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AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JUNE 17, 1998
REGISTRATION NO. 333-56063
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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Amendment No. 1
to
Form S-1
REGISTRATION STATEMENT UNDER THE
SECURITIES ACT OF 1933
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CNA SURETY CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
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DELAWARE 6331 36-4144905
(State or Other Jurisdiction (Primary Standard Industrial (IRS Employer Identification
of Classification Code Number) Number)
Incorporation or
Organization)
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CNA PLAZA, CHICAGO, ILLINOIS 60685 (312) 822-5000
(Address, Including Zip Code, and Telephone Number, Including Area Code,
of Registrant's Principal Executive Offices)
MARK C. VONNAHME, PRESIDENT AND CHIEF EXECUTIVE OFFICER
CNA SURETY CORPORATION, CNA PLAZA, CHICAGO, ILLINOIS 60685 (312) 822-5000
(Name, Address, Including Zip Code, and
Telephone Number, Including Area Code, of Agent for Service of Process)
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COPIES TO:
DAVID S. STONE, ESQ. GARY I. HOROWITZ, ESQ.
SEYFARTH, SHAW, FAIRWEATHER & GERALDSON SIMPSON THACHER & BARTLETT
55 EAST MONROE STREET, SUITE 4200 425 LEXINGTON AVENUE
CHICAGO, ILLINOIS 60603 (312) 346-8000 NEW YORK, NEW YORK 10017 (212) 455-2000
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Approximate date of commencement of proposed sale to public: As soon as
practicable after this Registration Statement becomes effective.
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If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [ ]
If this form is filed to register additional securities for any offering
pursuant to Rule 462(b) under the Securities Act of 1933, check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ]
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act of 1933, check the following box and list the
Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ]
If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act of 1933, check the following box and list the
Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
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The Registrant hereby amends this registration on such date as may be
necessary to delay its effective date until the Registrant shall file a further
amendment which specifically states that this Registration Statement shall
thereafter become effective in accordance with Section 8(a) of the Securities
Act of 1933 or until the Registration Statement shall become effective on such
date as the Securities and Exchange Commission, acting pursuant to Section 8(a),
may determine.
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INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR
MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT
BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR
THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE
SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE
UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS
OF ANY SUCH STATE.
SUBJECT TO COMPLETION, DATED JUNE 17, 1998
PRELIMINARY PROSPECTUS [CNA SURETY LOGO]
, 1998
4,388,129 SHARES
CNA SURETY CORPORATION
COMMON STOCK
All of the 4,388,129 shares of CNA Surety Corporation ("CNA Surety") common
stock, par value $0.01 per share (the "Common Stock"), are being offered for
sale (the "Offering") by certain stockholders of CNA Surety (such selling
stockholders are collectively referred to as the "Selling Stockholders"). See
"Principal and Selling Stockholders." Unless the over-allotment option granted
to the underwriters by CNA Surety is exercised, CNA Surety will not be selling
any of its Common Stock. CNA Surety will not receive any proceeds from the sale
of the shares offered hereunder by the Selling Stockholders.
The Common Stock is listed on the New York Stock Exchange (the "NYSE") and
trades under the symbol "SUR." The last reported sales price of the Common Stock
on June 16, 1998 was $13 7/8 per share. See "Price Range of Common Stock."
SEE "RISK FACTORS" COMMENCING ON PAGE 12 FOR CERTAIN INFORMATION WHICH
SHOULD BE CAREFULLY CONSIDERED BY PROSPECTIVE PURCHASERS OF THE COMMON STOCK.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
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PRICE UNDERWRITING PROCEEDS TO PROCEEDS
TO THE DISCOUNTS AND THE SELLING TO CNA
PUBLIC COMMISSIONS(1) STOCKHOLDERS(2) SURETY(3)
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Per Share..................... $ $ $ $
Total......................... $ $ $ $
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(1) CNA Surety and the Selling Stockholders have agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act of 1933, as amended (the "Securities Act"). See
"Underwriting" for indemnification arrangements with the Underwriters.
(2) Expenses, estimated at $ , will be paid by CNA Surety.
(3) CNA Surety has granted the Underwriters a 30-day option, exercisable in
whole or in part, from time to time, to purchase up to an additional 658,219
shares of Common Stock to cover over-allotments, if any (the "Over-Allotment
Option"). CNA Surety will receive the proceeds from the sale of shares of
Common Stock subject to the Over-Allotment Option. If all of such shares are
purchased, Proceeds to the Selling Stockholders will not be affected and the
total Price to the Public, Underwriting Discounts and Commissions, and
Proceeds to CNA Surety (before deducting expenses estimated at $ ,
which will be paid by CNA Surety) will be $ , $
and $ , respectively. See "Underwriting."
The shares of Common Stock are offered by the several Underwriters, subject
to prior sale, when, as and if delivered to and accepted by the Underwriters and
subject to various prior conditions, including their right to reject orders in
whole or in part. It is expected that delivery of the shares of Common Stock
will be made in New York, New York on or about , 1998.
DONALDSON, LUFKIN & JENRETTE SALOMON SMITH BARNEY
SECURITIES
CORPORATION
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CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN, OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK.
SPECIFICALLY, THE UNDERWRITERS MAY OVER-ALLOT IN CONNECTION WITH THE OFFERING,
AND MAY BID FOR, AND PURCHASE, SHARES OF THE COMMON STOCK IN THE OPEN MARKET.
FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING."
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The states in which CNA Surety's insurance subsidiaries are domiciled,
South Dakota and Texas, have enacted laws which require regulatory approval for
the acquisition of "control" of insurance companies. Under these laws, there
exists a presumption of "control" when an acquiring party acquires 10% or more
of the voting securities of an insurance company or of a company which itself
controls an insurance company. Therefore, any person acquiring 10% or more of
the Common Stock of CNA Surety would need the prior approval of the state
insurance regulators of South Dakota and Texas, or a determination from such
regulators that "control" has not been acquired.
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AVAILABLE INFORMATION
CNA Surety is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance
therewith, files reports and other information with the Securities and Exchange
Commission (the "Commission"). Such reports and other information filed by CNA
Surety can be inspected and copied at the public reference facilities maintained
by the Commission in Room 1024, 450 Fifth Street, N.W., Judiciary Plaza,
Washington, D.C. 20549, where copies may be obtained at prescribed rates, as
well as at the following regional offices: Northeast Regional Office, 7 World
Trade Center, Suite 1300, New York, New York 10048; and Midwest Regional Office,
Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois
60661-2511. This material may also be inspected at the offices of the NYSE, 20
Broad Street, New York, New York 10005. Certain information and reports are also
available electronically through the Commission's Electronic Data Gathering,
Analysis and Retrieval system database, which can be accessed through the
Commission's website located at http://www.sec.gov.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
When used in this Prospectus, the words "estimates," "targets," "projects,"
"intends," "expects," and similar expressions are intended to identify
forward-looking statements under the Private Securities Litigation Reform Act of
1995. The statements which are not historical facts contained in this Prospectus
are forward-looking statements that involve risks and uncertainties, including,
but not limited to, the impact of competitive products and other competitive
factors, the effect of controlling stockholders and conflicts of interest, the
effect of economic conditions, including interest rates, investment portfolio
developments and the reaction to market conditions, the impact of adverse
legislation, the effects of CNA Surety's holding company structure, rating
agency policies and practices, the ability of CNA Surety to effectively
integrate the businesses of the Predecessor Operations with Western Surety and
USA (as each term is hereinafter defined), regulatory changes and conditions,
development of claims and the effect on loss reserves, compliance with year 2000
issues by the Company and its suppliers, insureds, and bond obligees, risk of
insolvency of CNA Surety's insurance subsidiaries, limitations on change in
control of CNA Surety, the impact of shares eligible for future sale, product
and policy demand and market response risks, policies and pricing, product and
policy development, the performance of reinsurance companies under reinsurance
contracts with CNA Surety's insurance subsidiaries, the results of financing
efforts, the identification of potential transactions and the actual
consummation of contemplated transactions or agreements, and other risks. All
such statements are subject to risks and uncertainties that could cause actual
results to differ materially from those contemplated in such forward-looking
statements. For a discussion of such risks, see "Risk Factors." Readers are
cautioned not to place undue reliance on forward-looking statements. CNA Surety
does not undertake any obligation to publicly release any revisions to these
forward-looking statements to reflect events or circumstances after the date
hereof or to reflect the occurrence of unanticipated events.
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PROSPECTUS SUMMARY
The following summary is qualified in its entirety by, and should be read
in conjunction with, the more detailed information and financial statements,
including the notes thereto, appearing elsewhere in this Prospectus. All
financial information presented is in accordance with generally accepted
accounting principles ("GAAP"), unless otherwise specified. Financial
information presented in accordance with statutory accounting practices ("SAP")
is identified as such. Unless otherwise indicated, all information contained in
this Prospectus is based upon the assumption that the Underwriters'
Over-Allotment Option will not be exercised. Unless the context otherwise
requires, all references in this Prospectus to: (i) "CNA Surety" shall mean the
issuer, CNA Surety Corporation, and all references to the "Company" shall mean
CNA Surety Corporation together with its subsidiaries on a consolidated basis
and incorporating the combination of the respective insurance businesses in
connection with the Merger; (ii) "CNAF" shall mean CNA Financial Corporation and
its subsidiaries, each either individually or collectively; (iii) "Capsure"
shall mean Capsure Holdings Corp. and its property and casualty affiliates; (iv)
"CCC" shall mean Continental Casualty Company and its property and casualty
affiliates, each either individually or collectively; (v) "CIC" shall mean The
Continental Insurance Company and its property and casualty affiliates, each
either individually or collectively; (vi) "Predecessor Operations" shall refer
to the combined surety operations of CCC and CIC conducted prior to the Merger;
(vii) "Western Surety" shall mean Western Surety Company; (viii) "USA" shall
mean Universal Surety of America; (ix) the "Merger" shall mean the combination
of the Predecessor Operations with Capsure's principal insurance subsidiaries
pursuant to a reorganization agreement under which Capsure was merged with and
into a subsidiary of CNA Surety Corporation; and (x) "Merger Date" shall mean
the close of business on September 30, 1997 when the Merger was consummated.
THE COMPANY
BUSINESS OVERVIEW
CNA Surety is an insurance holding company that, through its subsidiaries,
develops, markets and underwrites primarily surety bonds. The Company is the
largest publicly-traded insurance holding company focused exclusively on the
surety business and is one of the leading providers of surety products in the
United States. During 1997, the insurance companies now owned by the Company
wrote over $266 million of gross written premiums, $244 million of which
consisted of surety premiums. For the three months ended March 31, 1998, the
Company wrote over $63 million of gross written premiums, $57 million of which
consisted of surety premiums.
The Company was formed to facilitate the merger of the surety business of
CNAF with Capsure's insurance subsidiaries, Western Surety and USA. Management
believes that the Merger, which occurred on September 30, 1997, resulted in the
combination of three complementary surety businesses, each with distinct
strengths, product focuses and marketing strategies. The combination of these
businesses resulted in a single, larger entity focused on serving the needs of
virtually all segments of the surety market, in terms of the types of products
offered and the size of bonds available. Based on management's knowledge of the
industry, management believes that the Company now offers the broadest range of
surety products available in the marketplace and that the Company's branch
system and independent agency network are the most extensive in the surety
industry, the combination of which provide the Company with a competitive
marketing advantage.
Surety products, unlike the standard two-party insurance policy, are
three-party agreements in which the Company as the issuer of the bond (the
surety) joins with a second party (the principal) in guaranteeing to a third
party (the owner/obligee) the fulfillment of some obligation on the part of the
principal. Sureties are generally entitled to recover from the principal any
losses and expenses paid to third parties.
The Company, through its principal insurance subsidiaries, underwrites a
broad spectrum of surety bonds, including contract surety bonds, non-contract
bonds, referred to as commercial bonds, small fidelity bonds and errors and
omissions ("E&O") liability insurance. The Company also assumes, on a
reinsurance basis,
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international surety and credit insurance written by CNA Reinsurance Company,
Limited, a United Kingdom domiciled subsidiary of CNAF ("CNA Re (London)").
Management believes that the Company is the largest writer of smaller commercial
surety bonds, with strong capabilities in marketing, distribution and service.
Western Surety and USA, the Company's principal insurance subsidiaries, are
currently rated A+ (Superior) and A (Excellent), respectively, by A.M. Best,
Inc. ("A.M. Best"). A.M. Best ratings are based upon factors relevant to
policyholders, agents, insurance brokers and intermediaries and are not directed
to the protection of investors.
The Company principally markets its products in all 50 states, as well as
the District of Columbia and Puerto Rico. Its products are marketed primarily
through independent producers, including multi-line agents and brokers, many of
whom belong to the National Association of Surety Bond Producers. The Company
enjoys broad national distribution of its products through approximately 36,000
of the approximately 44,000 independent property and casualty insurance agencies
in the United States.
The Company's primary focus is on evaluating the risk and determining if
the principal meets its underwriting requirements for the bond. Accordingly, the
Company's surety bond premiums primarily reflect the type and class of risk and
related costs associated with both processing the bond transaction and
investigating the applicant including, if necessary, an analysis of the
applicant's creditworthiness and ability to perform.
The Company is led by an experienced management team with an average of
over twenty years of experience, whose core expertise is in surety underwriting
and claims management. Management's underwriting philosophy is disciplined and
focused on consistent underwriting profitability. The extent and sophistication
of underwriting activity, including the amount of bonding authority granted to
independent agents, varies depending on the class of business and the type of
bond. For example, contractor accounts and large commercial surety customers
undergo extensive credit, financial and managerial review and analysis on a
regular basis. Similarly, certain classifications of bonds, such as fiduciary
and court appeal bonds, also receive extensive underwriting. On the other hand,
the Company requires comparatively little underwriting information for certain
low-exposure risks such as notary bonds. The Company's underwriting has resulted
in combined ratios of 79.7%, 81.0% and 87.4%, excluding the effects of favorable
loss reserve development, for the three months ended March 31, 1998 and on a pro
forma basis for the years ended December 31, 1997 and 1996, respectively. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations . . ."
CORPORATE STRATEGY
CNA Surety's corporate objective is to be the leading provider of surety
and surety-related products in the United States and in selected international
markets and to be the surety of choice for customers and independent agents and
brokers. The Merger was an integral step towards achieving this objective and,
in management's view, has enhanced the Company's position as a market leader in
addition to providing increased opportunities for long-term revenue and earnings
growth. Elements of management's operating strategy designed to achieve its
corporate objective include the following:
Leverage the Company's Broad Product Line and Distribution Network
Management intends to use the Company's expanded product offerings, and
extensive distribution network, to leverage its existing marketing capabilities.
For example, the Company has introduced Western Surety's small commercial
products and USA's small contractor products to the 41 CNA Surety branch offices
of the Company, which prior to the Merger, did not have access to these product
offerings. Similarly, the Company has introduced CNA Surety's larger contract
and commercial bond expertise and greater financial capacity to Western Surety's
and USA's broad independent agency distribution system. In addition, Western
Surety's and USA's marketing representatives now receive support, training and
education from CNA Surety branch office personnel. Management believes that,
over time, the development of more extensive relationships with its independent
agency force will enhance the Company's growth opportunities and operating
efficiencies.
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Pursue Cross-Marketing Opportunities between the Company and CNAF
Management believes that the Company's relationship with CNAF, its
principal stockholder, provides significant opportunities for the Company.
Management believes that CNAF's 100-year history, leading position in the
property and casualty insurance market, financial strength and name recognition
provide CNA Surety with a strong marketing advantage in the medium to large
surety marketplace. In addition, with a leading position in providing property
and casualty insurance to the construction sector, risk management services to
"Fortune 1000" clients and professional liability products to architects and
engineers, CNAF is well positioned to generate new business opportunities for
CNA Surety.
In an effort to capitalize on these cross-marketing opportunities, the
Company and CNAF have instituted various referral programs which will allow the
Company to access CNAF's clients that may have a need for surety products. These
referrals are transmitted to the Company's home and branch offices, allowing
Company representatives to pursue these leads.
Expand in the International Markets
The Company recently began its expansion into the European markets through
a relationship with CNA Re (London). Through this relationship, the Company
participates, on a 50% quota share basis, in an international book of
predominately credit insurance and surety business. While credit insurance is a
relatively small market in the United States, credit insurance has a far more
prominent role in Western Europe, where direct writers and reinsurers often
market surety-related products along with credit insurance. Therefore,
management believes that the relationship with CNA Re (London) will serve as an
entree into the large European credit market and, thereby, enhance CNA Surety's
ability to build a surety business in Western Europe.
The Company is also partnering with other members of CNAF's international
organization to establish an infrastructure to market surety bonds
internationally. CNA Surety management believes that these actions will build
name recognition in the international marketplace.
Promote the Company's Specialty and Service-Based Orientation
As a provider of specialty surety products, management believes that the
Company is better positioned than its competitors to deliver exceptional service
to its agents and customers. The Company has developed specialized technology
targeted specifically toward the surety market. For example, due to Western
Surety's historical focus on the small commercial surety market, which requires
immediate response, the Company has developed business systems and processing
expertise that efficiently supports the surety needs of smaller customers and
minimizes the handling costs associated with the low premium, high volume nature
of the small commercial surety business. The Company expects to utilize this
experience and service orientation to better compete in the broader commercial
surety market.
