000. The weighted average interest rate for the three months
ended September 30, 2001 was 3.9% compared to 6.8% for the same period in 2000.
Interest expense decreased 35.1% for the first nine months of 2001 as compared
to the same period in 2000. Average debt outstanding was $85.0 million for the
first nine months in 2000 compared to $101.8 million in the first nine months of
2000. The weighted average interest rate for the nine months ended September 30,
2001 was 4.9% compared to 6.5% for the same period in 2000.
Income Taxes
Income tax expense was $6.2 million and $6.3 million and the effective
income tax rates were 34.1% and 31.9% for the three months ended September 30,
2001 and 2000, respectively. For the nine months ended September 30, 2001 and
2000, income tax expense was $19.4 million and $21.0 million and the effective
income tax rates were 34.8% and 33.6%, respectively. The increases in the
estimated effective tax rate in 2001 primarily relates to anticipated decreases
in tax exempt investment income.
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.
On May 16, 2001, the CNA Surety Board of Directors increased the quarterly
dividend from $0.09 to $0.15 per share beginning with the quarterly dividend
payable on July 5, 2001.
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 September 30, 2001, the carrying value of the Company's
insurance subsidiaries' invested assets was
17
comprised of $458.6 million of fixed income securities, $30.7 million of equity
securities, $22.3 million of short-term investments, $5.2 million of other
investments and $5.6 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
September 30, 2001, the parent company's invested assets consisted of $5.0
million of fixed income securities and $29.7 million of short-term investments
and $3.7 million of 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 $36.0 million for the nine months ended September 30, 2001 and $68.8 million
for the comparable period in 2000. The decrease in net cash flow provided by
operating activities primarily relates to increases in insurance receivables,
primarily reinsurance recoverables, and higher net loss payments in the current
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 September 30, 2001, the Company has unused capacity under
the revolver of approximately $55 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
September 30, 2001 and can vary based on CNA Surety's leverage ratio (debt to
total capitalization) from 0.25% to 0.40%. As of September 30, 2001, the
weighted average interest rate was 2.9% on the $75.0 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 September 30, 2001, the
Company was in compliance with all restrictions and covenants contained in the
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 September 30, 2001 was $1.2 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
18
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 $35.0 million in dividends from its insurance subsidiaries during the
first nine 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 $18.2 million for the nine months ended
September 30, 2001 and $21.3 million for the same period in 2000.
CNA Surety management believes that it will have sufficient available
resources, including capital support provided by its reinsurers, to meet its
present capital needs.
19
IMPACT OF ACCOUNTING PRONOUNCEMENTS NOT YET ADOPTED
In June 2001, the FASB issued Statements of Financial Accounting Standards
No. 141 and No. 142 entitled "Business Combinations" ("SFAS No. 141") and
"Goodwill and Other Intangible Assets" ("SFAS No. 142"), respectively. SFAS No.
141 requires that the purchase method of accounting be used for all business
combinations subsequent to June 30, 2001 and specifies criteria for recognizing
intangible assets acquired in a business combination. SFAS No. 142 requires that
goodwill and intangible assets with indefinite useful lives no longer be
amortized, but instead be tested for impairment at least annually. Any
impairment loss for the excess of the carrying amount of an intangible asset
over its fair value would be recognized as a charge to operations. Intangible
assets with definite useful lives will continue to be amortized over their
respective estimated useful lives. The Company plans to adopt the provisions of
Statement No. 142 effective January 1, 2002. The Company has not completed a
full analysis of the impact of SFAS No. 142, but anticipates the adoption of
SFAS No. 142 will increase the Company's reported net income as amortization of
goodwill, currently $5.1 million annually, is expected to cease. The Company is
currently reviewing its accounting for intangible assets and the related $1.0
million in annual amortization expense under SFAS No. 142.
In August 2001, the FASB issued Statement of Financial Accounting Standards
No. 143 entitled "Accounting for Asset Retirement Obligations" ("SFAS No 143").
SFAS No. 143 addresses accounting and reporting for obligations associated with
the retirement of tangible long-lived assets and the associated asset retirement
costs. The provisions of this standard are effective for CNA Surety beginning
January 1, 2003. The Company is in the process of quantifying the impact this
new standard will have on the results of operations or equity of the Company.
In October 2001, the FASB issued Statement of Financial Accounting
Standards No. 144 entitled "Accounting for the Impairment or Disposal of
Long-Lived Assets" ("SFAS No. 144"). SFAS No. 144 addresses accounting and
reporting for the impairment or disposal of long-lived assets. This statement
supersedes FASB Statement No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of." The provisions of this
statement are effective for CNA Surety beginning January 1, 2002. The Company is
in the process of quantifying the impact this new standard will have on the
results of operations or equity of the Company.
20
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:
July 31, 2001; CNA Surety Corporation Press Release issued
on July 30, 2001.
August 15, 2001; CNA Surety Corporation Press Release
issued on August 14, 2001.
September 21, 2001; CNA Surety Corporation Press Release
issued on September 17, 2001.
21
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: November 13, 2001
22