Expand in the Private Sector
Based upon the Company's extensive knowledge of the surety business, its
focus almost exclusively on one sector of the insurance market, the experience
of its management team and its long-standing relationships with insurance agents
producing surety premiums, management believes that it is well positioned to
develop surety-related products for market niches that it believes are
underserved with regard to surety products. For example, the Company has
identified private construction as a market largely untapped with respect to
surety products. While surety bonds are widely used in the public construction
market, surety bonds are not yet as frequently used in the private construction
sector. Potential opportunities for this sector include not only the use of
existing surety bond products but also the development of new product offerings
tailored to the specific requirements of the private construction sector.
Consider Strategic Acquisitions
Management will continue to consider strategic acquisitions, as part of its
long-term approach to growing its business. CNA Surety's focus will be primarily
on specialty providers of surety-related products that bring geographic
diversity or product expertise or expansion to the Company.
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RELATIONSHIP WITH CNAF
The Merger was effected pursuant to a reorganization agreement dated as of
December 19, 1996 and amended as of July 14, 1997 (the "Reorganization
Agreement"). In connection with the Merger, the Company assumed the surety
business written by CNAF's subsidiaries, CCC and CIC, and the statutory surplus
of Western Surety was increased by $73.25 million as a result of a capital
contribution from CNAF and the contribution of debt proceeds from CNA Surety.
Immediately following the Merger, certain CNAF subsidiaries owned, on a
fully-diluted basis, approximately 61.75% of CNA Surety's outstanding Common
Stock and former Capsure stockholders owned, on a fully-diluted basis, the
remaining approximately 38.25% of the Company.
In connection with the Merger, the Company and CNAF entered into various
reinsurance and other operating agreements designed to provide continuing and
expanded underwriting capacity for the combined operations, to protect against
adverse loss reserve development related to the Predecessor Operations' reserves
prior to the Merger, and to help preserve, through the year 2000, the
profitability of the Predecessor Operations and certain additional accounts. In
addition to certain ongoing covenants in the Reorganization Agreement and other
agreements described below, in connection with the Merger, the Company entered
into the following reinsurance agreements: (i) the Surety Quota Share Treaty
(the "Quota Share Treaty"); (ii) the Aggregate Stop Loss Reinsurance Contract
(the "Stop Loss Contract"); and (iii) the Surety Excess of Loss Reinsurance
Contract (the "Excess of Loss Contract"). Subsequent to the Merger, the Company
entered into the Surety Second Excess of Loss Reinsurance Contract (the "Second
Excess of Loss Contract"). A description of each of these agreements is set
forth below. See "Certain Relationships and Related Transactions" for a more
complete discussion of the foregoing agreements.
Surety Quota Share Treaty
The Quota Share Treaty effected the formal transfer of the reserves of the
Predecessor Operations to Western Surety and provided CNA Surety with a
guarantee of such reserves for a period of five years following the Merger. In
addition, in order to protect the Company's business for a period of five years
following the Merger, CNAF agreed to refrain from making a quote or bid, and to
refer any inquiry or request, for surety business to the Company so that the
Company could exclusively offer such products. Notwithstanding the foregoing,
CNAF agreed that it will cede any such business it may write to CNA Surety
through the Quota Share Treaty.
Aggregate Stop Loss Reinsurance Contract
The Stop Loss Contract protects the Company from the variability of the
contract surety business in the form of adverse loss experience on certain
business underwritten after the Merger. Accordingly, the Stop Loss Contract
assures a minimum level of profitability (to the extent expenses do not
increase) for at least three full fiscal years following the Merger by limiting
the Company's insurance subsidiaries' prospective net loss ratios to 24% for
both certain insureds that were accounts of the Predecessor Operations as of the
Merger Date and certain lines of insured business (excluding all miscellaneous
bonds and small contract surety previously underwritten by Capsure's insurance
subsidiaries) (the "Loss Ratio Cap").
Surety Excess of Loss Reinsurance Contract and Surety Second Excess of Loss
Reinsurance Contract
The Excess of Loss Contract and the Second Excess of Loss Contract provide
the Company with the underwriting capacity to continue to expand the Company's
large surety bond business by providing the Company's insurance subsidiaries
with reinsurance support from CNAF's insurance subsidiary, CCC. Historically,
CCC's substantial capital base has enabled it to underwrite and retain large
aggregate surety bond exposures. The Excess of Loss Contract and the Second
Excess of Loss Contract cede to CCC certain liabilities in excess of the
capacity provided by the Company's insurance subsidiaries' other reinsurance
program with third party reinsurers. Specifically, pursuant to the Excess of
Loss Contract CCC provides the Company's insurance subsidiaries with $75 million
of coverage per principal in excess of the $55 million of coverage provided to
such insurance subsidiaries by third party reinsurers, which is in turn in
excess of the $5 million of coverage per principal to be retained by the
Company's insurance subsidiaries. In addition, the
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Second Excess of Loss Contract provides the Company's insurance subsidiaries
with coverage from CCC for losses in excess of $135 million per principal.
The Excess of Loss Contract and the Second Excess of Loss Contract both
provide that, at the request of the Company's insurance subsidiaries, CCC will
act as a joint insurer, or "co-surety," for business covered by either the
Excess of Loss Contract or the Second Excess of Loss Contract.
Administrative Services Agreement
To allow for the continued use by CNA Surety of real and personal property
currently owned or leased by CCC, CNA Surety and CCC entered into the
Administrative Services Agreement. Specifically, the Administrative Services
Agreement provides CNA Surety with the flexibility to purchase many of the
services provided by CCC to the Predecessor Operations, including
telecommunications, computer access and support, human resource assistance,
accounting, legal, financial and administrative support, marketing, and various
other business services.
Trademark License Agreement
In order to maintain its ability to utilize the valuable "CNA" trademark,
CNAF and the Company entered into a Trademark License Agreement pursuant to
which the Company obtained the right to use the "CNA" mark or some derivation
thereof for an unlimited period of time, subject to a right of termination in
the event of a change in control of CNA Surety.
Services and Indemnity Agreement
The Services and Indemnity Agreement authorizes the Company's insurance
subsidiaries to perform certain underwriting, claims, agency and accounting
functions on behalf of CCC as they relate to the business assumed under the
Quota Share Treaty for a period of five years from the Merger Date. Thus,
together with the foregoing reinsurance arrangements, the Company has been
granted the authority to access the CCC capital pool and to issue surety bonds
utilizing CCC rates and forms.
Continuing Covenants of CNAF
The Reorganization Agreement contains certain ongoing agreements, including
an agreement by CCC and CNA Surety to cause the bylaws of CNA Surety to require
approval by 75% of the holders of Common Stock in order for CNA Surety to (i)
enter into certain business combinations, (ii) accept proposals to sell all or
substantially all of the Company's assets, (iii) amend the bylaw provisions
requiring such supermajority voting or (iv) amend the certificate of
incorporation.
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THE OFFERING
Common Stock Offered by the Selling
Stockholders(1)................... 4,388,129 shares
Common Stock Outstanding after the
Offering(1)(2).................... 43,446,119 shares
Use of Proceeds..................... The Company will not receive any of the
proceeds from the sales of Common Stock
by the Selling Stockholders offered
hereunder and will only receive
proceeds from the sale of Common Stock
hereunder if and only to the extent
that the Over-Allotment Option is
exercised. In the event the
Underwriters elect to exercise their
Over-Allotment Option, the Company
intends to use the proceeds from such
sales of Common Stock by the Company
for general corporate purposes. See
"Use of Proceeds."
Dividend Policy..................... CNA Surety currently pays no dividends.
The CNA Surety Board of Directors (the
"Board"), however, recently adopted a
new dividend policy and intends to pay
quarterly dividends beginning in the
fourth quarter of 1998. The timing and
declaration and payment of dividends
will be at the discretion of the Board
and will depend upon many factors. The
Company expects that the first
quarterly dividend, if declared and
paid, will be $0.08 per share. See
"Dividend Policy."
NYSE Symbol......................... "SUR"
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(1) Excludes up to 658,219 shares of Common Stock which may be sold by CNA
Surety upon exercise of the Underwriters' Over-Allotment Option. See
"Underwriting."
(2) Based on the number of shares of Common Stock outstanding as of May 27,
1998. Does not include 749,116 shares of Common Stock issuable upon exercise
of currently outstanding CNA Surety stock options.
RISK FACTORS
In connection with a prospective purchaser's decision to purchase any of
the Common Stock offered hereby, such prospective purchaser should evaluate
certain risk factors associated with such an investment, which are discussed
herein beginning on page 12. The principal risk factors include: (i) the impact
of competition; (ii) the effect of controlling stockholders and conflicts of
interest; (iii) susceptibility to interest rate changes and general economic
conditions; (iv) the impact of adverse legislation; (v) the effects of the CNA
Surety holding company structure; (vi) changes in insurance ratings; (vii) the
ability of CNA Surety to effectively integrate the companies; (viii) the impact
of regulation of insurance companies; (ix) adequacy of reserves; (x) year 2000
compliance by the Company and its suppliers, insureds and bond obligees; (xi)
consequences of insolvency; (xii) limitations on change in control; and (xiii)
shares eligible for future sale.
8
<PAGE> 10
SUMMARY CONSOLIDATED PRO FORMA AND HISTORICAL
FINANCIAL DATA OF CNA SURETY
The following summary financial information is provided for the operations
that combined to form CNA Surety for various time periods in 1996 and 1997 as if
the Merger had been consummated on January 1, 1996. Periods presented on this
basis are therefore marked "pro forma." This pro forma financial information
gives effect to the following: (i) adjustment to the Capsure statement of
operations, as reported, to reflect the income effects as if a $10 per share
special cash distribution paid on October 4, 1996 had been made on January 1,
1996; (ii) consummation of the Merger and the related transactions and the
contribution of capital to, and the incurrence of additional debt, by CNA
Surety; (iii) purchase accounting adjustments to reflect Capsure's assets and
liabilities at fair value; (iv) estimated indirect and overhead expenses for the
Predecessor Operations; and (v) estimated interest expense related to the
additional debt. The pro forma financial information does not include the
estimated net investment income resulting from investment of Merger-related cash
flows, including (i) the $50 million debt proceeds drawn by CNA Surety under the
Credit Facility (as hereinafter defined) and contributed to Western Surety; (ii)
the $52.25 million capital contribution from CCC; and (iii) collection of the
receivable in the amount of approximately $117 million from CCC. Information for
the three months ended March 31, 1998 is derived from the actual quarterly
financial statements of CNA Surety. This information is provided to assist in
understanding and evaluating the consolidated financial information of the
various entities that comprise CNA Surety and is not necessarily indicative of
the future results of operations of CNA Surety. The summary financial data set
forth below should be read in conjunction with the table of Summary Consolidated
Historical Financial Data of CNA Surety which immediately follows and the more
detailed financial information or financial statements and related notes
included in this Prospectus. See "Selected Consolidated Financial Data" and "Pro
Forma Condensed Statement of Consolidated Operations."
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
------------------------- --------------------------
1996 1997 1997 1998
(PRO FORMA) (PRO FORMA) (PRO FORMA) (HISTORICAL)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Total revenues(1)(2)......................... $250,194 $258,682 $ 59,338 $65,534
======== ======== ======== =======
Gross written premiums....................... $251,414 $266,418 $ 59,779 $63,848
======== ======== ======== =======
Net written premiums......................... $235,186 $257,067 $ 56,128 $61,836
======== ======== ======== =======
Net earned premiums.......................... $238,330 $243,425 $ 56,125 $58,745
Net losses and LAE(3)........................ 41,450 5,648 (26,384) 11,218
Net commissions, brokerage and other......... 150,198 150,631 36,328 35,039
-------- -------- -------- -------
Underwriting income(3)....................... 46,682 87,146 46,181 12,488
Net investment income(2)..................... 10,796 14,534 3,126 6,789
Net investment gains......................... 1,068 723 87 --
Interest expense............................. 7,660 7,232 1,765 1,821
Non-recurring charges and Merger costs(4).... 8,565 12,087 -- --
Amortization of intangible assets............ 5,788 5,788 1,447 1,475
-------- -------- -------- -------
Income before income taxes(2)(3)............. 36,533 77,296 46,182 15,981
Income taxes................................. 14,101 42,921 16,771 6,166
-------- -------- -------- -------
Net income(2)(3)............................. $ 22,432 $ 34,375 $ 29,411 $ 9,815
======== ======== ======== =======
Basic and diluted net income per
share(2)(3)................................ $ 0.52 $ 0.79 $ 0.68 $ 0.23
======== ======== ======== =======
OPERATING DATA:
Loss ratio(3)................................ 17.4% 2.3% (47.0)% 19.1%
Expense ratio................................ 63.0 61.9 64.7 59.6
-------- -------- -------- -------
Combined ratio(3)............................ 80.4% 64.2% 17.7% 78.7%
======== ======== ======== =======
</TABLE>
(footnotes on following page)
9
<PAGE> 11
- - ---------------
(1) Includes net earned premiums, net investment income and net investment
gains.
(2) Pro forma investment income for the years ended December 31, 1996 and 1997
and for the three months ended March 31, 1997 does not include the pro forma
effects of estimated investment income resulting from the investment of
Merger-related cash flows as described in the introduction to this table. If
proceeds from these sources of funds were assumed to be invested in
high-quality, taxable fixed income securities with an average duration of
approximately 3 years, yielding 6.4%, net investment income would increase
approximately $14,200 (approximately $9,200 net of income taxes, or $0.21 in
pro forma earnings per share) and approximately $11,300 (approximately
$7,300 net of income taxes, or $0.17 in pro forma earnings per share) for
the years ended December 31, 1996 and 1997, respectively, and approximately
$3,700 (approximately $2,400 net of income taxes, or $0.05 in pro forma
earnings per share) for the three months ended March 31, 1997.
(3) Includes the effect of recording releases of prior years' loss reserves. The
dollar amount and percentage point effect on the loss ratio of these reserve
reductions were $16,642 or 7.0 percentage points and $40,886 or 16.8
percentage points for the years ended December 31, 1996 and 1997,
respectively, and $36,900 or 65.7 percentage points and $581 or 1.0
percentage point for the three months ended March 31, 1997 and 1998,
respectively. The after tax per share effects of recording these reserve
reductions were $0.25 and $0.61 per share for the years ended December 31,
1996 and 1997, respectively, and $0.55 and $0.01 per share for the three
months ended March 31, 1997 and 1998, respectively.
(4) Capsure incurred approximately $2,200, after applicable income taxes, or
$0.51 per share, in Merger-related costs in 1997 compared to approximately
$5,700, after applicable income taxes, or $0.13 per share in non-recurring
charges and Merger costs in 1996. In the fourth quarter of 1996, Capsure
incurred approximately $1,100, after applicable income taxes, or $0.03 per
share, in non-recurring Merger costs.
10
<PAGE> 12
SUMMARY CONSOLIDATED HISTORICAL FINANCIAL DATA OF CNA SURETY
The following are summary consolidated historical financial data for CNA
Surety at and for the periods subsequent to the Merger. The summary consolidated
historical financial information for CNA Surety should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations..." and the more detailed information or financial statements and
related notes included in this Prospectus. See "Selected Consolidated Financial
Data -- CNA Surety."
<TABLE>
<CAPTION>
SEPTEMBER 30,
(DATE OF INCEPTION)
THROUGH THREE MONTHS ENDED
DECEMBER 31, MARCH 31,
------------------- ------------------
1997 1998
(AMOUNTS IN THOUSANDS, EXCEPT
PERCENTAGES AND PER SHARE DATA)
<S> <C> <C>
INCOME STATEMENT DATA:
Total revenues.............................................. $ 71,284 $ 65,534
======== ========
Gross written premiums...................................... $ 75,252 $ 63,848
======== ========
Net written premiums........................................ $ 73,989 $ 61,836
======== ========
Net earned premiums......................................... $ 65,433 $ 58,745
Net losses and LAE(1)....................................... 12,134 11,218
Net commissions, brokerage and other........................ 38,213 35,039
-------- --------
Underwriting income(1)...................................... 15,086 12,488
Net investment income....................................... 5,766 6,789
Net investment gains........................................ 85 --
Interest expense............................................ 1,831 1,821
Amortization of intangible assets........................... 1,447 1,475
-------- --------
Income before income taxes(1)............................... 17,659 15,981
Income taxes................................................ 6,663 6,166
-------- --------
Net income(1)............................................... $ 10,996 $ 9,815
======== ========
Basic weighted average shares outstanding................... 43,302 43,348
======== ========
Basic and diluted net income per share...................... $ 0.25 $ 0.23
======== ========
OPERATING DATA:
Loss ratio(1)............................................... 18.5% 19.1%
Expense ratio............................................... 58.4 59.6
-------- --------
Combined ratio(1)........................................... 76.9% 78.7%
======== ========
BALANCE SHEET DATA:
Invested assets and cash.................................... $419,667 $427,599
Intangible assets, net of amortization...................... 161,962 160,487
Total assets................................................ 727,180 740,871
Insurance reserves.......................................... 304,217 309,620
Long-term debt.............................................. 118,000 118,000
Total liabilities........................................... 470,448 474,348
Stockholders' equity........................................ 256,732 266,523
Statutory surplus........................................... 142,429 144,849
Book value per share........................................ 5.93 6.14
</TABLE>
- - ---------------
(1) Includes the effect of recording releases of prior years' loss reserves. The
dollar amount and the percentage point effect on the loss ratio of these
reserve revisions was $647 or 1.0 percentage point for the period from
September 30, 1997 (date of inception) through December 31, 1997 and $581 or
1.0 percentage point for the three months ended March 31, 1998.
11
<PAGE> 13
RISK FACTORS
The following risk factors, in conjunction with and in addition to the
other information presented in this Prospectus, should be carefully considered
in evaluating the Company before making an investment in the Common Stock being
offered hereby.
COMPETITION
The surety market is highly competitive. Companies generally compete for
surety business on the basis of price, service, financial strength, ratings and
reputation of the company, as well as capabilities of the independent agents and
brokers who solicit the business. The small contract and commercial bond markets
in which the Company competes have seen additional competition as both large and
small insurance companies are competing and expanding in this area. The Company
does not have a direct sales force but instead relies on a nationwide network of
independent insurance agencies. In order to compete effectively in the market,
the Company will need to continue to maintain productive relationships with the
independent insurance agencies that offer its products. Since surety bonds may
account for only a small portion of an agency's revenues, an important factor
considered by agencies is the range of products and the services offered by a
surety company. Certain existing and potential competitors of the Company may be
larger, and may have greater financial resources and more extensive insurance
product lines than the Company. The businesses of CNA Surety's insurance
subsidiaries could be adversely affected by such competition.
U.S. House of Representatives Resolution No. 10, entitled "The Financial
Services Competition Act of 1998 ("HR 10"), was recently approved by the U.S.
House of Representatives. In the event that HR 10 is enacted into law, banking
and securities firms would be permitted to affiliate with insurance companies.
Such affiliations could expand the number and size of the competitors in the
insurance industry, which could have an adverse effect on CNA Surety's insurance
subsidiaries' ability to compete effectively in the market.
CONTROLLING STOCKHOLDER AND CONFLICTS OF INTEREST
Certain subsidiaries of CNAF own, on a fully diluted basis, an aggregate of
approximately 61.75% of the outstanding shares of Common Stock and have a number
of ongoing relationships with the Company. In light of CNAF's beneficial
ownership of stock, CNAF has the ability to elect the directors of the Board,
subject to CNAF's obligation under the Reorganization Agreement to elect certain
designees of Capsure until the 1999 annual meeting of CNA Surety stockholders.
In that regard, CNAF is able to control the policy decisions of CNA Surety,
including decisions regarding the issuance of securities, payment of dividends,
approval of acquisitions and the sale of its assets. CNAF also has the ability
to approve any action requiring majority stockholder approval, including
adopting amendments to CNA Surety's certificate of incorporation and approving
or disapproving mergers or sales of all or substantially all of the assets of
CNA Surety, subject to certain provisions of CNA Surety's bylaws which require
supermajority votes on certain matters for a period of two years following the
Merger. See "The Company -- Business Overview."
The Company is dependent upon its relationship with CNAF. The Company's
ability to write large contract surety business depends, to a certain extent, on
the Company's continuing relationship with CNAF, including the Company's
ability, through the various reinsurance and other agreements, to use CCC bond
rates and forms. See "Certain Relationships and Related Transactions." In
general, certain brokers and customers also may derive assurance from, and a
certain willingness to do business with the Company as a result of, the
Company's affiliation with CNAF. Further, significant administrative and service
functions necessary for the Company's operations are currently provided by CNAF.
Most of the contractual arrangements between CNAF and the Company were entered
into in connection with the Merger and have terms of not more than five years.
Although certain reinsurance agreements may be renewed, CNA Surety management
has no reason to believe that the reinsurance agreements will be extended at the
end of such periods or that, if extended, such agreements will be extended on
the same terms and conditions. In addition, no assurance can be given that the
other arrangements with CNAF will be renewed on the same terms and conditions
upon their respective dates of termination.
12
<PAGE> 14
CNAF has agreed not to write certain types of surety policies for its own
account for a period of five years from the Merger Date and, to the extent such
surety policies are written, to cede such policies to the Company. See "The
Company -- Business Overview." However, CNAF can continue to write other lines
of insurance, including fidelity and E&O, that the Company currently writes and
CNAF may expand such lines from time to time.
Conflicts of interest between CNA Surety and CNAF could arise with respect
to business dealings between them, including interpretation of existing
agreements between them, new products, potential acquisitions, the election of
new or additional directors, the payment of dividends and the amounts paid for
services provided pursuant to various agreements between the entities. There is
no formal plan or arrangement to resolve potential conflicts of interest that
may arise. CNA Surety intends to seek the approval of the audit committee of the
Board for any issues or future business transactions between the companies and
will refer to that committee any issues that arise with respect to those
transactions. See "Management of the Company" and "Certain Relationships and
Related Transactions."
SUSCEPTIBILITY TO CHANGES IN INTEREST RATES AND GENERAL ECONOMIC CONDITIONS
The Company's business is affected by fluctuations in interest rates and by
general economic conditions in the United States.
Approximately one-half of the Company's business is related to the contract
surety market, comprised of contract bonds typically required in construction
projects. The number of construction projects initiated from time to time is
directly related to general economic conditions at such time, the level of
interest rates, and the funding of public works projects by federal, state and
local governments. In the event of an increase in interest rates and/or an
economic downturn, the Company's business volume and claims experience could be
adversely affected.
The Company's investment portfolio consists primarily of investment grade
debt securities. The market value of those securities will vary depending upon
general economic and market conditions and the interest rate environment. From
time to time, the Company may be required for business or regulatory reasons to
sell certain of its investments at a time when their market value is less than
the cost of such investments.
The Company's portfolio includes collateralized mortgage obligations
("CMOs") and other asset-backed securities, which differ from traditional fixed
income securities in that they may expose the investor to yield variability and
even principal risk due to such factors as high mortgage prepayment rates and
defaults and delinquencies in the underlying asset pool. Management believes it
has reduced prepayment variability by investing only in short tranches and by
owning a substantial amount of planned amortization class ("PAC") tranches,
which have been structured largely to insulate the investor from prepayment
risk. A PAC tranche is structured to amortize in a predictable manner and
thereby shift the risk of prepayment of the underlying collateral to other
tranches. Although management believes it has reduced prepayment risk by
investing in PAC tranches, there can be no assurance that the Company will not
suffer a reduction in future investment income associated with prepayments.
ADVERSE LEGISLATION
A significant portion of the Company's insurance subsidiaries' business is
and will continue to be derived from the writing of small fidelity and
commercial surety bonds mandated by various state statutes and local ordinances
to cover acts of public officials and private businesses, such as realtors,
automobile dealers and others who generally interact with members of the public.
In recent years, several jurisdictions have repealed, or considered action to
repeal, legislation mandating use of various types of these bonds, often
replacing them with alternative protection mechanisms, such as recovery funds
administered by the states for the benefit of citizens who assert claims against
such officials or businesses. In addition, contract surety bonds are required
generally by federal, state and local governments for public works projects. If
numerous governments were to repeal the requirements for obtaining bonds of the
type written by the Company's insurance subsidiaries, the results of operations,
financial condition and cash flows of the Company's insurance subsidiaries would
be materially and adversely affected, and, consequently, CNA Surety's financial
condition could be materially and adversely affected.
13
<PAGE> 15
HOLDING COMPANY STRUCTURE
CNA Surety is a holding company which conducts substantially all of its
operations through its insurance subsidiaries and derives substantially all of
its operating income and operating cash flow from such subsidiaries. CNA Surety
relies on dividends from its insurance subsidiaries as well as returns on its
holding company cash and invested assets to generate the funds necessary to meet
its obligations and pay dividends, if any, on its capital stock. The ability of
the insurance subsidiaries to make such payments is subject to, among other
things, applicable state laws, rating agency requirements, and any restrictions
that may be contained in credit agreements or other financing arrangements
entered into by the insurance subsidiaries. Claims of creditors of the insurance
subsidiaries will generally have priority as to the assets of such subsidiaries
over the claims of CNA Surety and the holders of Common Stock.
The payment of dividends to CNA Surety by the insurance subsidiaries
without prior approval of the insurance subsidiaries' domiciliary state
insurance commissioners is limited to amounts determined by formula in
accordance with the accounting practices prescribed or permitted by the state's
insurance departments. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations . . . -- Liquidity and Capital Resources."
These formulae vary by state. All dividends must be reported to the appropriate
insurance departments prior to payment. No assurance can be given that there
will not be further regulatory actions restricting the ability of the insurance
subsidiaries to pay dividends and, accordingly, that funds held by the insurance
subsidiaries will be available to CNA Surety for payment of debt, expenses or
dividends.
INSURANCE RATINGS
CNA Surety's insurance subsidiaries compete with other insurance companies
on the basis of a number of factors, including the ratings assigned by A.M.
Best. A.M. Best's letter ratings range from A++ (Superior) to C- (Weak) with A++
being highest. A.M. Best ratings are based upon factors relevant to
policyholders, agents, insurance brokers and intermediaries and are not directed
to the protection of investors.
Western Surety and USA are currently rated A+ (Superior) and A (Excellent),
respectively, by A.M. Best. Through intercompany reinsurance and related
agreements, the Company's customers have access to CCC's broader underwriting
capacity. CCC has an A.M. Best rating of A (Excellent). There can be no
assurance that the ratings of Western Surety, USA or CCC will not be changed in
subsequent periodic reviews by A.M. Best. If such ratings were to be downgraded
below A-, such ratings downgrade could have a material adverse effect on the
results of operations of the Company and its ability to effectively compete in
the marketplace.
INTEGRATION OF THE COMPANIES
Capsure, CCC and CNA Surety entered into the Reorganization Agreement with
the expectation that the Merger would result in certain benefits. In order to
achieve such benefits, CNA Surety needs to continue to integrate the Predecessor
Operations with the businesses and operating systems of Western Surety and USA.
There can be no assurance that such integration process will continue to occur
in the desired manner. The transition to a fully combined company will continue
to require substantial attention from management, which could divert
management's attention and adversely effect the operating results of the
Company. In addition, the process of combining the organizations could cause the
interruption of, or disruption in, the activities of any or all of the
businesses, which could have a material adverse effect on the Company's combined
operations. There can be no assurance that the Company will realize all or any
of the anticipated benefits of the Merger.
REGULATION
CNA Surety's insurance subsidiaries are subject to varying degrees of
supervision and regulation in the jurisdictions in which they conduct business
under statutes which delegate regulatory, supervisory and administrative powers
to state insurance regulators. The nature of the regulation varies from
jurisdiction to jurisdiction but typically involves prior approval of the
acquisition of control of an insurance company or of any
14
<PAGE> 16
company controlling an insurance company, regulation of certain transactions
entered into by an insurance company with any of its affiliates, limitations on
dividends, approval or filing of premium rates and policy forms, solvency
standards, minimum amounts of capital and surplus that must be maintained,
limitations on amounts or types of investments, limitations on the size of risks
which may be insured by a single company, licensing of insurers and agents,
deposits of securities for the benefit of policy or surety bond holders,
reporting of financial condition and other matters. In addition, state insurance
regulators perform periodic financial and market conduct examinations of
insurance companies. All such regulation is intended generally to protect the
policy or surety bond holders, rather than equity holders. No assurance can be
given that future legislative or regulatory changes will not adversely affect
CNA Surety and its insurance subsidiaries.
Certain states in which CNA Surety's insurance subsidiaries conduct
business require insurers to participate in a guaranty association to provide
protection to policyholders against the insolvency of insurers licensed in such
states. In order to provide the association with funds to pay certain claims
under policies issued by insolvent insurers, the guaranty associations charge
members assessments based on the amount of direct premiums written in that
state. Such assessments have historically not been material to the combined
results of operations, but no assurance can be given that such assessments will
not be material in the future to the results of operations of CNA Surety's
insurance subsidiaries.
Although the federal government does not generally regulate the operations
of insurance companies, from time to time, the federal government considers
various bills which could expand its powers in the insurance industry. CNA
Surety cannot predict, however, whether such legislation will be enacted, what
the terms and conditions will be if enacted, or what effect, if any, such
legislation might have on CNA Surety and its insurance subsidiaries. If
regulation of CNA's businesses increases in the future at the federal and state
level, CNA Surety believes that the costs associated with compliance would also
increase.
The Company is currently bound by U.S. Department of Treasury regulations
which set underwriting limitations on sureties for federal and other public
works project bonds. The underwriting limitations of Western Surety and USA,
which are based on the amount of each insurer's statutory surplus, are currently
$3.4 million and $1.2 million per bond, respectively, which limits their ability
to underwrite certain large federal and other public works project bonds.
Through intercompany reinsurance and related agreements with CCC, CNA Surety has
access to CCC's $345.3 million per bond U.S. Treasury underwriting limitation,
enabling the Company to write larger bonds. However, there can be no assurance
that once the term of such reinsurance and related agreements expires, that such
reinsurance agreements will be extended, allowing CNA Surety to continue to have
access to the larger CCC U.S. Treasury underwriting limitation.
ADEQUACY OF RESERVES
CNA Surety's insurance subsidiaries' reserves for loss and loss adjustment
expenses ("LAE") may prove to be deficient in the future due to the inherent
uncertainties involved in the process of establishing reserves which relies on
estimates which may differ from actual future loss payments. The reserve
adjustments required to cure such deficiencies would be charged against future
operations and could have an adverse effect on CNA Surety's results of
operations and financial condition.
The Predecessor Operations transferred to CNA Surety by CNAF in the Merger
are subject to certain reinsurance agreements which provide certain guarantees
and protections against losses on such business. See "Certain Relationships and
Related Transactions." However, the Quota Share Treaty only guarantees and
protects the Company from losses incurred on the Predecessor Operations and does
not cover any business written by Capsure prior to the Merger Date or any surety
business written after the Merger Date. See "Business of the Company -- Reserves
for Unpaid Losses and LAE."
YEAR 2000 COMPLIANCE
As the year 2000 approaches, a critical business issue has emerged for
virtually all companies regarding how existing application software programs and
operating systems can accommodate this date field. In brief, many existing
application software products in the marketplace were designed to only
accommodate a two digit date position which represents the year (e.g., 95 is
stored on the system and represents the year 1995). As
15
<PAGE> 17
a result, the year 1999 (i.e., 99) could be the maximum date value these systems
will be able to accurately process. CNA Surety management is in the process of
replacing or upgrading its systems to accommodate business into and beyond the
year 2000. Based on information currently available, CNA Surety management
anticipates that by the end of 1998 it will have substantially completed its
program of replacement and upgrade. The Company anticipates that the cost of its
program of replacement and upgrade will be approximately $1 million in excess of
the cost of ordinary software upgrades and replacements. To the extent the
Company's systems are not fully year 2000 compliant or the Company's computer
systems must interact with the computer systems of other entities' computers
which are not year 2000 compliant, there can be no assurance that potential
systems interruptions or the resulting costs necessary to remediate systems and
to compensate for any losses would not have a material adverse effect on the
Company's business, financial condition, results of operations, cash flows and
business prospects.
Although the Company has not received any claims based on losses resulting
from the year 2000 issues, there can be no assurance that bond obligees or
insureds will not suffer losses of this type and seek compensation under the
Company's bonds or policies. If any claims are made, the Company's obligations,
if any, will depend on the facts and circumstances of the claim and provisions
of the bond or policy. At this time, the Company is unable to determine whether
the adverse impact, if any, in connection with the foregoing circumstances would
be material to the Company.
INSOLVENCY
In the event of insolvency, liquidation or other reorganization of CNA
Surety's insurance subsidiaries, the creditors and stockholders of CNA Surety
would have no right to proceed against CNA Surety's insurance subsidiaries or to
cause the liquidation or bankruptcy of such insurance subsidiaries under federal
or state bankruptcy laws. The insurance laws of the domiciliary state would
govern such proceedings and the relevant insurance commissioner would act as
liquidator or rehabilitator for the insurance subsidiary. Creditors and
policyholders of any such insurance subsidiary would be entitled to payment in
full from the assets of the insurance subsidiary before CNA Surety, as a
stockholder, would be entitled to receive any distribution therefrom.
In addition, insurance regulators have the authority in certain
circumstances to block payments by CNA Surety's insurance subsidiaries of
dividends and other amounts that would otherwise be permitted without prior
regulatory approval. See "Dividend Policy" and "Business of the
Company -- Regulation."
LIMITATIONS ON CHANGE IN CONTROL
CNA Surety's certificate of incorporation and bylaws contain a number of
provisions relating to corporate governance and the rights of stockholders.
Certain of these provisions may be deemed to have a potential "anti-takeover"
effect in that such provisions may delay, defer or prevent a change of control
of CNA Surety. These provisions include (i) the authority of the Board to issue
series of its preferred stock, $0.01 par value per share (the "Preferred
Stock"), with such voting rights and other powers as the Board may determine and
(ii) notice requirements in the bylaws relating to nominations to the Board and
to the raising of business matters at stockholders' meetings. For nominations or
other business to be properly brought before an annual meeting of stockholders
by a stockholder, CNA Surety's bylaws require such stockholder to deliver a
notice to the secretary, absent specified circumstances, not less than 50 days
nor more than 75 days prior to such meeting. This could have the effect of
discouraging a prospective acquirer from making a tender offer or otherwise
attempting to obtain control of CNA Surety.
In addition, certain provisions of Delaware law could have the effect of
delaying, deferring or preventing a change in control of CNA Surety, which could
adversely affect the market price of the Common Stock. CNA Surety is subject to
the anti-takeover provisions of Section 203 of the Delaware General Corporation
Law which prohibit CNA Surety from engaging in a "business combination" with an
"interested stockholder" for a period of three years after the date of the
transaction in which the person became an interested stockholder, unless the
combination is approved in the statutorily prescribed manner.
16
<PAGE> 18
Under applicable state insurance laws and regulations, no person may
acquire control of CNA Surety unless such person has filed a statement
containing specified information with appropriate regulatory authorities and has
obtained approval for such an acquisition. Under applicable laws and
regulations, any person acquiring, directly or indirectly, or holding proxies
with respect to, 10% or more of the voting stock of any other person is presumed
to have acquired "control of such person." Accordingly, any purchase resulting
in the purchaser owning 10% or more of the outstanding Common Stock, in the
Offering or otherwise, would require prior approval by applicable regulatory
authorities. Such prior approval requirement would also apply to an acquisition
of proxies to vote 10% or more of the outstanding Common Stock and, therefore,
could delay or prevent a stockholder from acquiring such proxies in a proxy
contest. No assurance can be given as to whether CNA Surety would seek to invoke
these laws and regulations in the event of a contested solicitation of proxies.
In addition, the Reorganization Agreement has certain covenants which could
have the effect of inhibiting a change of control, including certain
supermajority voting rights for a period of two years following the Merger. The
Reorganization Agreement contains an agreement whereby CCC and CNA Surety agreed
to cause the bylaws of CNA Surety to require approval by 75% of the holders of
Common Stock for CNA Surety in order to (i) enter into certain business
combinations, (ii) accept proposals to sell all or substantially all of the
Company's assets, (iii) amend the bylaw provisions requiring such supermajority
voting or (iv) amend the certificate of incorporation.
SHARES ELIGIBLE FOR FUTURE SALE
Sales of a substantial number of shares of the Common Stock in the public
market following this Offering, or the perception that such sales could occur,
could adversely affect the market price for the Common Stock. Based on the
number of shares of Common Stock outstanding on May 27, 1998, upon completion of
this Offering, CNA Surety will have 43,446,119 shares of Common Stock
outstanding, of which 16,177,426 shares will be freely tradeable without
restriction or future registration under the Securities Act (except those shares
acquired by affiliates of the Company). The remaining shares will be "restricted
securities" within the meaning of Rule 144 under the Securities Act. As of May
27, 1998, 749,116 shares of Common Stock were issuable upon the exercise of
outstanding stock options (111,516 of which are exercisable), which shares have
been registered by CNA Surety under the Securities Act and, subject to the
reoffer limitations for executive officers and directors of CNA Surety, are
freely tradeable without restriction upon issuance. The Company and certain of
its current stockholders, holding an aggregate of 27,268,693 shares of Common
Stock upon completion of this Offering, have agreed not to offer, sell, contract
to sell or otherwise dispose of, directly or indirectly, any Common Stock, or
any securities convertible into or exchangeable or exercisable for Common Stock,
until 180 days after the date of this Prospectus, without the prior consent of
Donaldson, Lufkin & Jenrette Securities Corporation, on behalf of the
Underwriters. Following the 180-day period, 27,268,693 of the restricted
securities will become immediately eligible for sale, subject to the manner of
sale, volume, notice and information requirements of Rule 144. In addition,
another current stockholder, holding an aggregate of 131,363 shares of Common
Stock upon completion of this Offering, has agreed not to offer, sell, contract
to sell or otherwise dispose of, directly or indirectly, his stock, until 30
days after the date of this Prospectus, without the prior consent of Donaldson,
Lufkin & Jenrette Securities Corporation, on behalf of the Underwriters.
In addition, while management is not aware of any current intention on the
part of CNAF to reduce its ownership of Common Stock, there is no restriction,
other than the foregoing 180-day agreement, on CNAF's ability to sell a portion
or all of the Common Stock owned by it at some future date (subject to certain
limitations under tax and securities laws). Any such sale may have an adverse
effect on the market price of the Common Stock. In addition, sales of shares of
Common Stock by CNA Surety or CNAF which result in a change of control may
affect the relationship between CNA Surety and CNAF. For instance, the trademark
license agreement between CNAF and CNA Surety allowing CNA Surety to use the
"CNA" name or some derivation thereof, is subject to termination by CNAF if a
change of control in CNA Surety occurs. Purchases of additional shares of Common
Stock by CNA Surety or CNAF could also have an impact on the market price of the
Common Stock; although CNA Surety and CNAF are subject to certain restrictions
on such purchases for a period of 18 months following the Merger Date. See
"Business of the Company."
17
<PAGE> 19
THE COMPANY
CNA Surety is an insurance holding company that, through its subsidiaries,
develops, markets and underwrites primarily surety bonds. The Company is the
largest publicly-traded insurance holding company focused exclusively on the
surety business and is one of the leading providers of surety products in the
United States. During 1997, the insurance companies now owned by the Company
wrote over $266 million of gross written premiums, $244 million of which
consisted of surety premiums. For the three months ended March 31, 1998, the
Company wrote over $63 million of gross written premiums, $57 million of which
consisted of surety premiums.
The Company was formed to facilitate the merger of the surety business of
CNAF with Capsure's insurance subsidiaries, Western Surety and USA. Management
believes that the Merger, which occurred on September 30, 1997, resulted in the
combination of three complementary surety businesses, each with distinct
strengths, product focuses and marketing strategies. The combination of these
businesses resulted in a single, larger entity focused on serving the needs of
virtually all segments of the surety market, in terms of the types of products
offered and the size of bonds available. Based on management's knowledge of the
industry, management believes that the Company now offers the broadest range of
surety products available in the marketplace and that the Company's branch
system and independent agency network are the most extensive in the surety
industry, the combination of which provides the Company with a competitive
marketing advantage.
Surety products, unlike the standard two-party insurance policy, are
three-party agreements in which the Company as the issuer of the bond (the
surety) joins with a second party (the principal) in guaranteeing to a third
party (the owner/obligee) the fulfillment of some obligation on the part of the
principal. Sureties are generally entitled to recover from the principal any
losses and expenses paid to third parties.
The Company, through its principal insurance subsidiaries, Western Surety
and USA, underwrites a broad spectrum of surety bonds. Western Surety writes
small fidelity and non-contract bonds and E&O liability insurance. Management
believes that Western Surety is the largest writer of smaller commercial surety
bonds and attributes Western Surety's volume to its strong capabilities in
marketing, distribution and service. In addition, Western Surety underwrites
contract surety bonds, primarily for mid to large sized contract accounts, and
assumes, on a reinsurance basis, international surety and credit insurance
written by CNA Re (London). USA specializes in the underwriting of small
contract and commercial surety bonds. Western Surety and USA are currently rated
A+ (Superior) and A (Excellent), respectively, by A.M. Best. A.M. Best ratings
are based upon factors relevant to policyholders, agents, insurance brokers and
intermediaries and are not directed to the protection of investors.
The Company principally markets its products in all 50 states, as well as
the District of Columbia and Puerto Rico. Its products are marketed primarily
through independent producers, including multi-line agents and brokers, many of
whom belong to the National Association of Surety Bond Producers. The Company
enjoys broad national distribution of its products through approximately 36,000
of the approximately 44,000 independent property and casualty insurance agencies
in the United States.
The Company's primary focus is on evaluating the risk and determining if
the principal meets its underwriting requirements for the bond. Accordingly, the
Company's surety bond premiums primarily reflect the type and class of risk and
related costs associated with both processing the bond transaction and
investigating the applicant including, if necessary, an analysis of the
applicant's creditworthiness and ability to perform.
The Company is led by an experienced management team with an average of
over twenty years of experience, whose core expertise is in surety underwriting
and claims management. Management's underwriting philosophy is disciplined and
focused on consistent underwriting profitability. The extent and sophistication
of underwriting activity, including the amount of bonding authority granted to
independent agents, varies depending on the class of business and the type of
bond. For example, contractor accounts and large commercial surety customers
undergo extensive credit, financial and managerial review and analysis on a
regular basis. Similarly, certain classifications of bonds, such as fiduciary
and court appeal bonds, also receive
18
<PAGE> 20
extensive underwriting. On the other hand, the Company requires comparatively
little underwriting information for certain low-exposure risks, such as notary
bonds. The Company's underwriting has resulted in combined ratios of 79.7%,
81.0% and 87.4%, excluding the effects of favorable loss reserve development,
for the three months ended March 31, 1998 and on a pro forma basis for the years
ended December 31, 1997 and 1996, respectively. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations . . ."
CNA Surety is a Delaware corporation which was formed for the purpose of
the Merger. Prior to the Merger, CNA Surety did not conduct any activities. Its
insurance subsidiaries are Western Surety, a South Dakota insurance corporation,
USA, a Texas insurance corporation, and Surety Bonding Company of America, a
South Dakota insurance corporation. The mailing address for CNA Surety's
principal executive offices is CNA Plaza, Chicago, Illinois, 60685; its
telephone number is (312) 822-5000.
USE OF PROCEEDS
The Common Stock being offered hereunder is being sold by the Selling
Stockholders. The Company will not receive any of the proceeds from the sales of
Common Stock by the Selling Stockholders, and will only receive proceeds from
the sale of Common Stock hereunder if and to the extent that the Over-Allotment
Option is exercised. In the event that the Underwriters elect to exercise their
Over-Allotment Option, the Company will sell to the Underwriters up to 658,219
shares of its Common Stock. The net proceeds to the Company from the Offering,
assuming exercise of the entire Over-Allotment Option, will be approximately
$ . The Company intends to use such proceeds for general corporate
purposes. See "Principal and Selling Stockholders" and "Underwriting."
DIVIDEND POLICY
Since its formation, CNA Surety has not paid any dividends to its
stockholders. The Board, however, recently adopted a new dividend policy and
intends to pay quarterly dividends, beginning with the fourth quarter of 1998.
The declaration and payment of dividends to holders of Common Stock, including
the amount and frequency of such dividends, is at the discretion of the Board
and depends upon many factors, including CNA Surety's financial condition,
operating characteristics, projected earnings and growth, capital requirements
of its insurance subsidiaries, debt service obligations and such other factors
as the Board deems relevant. The Company expects that the first quarterly
dividend, if declared and paid, will be approximately $0.08 per share.
As an insurance holding company, CNA Surety is dependent upon dividends and
other permitted payments from its insurance subsidiaries in order to pay cash
dividends, if any, as well as to pay operating expenses and meet debt service
requirements. The payment of dividends by the insurance subsidiaries are subject
to varying degrees of supervision by the insurance regulatory authorities in
South Dakota and Texas. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations . . . -- Liquidity and Capital Resources"
and "Risk Factors -- Holding Company Structure" and "-- Regulation."
19
<PAGE> 21
PRICE RANGE OF COMMON STOCK
CNA Surety's Common Stock is traded on the NYSE under the symbol "SUR." The
following table shows the range of high and low sales prices for shares of the
Common Stock as reported on the NYSE during the periods indicated. Prior to
September 30, 1997, shares of Common Stock were not publicly traded. The
reported last sales price of the Common Stock on the NYSE on June 16, 1998 was
$13 7/8.
<TABLE>
<CAPTION>
PRICE RANGE
OF COMMON STOCK
----------------
HIGH LOW
------ ------
<S> <C> <C>
1997
4th Quarter................................................. $16 1/2 $12 7/8
1998
1st Quarter................................................. $16 3/8 $14 1/3
2nd Quarter through June 16, 1998........................... $16 3/4 $13 7/8
</TABLE>
The number of stockholders of record of Common Stock on June 1, 1998 was
approximately 2,000.
20
<PAGE> 22
SELECTED CONSOLIDATED FINANCIAL DATA
Following are selected financial data for the operations which merged to
form CNA Surety, including information with respect to CNA Surety, the
Predecessor Operations and Capsure. This information is provided to assist in
understanding and evaluating the historical financial information of the various
entities that comprise CNA Surety and is not necessarily indicative of the
future results of operations of CNA Surety. In addition, selected financial
information for CNA Surety, as if the Merger had been consummated on January 1,
1996 (pro forma financial data), has been provided to further assist in
understanding and evaluating the consolidated financial information of the
various entities that comprise CNA Surety.
SELECTED CONSOLIDATED PRO FORMA AND HISTORICAL FINANCIAL DATA OF CNA SURETY
The following financial information is provided for the operations that
combined to form CNA Surety for various time periods in 1997 and 1996 as if the
Merger had been consummated on January 1, 1996. Periods presented on this basis
are therefore marked "pro forma." This pro forma financial information gives
effect to the following: (i) adjustment to the Capsure statement of operations,
as reported, to reflect the income effects as if the $10 per share special cash
distribution paid on October 4, 1996 had been made on January 1, 1996; (ii)
consummation of the Merger and the related transactions and the contribution of
capital to, and the incurrence of additional debt by, CNA Surety; (iii) purchase
accounting adjustments to reflect Capsure's assets and liabilities at fair
value; (iv) estimated indirect and overhead expenses for the Predecessor
Operations; and (v) estimated interest expense related to the additional debt.
The pro forma financial information does not include the estimated net
investment income resulting from investment of Merger-related cash flows,
including (i) the $50 million debt proceeds, (ii) the $52.25 million capital
contribution from CCC; and (iii) collection of the receivable in the amount of
approximately $117 million from CCC. Information for the three months ended
March 31, 1998 is derived from the actual quarterly financial statements of CNA
Surety. This information is provided to assist in understanding and evaluating
the consolidated financial information of the various entities that comprise CNA
Surety and is not necessarily indicative of future results of operations of CNA
Surety. The selected consolidated pro forma and historical financial data set
forth below should be read in conjunction with the more detailed financial
information or financial statements and related notes included in this
Prospectus. See "Pro Forma Condensed Statement of Consolidated Operations."
21
<PAGE> 23
SELECTED CONSOLIDATED PRO FORMA AND HISTORICAL FINANCIAL DATA OF CNA SURETY
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
------------------------- --------------------------
1996 1997 1997 1998
(PRO FORMA) (PRO FORMA) (PRO FORMA) (HISTORICAL)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Total revenues(1)(2)......................... $250,194 $258,682 $ 59,338 $65,534
======== ======== ======== =======
Gross written premiums....................... $251,414 $266,418 $ 59,779 $63,848
======== ======== ======== =======
Net written premiums......................... $235,186 $257,067 $ 56,128 $61,836
======== ======== ======== =======
Net earned premiums.......................... $238,330 $243,425 $ 56,125 $58,745
Net losses and LAE(3)........................ 41,450 5,648 (26,384) 11,218
Net commissions, brokerage and other......... 150,198 150,631 36,328 35,039
-------- -------- -------- -------
Underwriting income(3)....................... 46,682 87,146 46,181 12,488
Net investment income(2)..................... 10,796 14,534 3,126 6,789
Net investment gains......................... 1,068 723 87 --
Interest expense............................. 7,660 7,232 1,765 1,821
Non-recurring charges and Merger costs(4).... 8,565 12,087 -- --
Amortization of intangible assets............ 5,788 5,788 1,447 1,475
-------- -------- -------- -------
Income before income taxes(2)(3)............. 36,533 77,296 46,182 15,981
Income taxes................................. 14,101 42,921 16,771 6,166
-------- -------- -------- -------
Net income(2)(3)............................. $ 22,432 $ 34,375 $ 29,411 $ 9,815
======== ======== ======== =======
Basic and diluted net income per
share(2)(3)................................ $ 0.52 $ 0.79 $ 0.68 $ 0.23
======== ======== ======== =======
OPERATING DATA:
Loss ratio(3)................................ 17.4% 2.3% (47.0)% 19.1%
Expense ratio................................ 63.0 61.9 64.7 59.6
-------- -------- -------- -------
Combined ratio(3)............................ 80.4% 64.2% 17.7% 78.7%
======== ======== ======== =======
</TABLE>
- - ---------------
(1) Includes net earned premiums, net investment income and net investment
gains.
(2) Pro forma investment income for the years ended December 31, 1996 and 1997
and for the three months ended March 31, 1997 does not include the pro forma
effects of estimated investment income resulting from the investment of
Merger-related cash flows as described in the introduction to this table. If
proceeds from these sources of funds were assumed to be invested in
high-quality, taxable fixed income securities with an average duration of
approximately 3 years, yielding 6.4%, net investment income would increase
approximately $14,200 (approximately $9,200 net of income taxes, or $0.21 in
pro forma earnings per share) and approximately $11,300 (approximately
$7,300 net of income taxes, or $0.17 in pro forma earnings per share) for
the years ended December 31, 1996 and 1997, respectively, and approximately
$3,700 (approximately $2,400 net of income taxes, or $0.05 in pro forma
earnings per share) for the three months ended March 31, 1997.
(3) Includes the effect of recording releases of prior years' loss reserves. The
dollar amount and percentage point effect on the loss ratio of these reserve
reductions were $16,642 or 7.0 percentage points and $40,886 or 16.8
percentage points for the years ended December 31, 1996 and 1997,
respectively, and $36,900 or 65.7 percentage points and $581 or 1.0
percentage point for the three months ended March 31, 1997 and 1998,
respectively. The after tax per share effects of recording these reserve
reductions were $0.25 and $0.61 per share for the years ended December 31,
1996 and 1997, respectively, and $0.55 and $0.01 per share for the three
months ended March 31, 1997 and 1998, respectively.
(4) Capsure incurred approximately $2,200, after applicable income taxes, or
$0.51 per share, in Merger-related costs in 1997 compared to approximately
$5,700, after applicable income taxes, or $0.13 per share in non-recurring
charges and Merger costs in 1996. In the fourth quarter of 1996, Capsure
incurred approximately $1,100, after applicable income taxes, or $0.03 per
share, in non-recurring Merger costs.
22
<PAGE> 24
SELECTED CONSOLIDATED HISTORICAL FINANCIAL DATA OF CNA SURETY
The following selected consolidated historical financial information for
CNA Surety at and for periods subsequent to the Merger should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations . . ." and the more detailed information or financial
statements of CNA Surety included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
SEPTEMBER 30,
(DATE OF INCEPTION)
THROUGH THREE MONTHS ENDED
DECEMBER 31, MARCH 31,
------------------- ------------------
1997 1998
(AMOUNTS IN THOUSANDS, EXCEPT
PERCENTAGES AND PER SHARE DATA)
<S> <C> <C>
INCOME STATEMENT DATA:
Total revenues.............................................. $ 71,284 $ 65,534
======== ========
Gross written premiums...................................... $ 75,252 $ 63,848
======== ========
Net written premiums........................................ $ 73,989 $ 61,836
======== ========
Net earned premiums......................................... $ 65,433 $ 58,745
Net losses and LAE(1)....................................... 12,134 11,218
Net commissions, brokerage and other........................ 38,213 35,039
-------- --------
Underwriting income(1)...................................... 15,086 12,488
Net investment income....................................... 5,766 6,789
Net investment gains........................................ 85 --
Interest expense............................................ 1,831 1,821
Amortization of intangible assets........................... 1,447 1,475
-------- --------
Income before income taxes(1)............................... 17,659 15,981
Income taxes................................................ 6,663 6,166
-------- --------
Net income(1)............................................... $ 10,996 $ 9,815
======== ========
Basic weighted average shares outstanding................... 43,302 43,348
======== ========
Basic and diluted net income per share...................... $ 0.25 $ 0.23
======== ========
OPERATING DATA:
Loss ratio(1)............................................... 18.5% 19.1%
Expense ratio............................................... 58.4 59.6
-------- --------
Combined ratio(1)........................................... 76.9% 78.7%
======== ========
BALANCE SHEET DATA:
Invested assets and cash.................................... $419,667 $427,599
Intangible assets, net of amortization...................... 161,962 160,487
Total assets................................................ 727,180 740,871
Insurance reserves.......................................... 304,217 309,620
Long-term debt.............................................. 118,000 118,000
Total liabilities........................................... 470,448 474,348
Stockholders' equity........................................ 256,732 266,523
Statutory surplus........................................... 142,429 144,849
Book value per share........................................ 5.93 6.14
</TABLE>
- - ---------------
(1) Includes the effect of recording releases of prior years' loss reserves. The
dollar amount and the percentage point effect on the loss ratio of these
reserve revisions was $647 or 1.0 percentage point for the period from
September 30, 1997 (date of inception) through December 31, 1997 and $581 or
1.0 percentage point for the three months ended March 31, 1998.
23
<PAGE> 25
SELECTED CONSOLIDATED FINANCIAL DATA OF PREDECESSOR OPERATIONS
The following selected consolidated financial information for the
Predecessor Operations is derived from and should be read in conjunction with
the more detailed information or interim and annual financial statements of the
Predecessor Operations included elsewhere in this Prospectus. The selected
financial information of the Predecessor Operations does not include data with
respect to assets, liabilities (other than insurance reserves) and equity
because CNAF did not customarily allocate the investment portfolio or equity of
its operating subsidiaries to business units like the Predecessor Operations.
<TABLE>
<CAPTION>
THREE
MONTHS NINE MONTHS
ENDED ENDED
YEARS ENDED DECEMBER 31, MARCH 31, SEPTEMBER 30,
----------------------------------------- --------- -------------
1993 1994 1995(1) 1996 1997 1997
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Total revenues............................. $ 72,632 $ 77,981 $130,603 $149,069 $ 33,829 $108,564
======== ======== ======== ======== ======== ========
Gross written premiums..................... $ 88,040 $ 94,182 $136,605 $155,208 $ 33,042 $116,075
======== ======== ======== ======== ======== ========
Net written premiums....................... $ 73,005 $ 82,064 $122,012 $143,904 $ 30,480 $108,630
======== ======== ======== ======== ======== ========
Net earned premiums........................ $ 72,632 $ 77,981 $130,603 $149,069 $ 33,829 $108,564
Net losses and LAE(2)...................... 12,508 8,580 32,440 33,006 (27,612) (11,516)
Amortization of deferred policy acquisition
costs.................................... 27,928 34,202 58,243 66,382 14,753 48,075
Other direct expenses(3)................... 6,029 6,716 11,840 13,268 3,996 10,173
Policyholders' dividends................... 1,005 1,009 1,508 1,965 814 1,426
-------- -------- -------- -------- -------- --------
Excess of net earned premiums over direct
operating expenses before income
taxes(2)(3).............................. $ 25,162 $ 27,474 $ 26,572 $ 34,448 $ 41,878 $ 60,406
======== ======== ======== ======== ======== ========
OPERATING DATA:
Loss ratio(2).............................. 17.2% 11.0% 24.8% 22.1% (81.6)% (10.6)%
Expense ratio(3)........................... 48.2 53.8 54.8 54.8 57.8 55.0
-------- -------- -------- -------- -------- --------
Combined ratio(2)(3)....................... 65.4% 64.8% 79.6% 76.9% (23.8)% 44.4%
======== ======== ======== ======== ======== ========
BALANCE SHEET DATA:
Insurance reserves(4)...................... $112,764 $111,695 $239,716 $214,828 $177,586 $183,491
</TABLE>
- - ---------------
(1) CNAF acquired CIC in May 1995. Results include the surety operations of CIC
since its acquisition in May 1995 which affects the comparability of
financial information.
(2) Includes the effect of recording releases of prior year loss reserves. The
dollar amount and the percentage point effect on the loss ratio of these
reserve reductions, were $8,454 or 10.8 percentage points, $10,846 or 8.3
percentage points and $9,742 or 6.5 percentage points for the years ended
December 31, 1994, 1995 and 1996, respectively, $35,000 or 103.5 percentage
points for the three months ended March 31, 1997 and $35,000 or 32.2
percentage points for the nine months ended September 30, 1997.
(3) Does not include the effects of certain general and administrative expenses,
which are indirect or overhead in nature, since such costs were not
historically allocated to the Predecessor Operations by CNAF or its
subsidiaries. Accordingly, the comparability of this data or other data that
include such costs is affected.
(4) The insurance reserves include both loss and LAE and unearned premium
reserves. These reserves are shown before the effects of ceded reinsurance.
In accordance with the Reorganization Agreement and related reinsurance
agreements, these reserves, as of the Merger Date, were transferred to
Western Surety, net of reinsurance which totaled $28,362, $21,098, $31,060
and $21,779 at December 31, 1993, 1994, 1995 and 1996, respectively, $20,848
for the three months ended March 31, 1998 and $9,979 for the nine months
ended September 30, 1997.
24
<PAGE> 26
SELECTED CONSOLIDATED FINANCIAL DATA OF CAPSURE
The following financial information should be read in conjunction with
Capsure's consolidated financial statements and the notes thereto, for each of
the three years in the period ended December 31, 1996, included elsewhere in
this Prospectus.
<TABLE>
<CAPTION>
THREE
MONTHS
ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
---------------------------------------------- ---------
1993 1994(1)(2) 1995 1996(3) 1997
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Total revenues........................................ $107,915 $112,555 $117,510 $110,650 $ 25,509
======== ======== ======== ======== ========
Gross written premiums................................ $100,775 $102,356 $111,398 $107,269 $ 26,737
======== ======== ======== ======== ========
Net written premiums.................................. $ 88,306 $ 90,578 $ 97,728 $ 95,109 $ 25,648
======== ======== ======== ======== ========
Net earned premiums................................... $ 86,029 $ 92,481 $ 98,692 $ 92,491 $ 22,296
Underwriting income................................... $ 15,224 $ 15,233 $ 44,831 $ 19,233 $ 5,691
Net investment income................................. 19,815 19,129 20,471 16,444 3,126
Net investment gains (losses)......................... 2,071 945 (1,653) 1,715 87
Interest expense...................................... 6,280 4,726 4,103 1,717 1,003
Write-off of unamortized deferred loan fees(4)........ -- 1,556 -- 700 --
Non-recurring compensation and Merger costs(5)........ -- -- -- 7,865 --
Amortization and impairment of goodwill and
intangibles(6)...................................... 3,407 3,365 16,853 2,761 698
Other expenses, net................................... 1,905 1,881 2,442 2,789 668
-------- -------- -------- -------- --------
Income before income taxes............................ 25,518 23,779 40,251 21,560 6,535
Income taxes.......................................... 9,234 9,401 19,721 8,181 2,722
-------- -------- -------- -------- --------
Net income (loss)..................................... $ 16,284 $ 14,378 $ 20,530 $ 13,379 $ 3,813
======== ======== ======== ======== ========
OPERATING DATA:
Loss ratio(7)......................................... 23.2% 25.2% (7.5)% 10.9% 5.5%
Expense ratio......................................... 59.1 58.3 62.1 68.3 69.0
-------- -------- -------- -------- --------
Combined ratio(7)..................................... 82.3% 83.5% 54.6% 79.2% 74.5%
======== ======== ======== ======== ========
BALANCE SHEET DATA:
Invested assets and cash(2)........................... $317,077 $305,898 $307,556 $165,268 $166,381
Intangible assets, net of amortization................ 85,566 102,130 84,158 75,956 75,253
Total assets.......................................... 530,075 553,370 514,768 313,139 315,489
Insurance reserves.................................... 205,188 225,671 202,842 108,444 111,327
Long-term debt........................................ 85,214 71,000 25,000 60,000 59,000
Total liabilities..................................... 322,450 328,505 257,464 190,556 190,358
Stockholders' equity(2)(3)............................ 207,625 224,865 257,304 122,583 125,131
</TABLE>
- - ---------------
(1) Capsure acquired USA in September 1994. The inclusion of the results of USA
since the date of its acquisition affects the comparability of financial
information.
(2) Effective January 1, 1994, Capsure adopted Statement of Financial Accounting
Standards ("FAS") No. 115.
(3) Capsure disposed of United Capitol Holding Company and its subsidiaries
(collectively, "United Capitol") on May 22, 1996. The inclusion of the
results of United Capitol through May 22, 1996 and the payment of a $10.00
per share ($156,248) special cash distribution on October 4, 1996 effects
the comparability of financial information.
(4) Capsure incurred a $700 charge in 1996 related to the refinancing of its
revolving credit facility and a similar charge of $1,556 in 1994 for the
early retirement of bank term loans.
(5) Capsure incurred a non-recurring compensation charge of $6,341 in 1996 for
the repricing of all outstanding common stock options in connection with a
$10.00 per share special cash distribution paid on October 4, 1996 and an
additional $1,524 in non-recurring Merger-related expenses.
(6) Amortization and impairment of goodwill and intangibles for 1995 included a
write-down of approximately $13,200 of goodwill associated with the 1990
United Capitol acquisition to reflect the estimated net realizable value on
the sale of those operations.
(7) Capsure's incurred losses and LAE in 1995 were reduced by approximately
$29,100, net of reinsurance, as a result of favorable claim settlements and
certain changes in estimates relating to insured events of prior years, of
which approximately $23,200, net of reinsurance, related to United Capitol.
25
<PAGE> 27
PRO FORMA CONDENSED STATEMENT OF CONSOLIDATED OPERATIONS
BASIS OF PREPARATION
The following Pro Forma Condensed Statement of Consolidated Operations for
the year ended December 31, 1997 reflects the effects of the Merger and various
transactions related to the Merger as if the Merger had been consummated on
January 1, 1996. This pro forma financial statement gives effect to the
following, all of which are set forth in greater detail in the explanatory notes
to the pro forma financial statements: (i) adjustment to the Capsure statement
of operations, as reported, to reflect the income effects as if a $10 per share
($156.2 million) special cash distribution paid on October 4, 1996 had been made
on January 1, 1996; (ii) consummation of the Merger and the related transactions
and the contribution of capital to, and the incurrence of additional debt by,
CNA Surety; (iii) purchase accounting adjustments to reflect Capsure's assets
and liabilities at fair value; (iv) estimated indirect and overhead expenses for
the Predecessor Operations; and (v) estimated interest expense related to the
additional debt. This Pro Forma Condensed Statement of Consolidated Operations
is the source for the pro forma financial data for the year ended December 31,
1997 which is set forth in the Summary Consolidated Pro Forma and Historical
Financial Data and the Selected Consolidated Pro Forma Historical Financial Data
which are included elsewhere in this Prospectus. The adjustments necessary for
deriving the pro forma results of operations for the year ended December 31,
1996 and the three months ended March 31, 1997 are similar to the adjustments
described above and, therefore, pro forma condensed statements of operations for
these periods are not presented herein.
The accompanying Pro Forma Condensed Statement of Consolidated Operations
does not include the estimated net investment income resulting from investment
of Merger-related cash flow, including (i) the $50 million debt proceeds drawn
by CNA Surety under the Credit Facility and contributed to Western Surety, (ii)
the $52.25 million capital contribution from CCC, and (iii) collection of the
receivable in the amount of approximately $117 million from CCC. Investment
earnings are an integral part of an insurance entity's operations. If proceeds
from these sources of funds were assumed to be invested in high-quality, taxable
fixed income securities with an average duration of approximately 3 years,
yielding 6.4%, net investment income would increase approximately $11.3 million
($7.3 million net of tax, or $0.17 in pro forma earnings per share) for the year
ended December 31, 1997.
PURCHASE ACCOUNTING
The Merger has been accounted for by CNA Surety as an acquisition of
Capsure, using purchase accounting. Accordingly, the assets and liabilities of
Capsure which form the basis of measuring subsequent results of operations were
reflected at their estimated fair value as of the assumed acquisition date. The
purchase price was $182.1 million, which is based on the traded market price of
shares of Capsure common stock of $11.00 per share, the estimated fair market
value of the Capsure Options and the estimated Merger-related costs of the
Predecessor Operations.
LIMITATIONS AND INSTRUCTIONS
The Pro Forma Condensed Statement of Consolidated Operations should be read
in conjunction with the accompanying explanatory notes, the financial statements
of Capsure and Predecessor Operations and the notes thereto, and the other
financial information pertaining to Capsure and Predecessor Operations included
in this Prospectus. The Pro Forma Condensed Statement of Consolidated Operations
is intended for information purposes only and is not necessarily indicative of
the results of operations which would have been achieved and reported had the
Merger and related transactions been consummated on the date assumed, nor is it
necessarily indicative of the future consolidated operating results of CNA
Surety.
26
<PAGE> 28
CNA SURETY
PRO FORMA CONDENSED STATEMENT OF CONSOLIDATED OPERATIONS
YEAR ENDED DECEMBER 31, 1997
(UNAUDITED)
<TABLE>
<CAPTION>
CNA SURETY
------------------------------------------
SEPTEMBER 30,
NINE MONTHS ENDED (DATE OF
SEPTEMBER 30, 1997 INCEPTION)
---------------------- THROUGH PRO FORMA PRO FORMA
PREDECESSOR DECEMBER 31, ACCOUNTING CONDENSED
CAPSURE OPERATIONS 1997 ADJUSTMENTS CONSOLIDATED
-------- ----------- ------------- ----------- ------------
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Revenues:
Net earned premiums.............. $ 69,428 $108,564 $65,433 $ -- $243,425
Net investment income............ 8,768 -- 5,766 -- 14,534*
Net investment gains............. 638 -- 85 -- 723
-------- -------- ------- ------- --------
Total revenues................ 78,834 108,564 71,284 -- 258,682
-------- -------- ------- ------- --------
Expenses:
Net losses and LAE............... 5,030 (11,516) 12,134 -- 5,648
Net commissions, brokerage and
other underwriting............ 50,585 59,392 38,213 2,441a 150,631
Interest expense................. 2,961 -- 1,831 2,440b 7,232
Non-recurring charges and Merger-
related costs................. 12,087 -- -- -- 12,087
Amortization of intangible
assets........................ 2,094 282 1,447 1,965c 5,788
-------- -------- ------- ------- --------
Total expenses................ 72,757 48,158 53,625 6,846 181,386
-------- -------- ------- ------- --------
Income before income taxes......... 6,077 60,406 17,659 (6,846) 77,296
Income taxes....................... 16,995 21,241 6,663 (1,978)a,b 42,921
-------- -------- ------- ------- --------
Net income (loss).................. $(10,918) $ 39,165 $10,996 $(4,868)* $ 34,375*
======== ======== ======= ======= ========
Basic weighted average shares
outstanding...................... 43,302 43,302
======= ========
Diluted weighted average shares
outstanding...................... 43,552 43,552
======= ========
Basic net income per share......... $ 0.25 $ 0.79*
======= ========
Diluted net income per share....... $ 0.25 $ 0.79*
======= ========
</TABLE>
- - ---------------
* Amounts do not include the estimated investment income that would have been
earned by the Predecessor Operations. See Note 2 to Pro Forma Condensed
Statement of Consolidated Operations.
SEE BASIS OF PREPARATION, PURCHASE ACCOUNTING, LIMITATIONS AND INSTRUCTIONS,
AND NOTES TO PRO FORMA CONDENSED STATEMENT OF CONSOLIDATED OPERATIONS.
27
<PAGE> 29
NOTES TO PRO FORMA CONDENSED STATEMENT OF CONSOLIDATED OPERATIONS
NOTE 1. MERGER AND PURCHASE ACCOUNTING ADJUSTMENTS
The Predecessor Operations and Capsure merged their operations on September
30, 1997 into CNA Surety according to terms and conditions discussed elsewhere
in this Prospectus.
This transaction has been accounted for by CNA Surety as an acquisition of
Capsure, using purchase accounting. The purchase price for Capsure has been
allocated to Capsure's assets that were acquired and to Capsure's liabilities
that were assumed based on the estimated fair value of such assets and
liabilities at the Merger Date. The purchase price for the outstanding shares of
Capsure common stock was determined as follows (dollars in thousands, except per
share data):
<TABLE>
<S> <C>
Traded value of Capsure shares to be exchanged at $11.00 per
share..................................................... $178,177
Value of Capsure options.................................... 2,527
Predecessor Operations' Merger-related costs................ 1,358
--------
Total purchase price........................................ $182,062
========
</TABLE>
The purchase price was allocated as follows (dollars in thousands):
<TABLE>
<S> <C>
Capsure net assets at historical cost....................... $100,875
Fair value adjustments:
Purchased intangibles..................................... (73,844)
Intangibles arising from Merger........................... 155,031
--------
Purchase price.............................................. $182,062
========
</TABLE>
Pro Forma Condensed Statement of Consolidated Operations
The Pro Forma Condensed Statement of Consolidated Operations gives effect
to the adjustments necessary to reflect the Merger and other transactions as if
the Merger and the other transactions had occurred on January 1, 1997. Those
adjustments and their effects on revenues, expenses, income taxes and net income
for the nine months ended September 30, 1997 which preceded the Merger are
summarized and explained below (dollars in following table and footnotes in
thousands, except per share amounts). Results of operations from September 30,
1997 through December 31, 1997 which comprise the remainder of 1997 are derived
from the actual financial statements of CNA Surety.
<TABLE>
<CAPTION>
INCOME NET
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 REVENUES EXPENSES TAXES INCOME
- - -------------------------------------------- -------- -------- ------- -------
ADD (SUBTRACT)
<S> <C> <C> <C> <C>
Pro forma adjustments:
(a) Record the expense effects of estimated indirect and
overhead expenses allocable to the Predecessor
Operations.(1)...................................... $ -- $2,441 $ (854) $(1,587)
(b) Record the estimated interest expense adjustment(2)
related to the total pro forma debt................. -- 2,440 (854) (1,586)
(c) Record additional amortization of intangible assets
resulting from the Merger and related transactions,
using useful lives of 20 to 30 years................ -- 1,965 (270) (1,695)
------- ------ ------- -------
Total pro forma adjustments................... $ -- $6,846 $(1,978) $(4,868)
======= ====== ======= =======
</TABLE>
(1) The estimate of overhead and other indirect expenses of $2,441 for the nine
months ended September 30, 1997 (Merger Date) was determined pursuant to the
terms of the Administrative Services Agreement and assumes that all services
offered thereunder were purchased by CNA Surety. The estimated cost of such
services was based on the rates set forth in the Administrative Services
Agreement and
28
<PAGE> 30
NOTES TO PRO FORMA CONDENSED STATEMENT OF CONSOLIDATED OPERATIONS (CONTINUED)
management's best estimate of usage of each of the services to be provided,
without giving effect to any potential savings resulting from the Merger.
CNA Surety is under no obligation to purchase any services under the
Administrative Services Agreement.
(2) The estimated interest expense adjustment is comprised of (i) the interest
expense on the additional $63,000 of debt and (ii) the adjustment to
interest expense on Capsure's pre-Merger debt, based on the terms of the
Credit Facility. Based on the terms of the Credit Facility, the average
interest rates for the nine months ended September 30, 1997 (Merger Date)
would have been 5.86%.
NOTE 2. INVESTMENT INCOME
The accompanying Pro Forma Condensed Statement of Consolidated Operations
does not include the estimated net investment income resulting from investment
of Merger-related cash flow, including (i) the $50 million debt proceeds drawn
by CNA Surety under the Credit Facility and contributed to Western Surety, (ii)
the $52.25 million capital contribution from CCC, and (iii) collection of the
receivable in the amount of approximately $117 million from CCC. Investment
earnings are an integral part of an insurance entity's operations. If proceeds
from these sources of funds were assumed to be invested in high-quality, taxable
fixed income securities with an average duration of approximately 3 years,
yielding 6.4%, net investment income would increase by approximately $11.3
million ($7.3 million net of tax, or $0.17 in pro forma earnings per share) for
the year ended December 31, 1997.
NOTE 3. SIGNIFICANT NON-RECURRING CHARGES
Capsure incurred $22.0 million, after applicable income taxes, or $0.51 per
share, in Merger-related costs during the nine months ended September 30, 1997.
Income tax expense for this nine month period for Capsure includes the effects
of the limitations placed on CNA Surety's ability to utilize Capsure's NOL
carryforwards to offset future taxable income.
29
<PAGE> 31
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS OF CNA SURETY AND OF THE STATEMENT OF CERTAIN
ASSETS AND LIABILITIES AND THE STATEMENTS OF CERTAIN REVENUES AND
DIRECT OPERATING EXPENSES OF THE PREDECESSOR OPERATIONS
GENERAL
The following is a discussion and analysis of CNA Surety and its insurance
subsidiaries' operating results, financial condition, liquidity and capital
resources as well as a discussion of the Predecessor Operations' special purpose
Statement of Certain Assets and Liabilities and special purpose Statements of
Certain Revenues and Direct Operating Expenses. This discussion should be read
in conjunction with the Consolidated Financial Statements of CNA Surety and
notes thereto and the Statement of Certain Assets and Liabilities and Statements
of Certain Revenues and Direct Operating Expenses and the related notes thereto
of the Predecessor Operations.
FORMATION OF CNA SURETY AND MERGER
Pursuant to the Merger, CNAF and Capsure combined the surety business of
CNAF, referred to herein as the Predecessor Operations, with Capsure's principal
insurance subsidiaries, Western Surety and USA, under the control of a
newly-formed holding company, CNA Surety. CIC and CCC were the principal
operating subsidiaries of CNAF that wrote the surety line of business for their
own account prior to the Merger. CIC was acquired by CNAF on May 10, 1995.
Pursuant to the Reorganization Agreement, the Predecessor Operations and
Capsure's insurance businesses were merged on the 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 LAE reserves, as
of the Merger Date, and will cede to Western Surety all surety business written
or renewed by CCC or CIC for a period of five years thereafter. Further, CCC and
CIC have assumed or agreed to assume the obligation for any adverse development
on recorded reserves for the Predecessor 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.
CCC also agreed to provide certain administrative services at specified rates,
subject to inflationary increases, for the three years after the Merger if CNA
Surety elects to purchase such services. See "Certain Relationships and Related
Transactions."
FINANCIAL STATEMENT PRESENTATION
As set forth in Note 1 to the Consolidated Financial Statements, the
results of the Predecessor Operations did not reflect investment income and
investment gains and losses. Additionally, certain general and administrative
expenses, which were indirect or overhead in nature, were not allocated to the
Predecessor Operations by CNAF. As a result of these factors and because the
Merger with Capsure significantly affected the combined organization, it is not
useful to compare CNA Surety results for the first quarter of 1998 to
Predecessor Operations results for the first quarter of 1997, and the CNA Surety
results from September 30, 1997 (date of inception) through December 31, 1997 to
Predecessor Operations results for the fourth quarter ended December 31, 1996.
Also, a comparison of the results of operations of the Predecessor Operations
for the nine months ended September 30, 1997 to the year ended December 31, 1996
would not be useful due to the different reporting periods of nine and twelve
months.
Accordingly, the remainder of this discussion and analysis is formatted to
compare information for CNA Surety for various time periods as if the Merger had
been consummated on January 1, 1996. Periods presented on this basis are
therefore marked "pro forma." This pro forma financial information gives effect
to the following: (i) adjustment to the Capsure statement of operations, as
reported, to reflect the income effects as if the $10 per share ($156.2 million)
special cash distribution paid on October 4, 1996 had been made on January 1,
1996; (ii) consummation of the Merger and the related transactions and the
contribution of capital to, and the incurrence of additional debt by, CNA
Surety; (iii) purchase accounting adjustments to reflect Capsure's assets and
liabilities at fair value; (iv) estimated indirect and overhead expenses for the
Predecessor
30
<PAGE> 32
Operations; and (v) estimated interest expense related to the additional debt.
The pro forma financial information does not include the estimated net
investment income resulting from investment of Merger-related cash flows,
including (i) the $50 million debt proceeds, (ii) the $52.25 million capital
contribution from CCC and (iii) collection of the receivable from CCC. See
"Selected Consolidated Pro Forma and Historical Financial Data of CNA Surety"
and "Pro Forma Condensed Statement of Consolidated Operations."
RESULTS OF OPERATIONS
ANALYSIS OF CNA SURETY RESULTS FOR THE THREE MONTHS ENDED MARCH 31, 1998
COMPARED TO THE PRO FORMA THREE MONTHS ENDED MARCH 31, 1997
The components of income for the Company for the three months ended March
31, 1998 and 1997 are summarized as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
---------------------
1998 1997
(PRO FORMA)
(DOLLARS IN
THOUSANDS, EXCEPT PER
SHARE DATA)
<S> <C> <C>
Total revenues(1)........................................... $65,534 $59,338
======= =======
Underwriting income(2)...................................... $12,488 $46,181
Net investment income(1).................................... 6,789 3,126
Net investment gains........................................ -- 87
Interest expense............................................ 1,821 1,765
Amortization of intangible assets........................... 1,475 1,447
------- -------
Income before income taxes.................................. 15,981 46,182
Income taxes................................................ 6,166 16,771
------- -------
Net income.................................................. $ 9,815 $29,411
======= =======
Basic net income per share.................................. $ 0.23 $ 0.68
======= =======
</TABLE>
- - ---------------
(1) Pro forma revenues and net investment income for the three months ended
March 31, 1997 do not include the pro forma effects of estimated investment
income resulting from investment of Merger-related cash flows. If proceeds
from these sources of funds were assumed to be invested in high-quality,
taxable fixed income securities with an average duration of approximately 3
years, yielding 6.4%, net investment income would increase approximately
$14,200 (approximately $9,200 net of income taxes, or $0.21 in pro forma
earnings per share) and approximately $11,300 (approximately $7,300 net of
income taxes, or $0.17 in pro forma earnings per share) for the years ended
December 31, 1996 and 1997, respectively, and approximately $3,700
(approximately $2,400 net of income taxes, or $0.05 in pro forma earnings
per share) for the three months ended March 31, 1997.
(2) Includes $581 of favorable reserve development for the three months ended
March 31, 1998. Includes $36,900 of favorable reserve development for the
three months ended March 31, 1997 of which $35,000 is related to the
Predecessor Operations and is principally related to accident years prior to
1996.
31
<PAGE> 33
Insurance Underwriting
Underwriting results for the Company for the three months ended March 31,
1998 and 1997 are summarized in the following table:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
----------------------
1998 1997
(PRO FORMA)
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Gross written premiums...................................... $ 63,848 $ 59,779
======== ========
Net written premiums........................................ $ 61,836 $ 56,128
======== ========
Net earned premiums......................................... $ 58,745 $ 56,125
Net losses and LAE(1)....................................... 11,218 (26,384)
Net commissions, brokerage and other........................ 35,039 36,328
-------- --------
Underwriting income......................................... $ 12,488 $ 46,181
======== ========
Loss ratio(1)............................................... 19.1% (47.0)%
Expense ratio............................................... 59.6 64.7
-------- --------
Combined ratio(1)........................................... 78.7% 17.7%
======== ========
</TABLE>
- - ---------------
(1) Includes $581 of favorable reserve development for the three months ended
March 31, 1998. Includes $36,900 of favorable reserve development for the
three months ended March 31, 1997 of which $35,000 is related to the
Predecessor Operations and is principally related to accident years prior to
1996.
Premiums Written
CNA Surety primarily markets contract and commercial surety bonds. Contract
bonds guarantee obligations covered by a written agreement between two parties.
The most common types include bid, performance and payment bonds. The commercial
surety market includes numerous types of bonds categorized as court judicial,
court fiduciary, public official, license and permit, and many miscellaneous
bonds that include guarantees of financial performance. The Company also writes
fidelity bonds that cover losses arising from employee dishonesty and E&O
liability insurance.
Gross written premiums are shown in the table below:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
---------------------
1998 1997
(PRO FORMA)
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
Commercial.................................................. $30,689 $28,166
Contract.................................................... 26,200 25,120
Fidelity.................................................... 4,434 4,241
E&O and other............................................... 2,525 2,252
------- -------
$63,848 $59,779
======= =======
</TABLE>
Gross written premiums increased 6.8%, or $4.1 million, in the first
quarter ended March 31, 1998 compared to the pro forma first quarter of 1997.
Commercial surety gross written premiums were up 9.0% in the first quarter of
1998 compared to pro forma first quarter 1997. The increase in commercial surety
premium was largely due to the Company's continued international expansion which
began in 1997. The Company assumed $2.5 million of international surety and
credit premiums in the first quarter of 1998 under a quota share reinsurance
treaty with CNA Re (London), an affiliate of CCC. Exclusive of the international
surety and credit business, commercial surety gross written premiums were
comparable to first quarter 1997. The
32
<PAGE> 34
contract business increased by 4.3% over first quarter 1997 results. The
fidelity and other business, primarily written by Western Surety, increased 7.2%
in the first quarter of 1998. These increases were primarily due to growth in
the small contract surety and other businesses marketed through the Western
Surety agency force.
Net written premiums are shown in the table below:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
---------------------
1998 1997
(PRO FORMA)
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
Commercial.................................................. $30,257 $26,213
Contract.................................................... 25,240 23,963
Fidelity.................................................... 4,411 4,230
E&O and other............................................... 1,928 1,722
------- -------
$61,836 $56,128
======= =======
</TABLE>
For the quarter ended March 31, 1998, net written premiums increased 10.2%,
or $5.7 million, over the comparable period in 1997. Net written premiums were
up primarily due to a 15.4% increase in commercial surety business in the first
quarter of 1998. The increase in commercial net written premiums included the
aforementioned $2.5 million of assumed international surety and credit business
as well as the effects of increased net retentions of commercial surety risks
effective October 1, 1997. Net written premiums, exclusive of the international
business, increased 5.7% for the three months ended March 31, 1998. Net written
premiums for contract surety increased 5.3%, or $1.3 million, for the first
quarter of 1998. Net written premiums for fidelity and other lines increased
6.5% for the first quarter of 1998 to $6.3 million. These increases are
primarily due to growth in the small contract surety and other businesses
marketed through the Western Surety agency force.
Underwriting Income
Underwriting income was $12.5 million in the first quarter of 1998 compared
to $46.2 million in the pro forma first quarter of 1997. The first quarter 1997
results included a significant amount of favorable loss reserve development as
more fully described below.
Loss Ratio
The loss ratio for the first quarter 1998 was 19.1% compared to (47.0)% for
the pro forma first quarter of 1997. Excluding the impact of the favorable
reserve development of $0.6 million and $36.9 million in the first quarter of
1998 and 1997, respectively, the loss ratios would have been 20.1% and 18.7%,
respectively. The increase in the adjusted loss ratio was primarily associated
with the addition of the international surety and credit business, which is
characterized by relatively higher loss ratios than the Company's domestic
surety business. Approximately $35.0 million in favorable reserve development in
the first quarter of 1997 related to the Predecessor Operations. Based on the
Predecessor Operations' study of reserves, management determined that it had
been overly cautious in interpreting claim data and had discounted favorable
trends. Consistent with the Predecessor Operations' regular study of reserve
levels, the Predecessor Operations released $35.0 million of prior year reserves
in the first quarter of 1997. Approximately $33.0 million of this reserve
development related to CIC and principally to accident years prior to 1996.
Expense Ratio
The expense ratio decreased to 59.6% in the first quarter of 1998 compared
to 64.7% in the pro forma first quarter of 1997. The decline in the Company's
expense ratio for the quarter was largely due to the larger scale of the
combined organization as net earned premiums increased 4.7% for the quarter
while total underwriting expenses decreased 3.5%. The $1.3 million decline in
underwriting expenses on a pro forma basis for the quarter is not necessarily
indicative of a trend management expects to continue near term.
33
<PAGE> 35
Investment Income
Net investment income was $6.8 million for the first quarter of 1998
compared to $3.1 million for the pro forma first quarter of 1997. The increase
in investment income for the first quarter of 1998 was the result of higher
invested cash balances in the first quarter of 1998 which reflects the
investment of Merger-related cash flows. As described below, pro forma
investment income for the first quarter of 1997 does not include any estimate of
net investment income resulting from investment of Merger-related cash flows.
The average pretax yield was 6.5% for the three months ended March 31, 1998.
The unaudited pro forma financial information for the first quarter of 1997
does not include the estimated net investment income resulting from investment
of Merger-related cash flows, including (i) the $50 million of debt proceeds,
(ii) the $52.25 million capital contribution from CCC, and (iii) collection of
the receivable from CCC. Investment earnings are an integral part of an
insurance entity's operations. If proceeds from these sources of funds were
assumed to be invested in high-quality, taxable fixed income securities with an
average duration of approximately 3 years, yielding 6.4%, net investment income
would increase approximately $3.7 million ($2.4 million net of income taxes, or
$0.05 in pro forma earnings per share) for the three months ended March 31,
1997.
Analysis of Other Operations
Amortization of intangible assets was $1.5 million for the first quarter of
1998, compared to $1.4 million for pro forma first quarter ended March 31, 1997.
Intangible assets represent goodwill and identified intangibles arising from the
acquisition of Capsure and goodwill arising from the May 1995 acquisition of CIC
by CNAF that was allocated to the surety business of CIC. Intangible assets are
generally amortized over 30 years.
Interest expense for the first quarter of 1998 increased 3.2% compared to
the pro forma first quarter 1997. The weighted average interest rate was 5.8%
compared to 5.7% in the first quarter of 1997.
Income Taxes
Income tax expense was $6.2 million for the first quarter ended March 31,
1998 compared to $16.8 million for the pro forma first quarter of 1997 (which
includes approximately $12.9 million of income tax expense related to the $36.9
million favorable reserve development). The effective income tax rates for the
three months ended March 31, 1998 and 1997 were 38.6% and 36.3%, respectively.
ANALYSIS OF CNA SURETY RESULTS FOR THE PERIOD FROM SEPTEMBER 30, 1997 (DATE OF
INCEPTION) THROUGH DECEMBER 31, 1997 AND THE PRO FORMA THREE MONTHS ENDED
DECEMBER 31, 1996 AND PRO FORMA YEARS ENDED DECEMBER 31, 1997 AND 1996
A discussion of CNA Surety's results for the period from September 30, 1997
(date of inception) through December 31, 1997 compared to pro forma results of
operations for the comparative period in 1996 and a discussion of pro forma
results of operations for the years ended December 31, 1997 and 1996 follows.
The operating results of CNA Surety for the period from September 30, 1997 (date
of inception) through December 31, 1997 are hereinafter referred to as the
customarily subscribed terms "Three Months Ended" or "Fourth Quarter."
34
<PAGE> 36
The components of income for the Company for the three months and years
ended December 31, 1997 and 1996 are summarized as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED YEARS ENDED
DECEMBER 31, DECEMBER 31,
--------------------- -------------------
1997 1996 1997 1996
(PRO FORMA) (PRO FORMA)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE
DATA)
<S> <C> <C> <C> <C>
Total revenues....................................... $71,284 $62,754 $258,682 $250,194
======= ======= ======== ========
Underwriting income.................................. $15,086 $ 8,989 $ 87,146 $ 46,682
Net investment income................................ 5,766 2,866 14,534 10,796
Net investment gains................................. 85 19 723 1,068
Interest expense..................................... 1,831 1,807 7,232 7,660
Non-recurring charges and Merger costs............... -- 1,524 12,087 8,565
Amortization of intangible assets.................... 1,447 1,447 5,788 5,788
------- ------- -------- --------
Income before income taxes........................... 17,659 7,096 77,296 36,533
Income taxes......................................... 6,663 2,751 42,921 14,101
------- ------- -------- --------
Net income........................................... $10,996 $ 4,345 $ 34,375 $ 22,432
======= ======= ======== ========
Basic and diluted net income per share............... $ 0.25 $ 0.10 $ 0.79 $ 0.52
======= ======= ======== ========
</TABLE>
Insurance Underwriting
Underwriting results for the Company for the three months and years ended
December 31, 1997 and 1996 are summarized in the following table:
<TABLE>
<CAPTION>
THREE MONTHS ENDED YEARS ENDED
DECEMBER 31, DECEMBER 31,
--------------------- -------------------
1997 1996 1997 1996
(PRO FORMA) (PRO FORMA)
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Gross written premiums............................... $75,252 $64,126 $266,418 $251,414
======= ======= ======== ========
Net written premiums................................. $73,989 $59,808 $257,067 $235,186
======= ======= ======== ========
Net earned premiums.................................. $65,433 $59,869 $243,425 $238,330
Net losses and LAE................................... 12,134 11,237 5,648 41,450
Net commissions, brokerage and other................. 38,213 39,643 150,631 150,198
------- ------- -------- --------
Underwriting income.................................. $15,086 $ 8,989 $ 87,146 $ 46,682
======= ======= ======== ========
Loss ratio........................................... 18.5% 18.8% 2.3% 17.4%
Expense ratio........................................ 58.4 66.2 61.9 63.0
------- ------- -------- --------
Combined ratio....................................... 76.9% 85.0% 64.2% 80.4%
===== ======= ====== ======
</TABLE>
35
<PAGE> 37
Premiums Written
Gross written premiums are shown in the table below:
<TABLE>
<CAPTION>
THREE MONTHS ENDED YEARS ENDED
DECEMBER 31, DECEMBER 31,
--------------------- -------------------
1997 1996 1997 1996
(PRO FORMA) (PRO FORMA)
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Commercial........................................... $40,638 $27,490 $120,660 $105,401
Contract............................................. 29,185 31,639 123,014 124,477
Fidelity............................................. 3,495 3,404 15,762 15,134
E&O and other........................................ 1,934 1,593 6,982 6,402
------- ------- -------- --------
$75,252 $64,126 $266,418 $251,414
======= ======= ======== ========
</TABLE>
Gross written premiums increased 17.4%, or $11.1 million, in the fourth
quarter ended December 31, 1997 compared to the fourth quarter of 1996 and gross
written premiums increased 6.0%, or $15.0 million, for the year ended December
31, 1997 compared to 1996. These increases were primarily attributable to $10.1
million of international surety and credit business assumed in the fourth
quarter of 1997, as a result of the Company's initiative to more aggressively
expand its products and services into the international markets. In 1997, CNA
Surety expanded into the international surety and credit insurance market
through a quota share reinsurance treaty with CNA Re (London), an affiliate of
CCC. Commercial surety, exclusive of international surety and credit business,
increased 11.0% for the fourth quarter and 4.9% for the year ended December 31,
1997, respectively. The fidelity and other book of business, primarily written
by Western Surety, increased 8.6% and 5.6% in the fourth quarter and year ended
December 31, 1997, respectively. These increases in commercial surety and
fidelity and other business were offset by a decrease in contract surety
business of 7.8% in the fourth quarter and 1.2% for the full year ended December
31, 1997. The decreases in contract surety reflected the competitive pressures
primarily in the medium to large contract segment of the market and, to a lesser
extent, the timing of contractor accounts being awarded new business by their
customers.
Net written premiums are shown in the table below:
<TABLE>
<CAPTION>
THREE MONTHS ENDED YEARS ENDED
DECEMBER 31, DECEMBER 31,
--------------------- -------------------
1997 1996 1997 1996
(PRO FORMA) (PRO FORMA)
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Commercial........................................... $41,272 $25,157 $118,160 $ 97,407
Contract............................................. 27,836 30,170 118,138 118,268
Fidelity............................................. 3,516 3,395 15,750 15,090
E&O and other........................................ 1,365 1,086 5,019 4,421
------- ------- -------- --------
$73,989 $59,808 $257,067 $235,186
======= ======= ======== ========
</TABLE>
For the three months ended December 31, 1997, net written premiums
increased 23.7%, or $14.2 million, over the comparable period in 1996. For the
year ended December 31, 1997, net written premiums increased 9.3%, or $21.9
million, over the comparable period in 1996. Net written premiums were up
primarily due to a 21.3% increase in commercial surety business in 1997. The
increase in commercial net written premiums included the addition of the
aforementioned international surety and credit business as well as relatively
strong growth in Western Surety's core small commercial surety business
throughout 1997. Net written premiums, exclusive of the international business,
increased 6.8% and 5.0% for the three months and year ended December 31, 1997,
respectively. The rise in commercial net written premiums was offset by a
decrease in contract surety net written premiums as a result of the competitive
market conditions that exist in the contract surety market. Net written premiums
for contract surety decreased 7.7%, or $2.3 million, for the quarter and
36
<PAGE> 38
were down slightly for the year ended December 31, 1997. The Company also
renegotiated its reinsurance agreements with its reinsurers, increasing the
Company's net retention to $5.0 million per principal (e.g., the contractor on
contract surety bonds) on its commercial surety business. In the fourth quarter
of 1997, the Company received $3.8 million in previously ceded reinsurance
premiums from its reinsurers. Absent these returned premiums, domestic
commercial surety net written premiums were up 8.6% for the quarter and 7.0% for
the year.
Underwriting Income
Underwriting income increased 67.8% to $15.1 million from $9.0 million in
the fourth quarter of 1997 and increased 86.7% to $87.1 million from $46.7
million for the year ended December 31, 1997 as compared to the similar periods
in 1996. The period to period change in underwriting income and combined ratios
was due to fluctuations in both the loss and expense ratios as more fully
described below.
Loss Ratio
The loss ratio for the fourth quarter 1997 was 18.5% compared to 18.8% for
the pro forma fourth quarter of 1996. The loss ratio included approximately $0.6
million and $4.9 million, respectively, in favorable reserve development for the
three months ended December 31, 1997 and 1996, respectively.
The loss ratios for the years ended December 31, 1997 and 1996 were 2.3%
and 17.4%, respectively. Excluding the impact of the favorable reserve
development of $40.9 million and $16.6 million in 1997 and 1996, respectively,
the loss ratios would have been 19.1% and 24.4%, respectively. The decrease in
the adjusted loss ratio was due to the ongoing favorable economic trends that
continue to benefit the surety business in addition to the more disciplined
underwriting practices the Company applied to the book of business acquired from
CIC in May of 1995. Approximately $35.0 million in favorable reserve development
in 1997 related to the Predecessor Operations. Based on the Predecessor
Operations' study of reserves, management determined that it had been overly
cautious in interpreting claim data and had discounted favorable trends.
Consistent with the Predecessor Operations' regular study of reserve levels, the
Predecessor Operations released $35.0 million of prior year reserves in the
first quarter of 1997. Approximately $33.0 million of this reserve development
related to CIC and principally to accident years prior to 1996.
Expense Ratio
The expense ratio decreased to 58.4% in the fourth quarter of 1997 compared
to 66.2% in the pro forma fourth quarter of 1996. The decline in the Company's
expense ratio for the quarter was largely due to the larger scale of the
combined organization as net earned premiums advanced 9.3% for the quarter while
total underwriting expenses decreased 3.6%. The $1.4 million decline in
underwriting expenses on a pro forma basis for the quarter is not necessarily
indicative of a trend management expects to continue near term.
The expense ratio for the year ended December 31, 1997 decreased to 61.9%
from 63.0% for 1996. This decline in the Company's expense ratio was also
primarily due to the increased scale of the Company as net earned premiums
increased 2.1% and underwriting expenses increased only 0.3%.
Investment Income
Net investment income was $5.8 million for the fourth quarter of 1997
compared to $2.9 million for the pro forma fourth quarter of 1996. The average
pretax yield was 5.7% for the three months ended December 31, 1997. Pro forma
net investment income for the years ended December 31, 1997 and 1996 was $14.5
million and $10.8 million, respectively. Increases in investment income for the
quarter and in pro forma investment income for the year ended December 31, 1997
were the direct result of higher actual invested cash balances in the fourth
quarter of 1997 which reflected the investment of Merger-related cash flows.
However, pro forma investment income for periods prior to the Merger do not
include the pro forma effects of estimated net investment income resulting from
investment of Merger-related cash flows as described below.
37
<PAGE> 39
The foregoing pro forma financial information does not include the
estimated net investment income resulting from investment of Merger-related cash
flows, including (i) $50 million of debt proceeds, (ii) a $52.25 million capital
contribution from CCC and (iii) collection of the receivable from CCC.
Investment earnings are an integral part of an insurance entity's operations. If
proceeds from these sources of funds were assumed to be invested in
high-quality, taxable fixed income securities with an average duration of
approximately 3 years, yielding 6.4%, net investment income would increase
approximately $11.3 million ($7.3 million net of income taxes, or $0.17 in pro
forma earnings per share) for the year ended December 31, 1997, and
approximately $3.8 million ($2.5 million net of income taxes, or $0.06 in pro
forma earnings per share) and approximately $14.2 million ($9.2 million net of
income taxes, or $0.21 in pro forma earnings per share) for the three months and
year ended December 31, 1996, respectively.
Net realized investment gains were $0.1 million in the fourth quarter of
1997 and pro forma net realized investment gains were $0.7 million and $1.1
million for the years ended December 31, 1997 and 1996, respectively. Net
realized investment gains on securities held at Capsure's parent company were
$0.8 million for the year ended December 31, 1996.
Analysis of Other Operations
Amortization expense was $1.4 million for the fourth quarter of 1997 and
the pro forma fourth quarter of 1996 and was $5.8 million for the years ended
December 31, 1997 and 1996. Intangible assets represent goodwill and identified
intangibles arising from the acquisition of Capsure and goodwill arising from
the May 1995 acquisition of CIC by CNAF that was allocated to the surety
business of CIC. Intangible assets are generally amortized over 30 years.
Interest expense for the fourth quarter of 1997 increased 1.3% compared to
the pro forma fourth quarter 1996. While the average outstanding debt was down
to $117.3 million in the fourth quarter of 1997, the weighted average interest
rate was 5.9% compared to 5.6% in the pro forma fourth quarter of 1996. Pro
forma interest expense decreased 5.6%, or $0.4 million, for the year ended
December 31, 1997 compared to the prior year. This decrease was primarily due to
lower average outstanding debt of $119.2 million in 1997 compared to $124.7
million in 1996. The weighted average interest rate for the year ended December
31, 1997 was 5.8% compared to 5.7% for the year ended December 31, 1996.
Capsure incurred $22.0 million, after applicable income taxes, or $0.51 per
share, in Merger costs in 1997 compared to $5.7 million, after applicable income
taxes, or $0.13 per share in non-recurring charges and Merger costs in 1996. In
the fourth quarter of 1996, Capsure incurred $1.1 million, after applicable
income taxes, or $0.03 per share, in non-recurring Merger costs.
Income Taxes
Income tax expense was $6.7 million for the fourth quarter ended December
31, 1997. The effective income tax rate for the three months ended December 31,
1997 was 37.7%. Income taxes were $42.9 million and $14.1 million and the
effective income tax rates were 55.5% and 38.6% for the years ended December 31,
1997 and 1996, respectively. The effective rate for the full year 1997 reflects
the effects of limitations placed on CNA Surety's ability to utilize Capsure's
available net operating loss tax carryforwards ("NOLs") to offset future taxable
income.
38
<PAGE> 40
ANALYSIS OF PREDECESSOR OPERATIONS RESULTS FOR THE YEARS ENDED DECEMBER 31,
1996 AND 1995
Premiums Written
Net written premiums for the years ended December 31, 1996 and 1995 of the
Predecessor Operations throughout the period and of CIC subsequent to May 10,
1995 (the date of acquisition) are shown in the table below:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------
1996 1995
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Commercial.................................................. $ 40,459 $ 33,446
Contract.................................................... 103,445 88,566
--------------- ---------------
$ 143,904 $ 122,012
=============== ===============
</TABLE>
Changes in net written premiums during this period were primarily due to
the acquisition of CIC in May of 1995 and, in 1996, also due to changes in the
reinsurance programs. CIC net written premiums have been included for
approximately seven and one-half months in the 1995 results and have been
included for the full year in the 1996 results. The more significant changes in
the reinsurance programs were that contract surety retentions increased from
$3.0 million to $5.0 million per principal effective January 1, 1996. Similarly,
commercial bond retentions increased from $0.8 million to $3.0 million effective
January 1, 1996. These changes in the reinsurance arrangements were made as a
result of the larger capital base of the combined operations, and allowed the
Predecessor Operations to lower reinsurance costs and retain additional amounts
of surety premiums. The increase in retentions in 1996 accounted for
approximately 25% of the total 1996 increase in net written premiums.
Correspondingly, the increased retention by the Predecessor Operations, in part,
contributed to the reduction of ceded loss reserves which decreased from $24.5
million at December 31, 1995 to $15.5 million at December 31, 1996. Although the
Predecessor Operations' potential exposure increased as a result of the
increased retentions, the Predecessor Operations' management believed that,
based upon the favorable loss experience with respect to such business, the
retention of potentially profitable business offset such increased exposure.
Due to the significant effect of the CIC acquisition on premiums and
changes in the reinsurance programs, it is more meaningful to review gross
written premiums (premiums written before ceded premiums) during the periods
ended December 31, 1996 and 1995, for CCC and CIC, as if they had been combined
throughout this period:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------
1996 1995
(PRO FORMA)
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Commercial............................................ $ 47,078 30.3% $ 50,588 30.9%
Contract.............................................. 108,130 69.7 113,255 69.1
-------- ----- -------- -----
$155,208 100.0% $163,843 100.0%
======== ===== ======== =====
</TABLE>
Gross written premiums in 1996 declined from the pro forma combined 1995
level by $8.6 million. This decrease was attributable in part to the continued
program that commenced in 1995 to re-underwrite the CIC book of business on an
account-by-account basis and remove business with unsatisfactory profit
potential and risk. To a lesser extent, a portion of the decrease is believed to
be due to considerable management attention focused on effecting and completing
the integration of CIC and CCC. The decrease in gross written premiums in 1996
was 5.3%; this percentage decline was less than half of the 1995 percentage
decrease.
39
<PAGE> 41
OPERATING RESULTS
The following table is a summary of the pretax operating results of the
Predecessor Operations and certain operating ratios for the years ended December
31, 1996 and 1995. These pretax operating results do not include investment
income, realized capital gains and losses, and certain indirect or overhead type
expenses.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------
1996 1995
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Net earned premiums......................................... $149,069 $130,603
Net losses and LAE.......................................... 33,006 32,440
Other direct costs and expenses(1).......................... 81,615 71,591
-------- --------
Excess of net earned premiums over direct
operating expenses before income taxes(1)................. $ 34,448 $ 26,572
======== ========
Large losses................................................ $ 14,900 $ 13,900
======== ========
Loss ratio.................................................. 22.1% 24.8%
Expense ratio(1)............................................ 54.8 54.8
-------- --------
Combined ratio(1)........................................... 76.9% 79.6%
======== ========
Effect of large losses on combined ratio.................... 10.0% 10.6%
======== ========
</TABLE>
- - ---------------
(1) Does not include the effects of certain general and administrative expenses,
which are indirect or overhead in nature, since such costs were not
historically allocated to the Predecessor Operations by CNAF or its
subsidiaries.
The year-over-year change in the combined ratio was due to fluctuations in
the loss ratio as more fully discussed under "Loss Ratio" below.
Loss Ratio
The loss ratio was 22.1% in 1996, compared to 24.8% in 1995. Prior to the
CIC acquisition, the average loss ratio was approximately 17% for the last ten
years and 19% for the last 15 years. This decrease in the loss ratio in 1996
compared to 1995 was attributable in part to the continued program that
commenced in 1995 to re-underwrite the CIC book of business on an
account-by-account basis and remove business with unsatisfactory profit
potential and risk, in addition to more disciplined underwriting practices the
Company applied to the book of business acquired from CIC by CNAF in May of
1995. Also in 1996, large losses (individual claims which are in excess of $2.5
million, net of reinsurance) were $14.9 million in aggregate compared to $13.9
million in 1995. These large losses had the effect of increasing loss ratios for
1996 and 1995 by 10.0% and 10.6%, respectively.
Expense Ratio
The expense ratio was 54.8% in 1996, unchanged from 1995.
LIQUIDITY AND CAPITAL RESOURCES
The liquidity requirements of the Company are met primarily by funds
generated from operations. The principal cash flow sources are premiums,
investment income, and sales and maturities of investments. CNA Surety also may
generate funds from additional borrowings under the Credit Facility (as
hereinafter defined). The primary cash flow uses are payments for claims,
operating expenses, debt service on the Credit Facility, as well as dividends,
if any, 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 losses and
LAE.
40
<PAGE> 42
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 income tax sharing payments of its insurance
subsidiaries. At March 31, 1998, the carrying value of the Company's insurance
subsidiaries' invested assets and cash was $418.8 million, comprised of $389.4
million of fixed income securities, $19.9 million of short-term investments,
$6.0 million of other investments and $3.4 million of cash.
Cash flow at the CNA Surety 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 and pay operating expenses. At
March 31, 1998, the parent company's invested assets and cash were $8.8 million.
The Company's consolidated net cash flow provided by operating activities
was $12.5 million for the three months ended March 31, 1998. Consolidated
operating cash flow (pretax income excluding net investment gains and
amortization of intangibles assets) for the three months ended March 31, 1998
was $17.5 million.
The Company's consolidated net cash flow provided by operating activities
was $29.0 million for the three months ended December 31, 1997. Consolidated
operating cash flow (pretax income excluding net investment gains and
amortization of intangible assets) for the three months ended December 31, 1997
was $19.0 million.
The Company received $116.9 million in cash from CNAF on October 1, 1997.
This payment from CNAF reflects the effects of the reinsurance agreement whereby
CCC and CIC ceded all of their net unearned premiums and loss and LAE reserves
for their surety business to Western Surety as of the Merger Date.
CNA Surety's bank borrowings are under a five-year unsecured revolving
credit facility pursuant to a Credit Agreement, dated as of September 30, 1997,
among CNA Surety, the lender parties thereto and Chase Manhattan Bank, as
Administrative Agent (the "Credit Facility") which provides for borrowings of up
to $130 million. CNA Surety borrowed $105 million as of September 30, 1997 and
used the proceeds to retire the existing Capsure debt of approximately $54
million and to make a $50 million capital contribution to Western Surety. On
October 6, 1997, CNA Surety borrowed an additional $13 million to pay the $10.6
million closing dividend to Capsure stockholders and other Merger-related costs.
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, varies based on CNA
Surety's leverage ratio (debt to total capitalization) and ranges from 0.25% to
0.40%. At March 31, 1998, the weighted average interest rate was 5.9% on the
$118.0 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, 1998, 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 after five years 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.
As an insurance holding company, CNA Surety is dependent upon dividends and
other permitted payments from its insurance subsidiaries to pay cash dividends,
if any, as well as to pay operating expenses and meet debt service requirements.
The payment of dividends by the insurance subsidiaries are subject to varying
degrees of supervision by the insurance regulatory authorities in South Dakota
and Texas. In South Dakota, where Western Surety is domiciled, insurance
companies may pay dividends only from earned surplus excluding surplus arising
from unrealized capital gains or revaluation of assets. In Texas, where USA is
domiciled, an insurance company may declare or pay dividends to stockholders
only 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 and (ii)
statutory net income. In South Dakota, net income includes net realized capital
gains in
41
<PAGE> 43
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 formulae 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. Accordingly, dividend capacity for 1998 does
not fully reflect the effects of the Merger. Dividend capacity for 1998 is based
on statutory surplus and income at and for the year ended December 31, 1997
which will only include the results of the Predecessor Operations for the period
from September 30, 1997 (date of inception) through December 31, 1997. Dividend
capacity for 1999 will be based on statutory surplus and income at and for the
year ended December 31, 1998 which will include the effects of the Predecessor
Operations for all of 1998. Without prior regulatory approval in 1998, CNA
Surety's insurance subsidiaries may pay dividends to the Company of $16.3
million in the aggregate. CNA Surety received $4.4 million and $5.0 million in
dividends from its insurance subsidiaries in the first quarter of 1998 and the
period from September 30, 1997 through December 31, 1997, respectively. Because
the Predecessor Operations were conducted through several wholly-owned insurance
subsidiaries of CNAF, and the surety business only represented a small portion
of the business of such subsidiaries, dividends paid by the insurance
subsidiaries to CNAF were not allocated among lines of insurance. Accordingly,
the amounts of dividends paid by the insurance subsidiaries to CNAF attributable
to the Predecessor Operations cannot be determined for years prior to the
Merger.
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, as calculated
in accordance with the Internal Revenue Code of 1986, as amended (the "Code").
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 $1.6 million and $2.4 million in the
first quarter of 1998 and the period from September 30, 1997 through December
31, 1997, respectively.
CNA Surety management believes that it will have sufficient available
resources to meet its present capital needs.
FINANCIAL CONDITION
Investment Portfolio
The Company's policy is to invest primarily in fixed income securities with
high quality credit ratings. As of March 31, 1998, 100% of the Company's fixed
income securities were considered investment grade by The Standard & Poors
Corporation ("S&P") or Moody's Investor Services, Inc. ("Moody's"), and
approximately 84% were rated at least AA by those agencies. In addition, the
Company's investments in fixed income securities did not contain any significant
geographic or industry concentration of credit risk.
The following table sets forth the ratings assigned by S&P or Moody's of
the fixed income securities portfolio of the Company as of March 31, 1998.
<TABLE>
<CAPTION>
MARCH 31, 1998
-----------------------
CREDIT RATING FAIR VALUE PERCENT
------------- ----------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
AAA/Aaa..................................................... $302,482 77.7%
AA/Aa....................................................... 23,557 6.0
A/A......................................................... 51,286 13.2
BBB......................................................... 12,071 3.1
-------- -----
Total............................................. $389,396 100.0%
======== =====
</TABLE>
As of March 31, 1998, approximately 33% of the investment portfolio was
held in high-quality, short-duration mortgage pass-through instruments, CMOs and
other asset-backed securities. CMOs differ from
42
<PAGE> 44
traditional fixed income securities in that they may expose the investor to
yield variability and even principal risk due to such factors as high mortgage
prepayment rates and defaults and delinquencies in the underlying asset pool.
Management believes it has reduced prepayment variability by investing only in
short tranches and by owning a substantial amount of PAC tranches which have
been structured largely to insulate the investor from prepayment risk. A PAC
tranche is structured to amortize in a predictable manner and, thereby shift the
risk of prepayment of the underlying collateral to other tranches, whose owners
are willing to accept such risk. Further, management believes it has minimized
credit risk by generally purchasing securities rated "A" or better on the date
of acquisition and which are collateralized or guaranteed by U.S. Government
agencies or have substantial credit enhancement in the form of financial
guarantees, mortgage insurance, letters of credit, over-collateralization,
subordinated structures and excess servicing spreads. Management monitors the
investment portfolio of the insurance subsidiaries and the current rating of
each security owned on a monthly basis. See "Risk Factors -- Susceptibility to
Changes in Interest Rates and General Economic Conditions."
Reserves for Unpaid Losses and LAE
CNA Surety's insurance subsidiaries employ accepted reserving approaches in
establishing the estimated liability for unpaid losses and LAE that give
consideration to the inherent difficulty and variability in the estimation
process. In addition, CNA Surety utilizes independent actuarial firms of
national standing to conduct periodic reviews of claim procedures and loss
reserving practices, and annually obtains actuarial certification as to the
reasonableness of actuarial assumptions used and the sufficiency of year-end
reserves for each of its principal insurance subsidiaries.
The estimated liability for unpaid losses and LAE includes, on an
undiscounted basis, estimates of (a) the ultimate settlement value of reported
claims, (b) incurred but not reported ("IBNR") claims, (c) future expenses to be
incurred in the settlement of claims and (d) claim recoveries, exclusive of
reinsurance recoveries which are reported as an asset. These estimates are
determined based on the Company's and surety industry loss experience as well as
consideration of current trends and conditions. The estimated liability for
unpaid losses and LAE is an estimate and there is the potential that actual
future loss payments will differ significantly from initial estimates. The
methods of determining such estimates and the resulting estimated liability are
regularly reviewed and updated. Changes in the estimated liability, known as
reserve development, are reflected in operating income in the year in which such
changes are determined to be needed. See "Business of the Company -- Reserves
for Unpaid Losses and LAE" and Note 8 of "Notes to Consolidated Financial
Statements."
Risk Based Capital and Other Regulatory Ratios
The National Association of Insurance Commissioners ("NAIC") has
promulgated Risk Based Capital ("RBC") requirements for property and casualty
insurance companies to evaluate on an annual basis the adequacy of statutory
capital and surplus in relation to investment and insurance risks such as asset
quality, loss reserve adequacy, and other business factors. The RBC information
is used by state insurance regulators as an early warning mechanism to identify
insurance companies that potentially are inadequately capitalized. In addition,
the formula defines new minimum capital standards that supplement the current
system of fixed minimum capital and surplus requirements on a state-by-state
basis. Regulatory compliance is determined by a ratio (the "Ratio") of the
enterprise's regulatory total adjusted capital, as defined by the NAIC, to its
authorized control level RBC, as defined by the NAIC. Generally, a Ratio in
excess of 200% of authorized control level RBC requires no corrective actions on
behalf of the company or regulators. As of December 31, 1997, each of CNA
Surety's insurance subsidiaries had a Ratio that was in excess of the minimum
RBC requirements.
CNA Surety's insurance subsidiaries require capital to support premium
writings. In accordance with industry and regulatory guidelines, the net written
premiums to surplus ratio of a property and casualty insurer should not exceed 3
to 1 (the terms of the Credit Facility also limit this ratio to 3 to 1 for
Western Surety and USA). On December 31, 1997, the Company had a combined
statutory surplus of $142.4 million. Western Surety's statutory surplus was
$128.7 million and its net written premiums to surplus ratio was 1.8 to 1. USA's
statutory surplus was $13.7 million and its net written premiums to surplus
ratio was 1.6 to 1. The Company
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<PAGE> 45
believes that each of its insurance subsidiary's statutory surplus is sufficient
to support its current and anticipated premium levels.
The NAIC has also developed a rating system, the Insurance Regulatory
Information System ("IRIS"), primarily intended to assist state insurance
departments in overseeing the financial condition of all insurance companies
operating within their respective states. IRIS consists of eleven key financial
ratios that address various aspects of each insurer's financial condition and
stability. In 1997, USA's IRIS ratios fell within all of the "usual" ranges. Due
to the Merger that occurred on September 30, 1997, and related reinsurance
transactions, Western Surety's net writings, surplus and agents balances
increased significantly, causing the applicable IRIS ratios to be outside the
"usual" ranges. All of the remaining IRIS ratios for Western Surety were within
the "usual" ranges.
IMPACT OF YEAR 2000 ON THE COMPANY
The widespread use of computer programs, both in the United States and
internationally, that rely on two digit fields to perform computations and
decision making functions may cause computer systems to malfunction when
processing information involving dates after 1999. Such malfunction could lead
to business delays and disruptions. The Company is in the process of replacing
or upgrading its systems to accommodate business for the year 2000, and
anticipates that by December 31, 1998 it will have substantially completed its
program of replacements and the necessary upgrades to accommodate year 2000
processing of its business. However, due to the interdependent nature of
computer systems, the Company may be adversely impacted depending upon whether
it or other entities not affiliated with the Company (vendors and business
partners) address this issue successfully. The cost to the Company of achieving
year 2000 compliance is estimated to be less than $1.0 million in excess of the
cost of normal software upgrades and replacements and will primarily be incurred
in 1998 and funded through working capital. See "Risk Factors -- Year 2000
Compliance."
IMPACT OF ADOPTING STATEMENTS OF FINANCIAL ACCOUNTING STANDARDS ("SFAS")
In February 1997, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 128, "Earnings Per Share". SFAS No. 128 is effective for both interim
and annual periods ending after December 15, 1997 SFAS No. 128 replaces
Accounting Principles Board ("APB") Opinion No. 15, "Earnings Per Share." APB
Opinion No. 15 required that entities with simple capital structures present a
single earnings per common share ("EPS") on the face of the income statement,
whereas those with complex capital structures had to present both primary and
fully diluted EPS. SFAS No. 128 simplifies the computation of EPS by replacing
the presentation of primary EPS with a presentation of basic EPS and requires
dual presentation of basic and diluted EPS by entities with complex capital
structures. Basic EPS includes no dilution and is computed by dividing income
available to common stockholders by the weighted average number of common shares
outstanding for the period, whereas primary EPS includes the dilutive effect of
common stock equivalents, such as stock options. Diluted EPS reflects the
potential dilution of securities that could share in the earnings of an entity,
similar to fully diluted EPS. The Company has adopted SFAS No. 128 in the
accompanying Consolidated Financial Statements.
In February 1997, the FASB issued SFAS No. 129, "Disclosure of Information
about Capital Structure," which establishes standards for disclosing information
about an entity's capital structure. The Statement consolidates existing
disclosure requirements for ease of retrieval and greater visibility to
nonpublic entities. The new Statement contains no change in disclosure
requirements for companies previously subject to the requirements of APB No. 10,
"Omnibus Opinion -- 1966" APB Opinion No. 15, "Earnings per Share" and FASB
Statement No. 47 "Disclosure of Long-Term Obligations" and as such the adoption
of SFAS No. 129 did not have any effect on the Company's financial reporting.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income" which establishes accounting standards for reporting and display of
comprehensive income and its components (revenues, expenses, gains, and losses)
in a full set of general-purpose financial statements. This Statement requires
that an enterprise (a) classify items of other comprehensive income by their
nature in a financial statement and
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<PAGE> 46
(b) display the accumulated balance of other comprehensive income separately
from retained earnings and additional paid-in capital in the equity section of a
statement of financial position.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information" which establishes accounting standards
about the way public enterprises report information about operating segments in
its annual financial statements and requires that those enterprises report
selected information about operating segments in interim financial reports
issued to stockholders. It also establishes standards for related disclosures
about products and services, geographic areas and major customers. SFAS No. 131
replaces SFAS No. 14, "Financial Reporting for Segments of a Business
Enterprise."
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits" which revises employers'
disclosures about pensions and other postretirement benefit plans. SFAS No. 132
does not change the measurement or recognition requirements of those plans under
the previous accounting standards. The new standardized disclosures require
additional information on changes in the benefit obligations and fair value of
plan assets as well as eliminate certain disclosures from prior accounting
standards that are no longer as useful. Restatement of disclosures of prior
periods for comparative purposes is required.
Each of SFAS Nos. 130, 131 and 132 is effective for fiscal years beginning
after December 15, 1997. Each Statement was adopted by CNA Surety in its
Condensed Consolidated Financial Statements as of and for the three months ended
March 31, 1998. Any necessary changes in disclosures and reporting requirements
from the adoption of such statements are reflected in the Company's Consolidated
Financial Statements.
In December 1997, the American Institute of Certified Public Accountants'
Accounting Executives Standards Committee issued Statement of Position ("SOP")
97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related
Assessments" which provides guidance on accounting by all entities that are
subject to insurance-related assessments. It requires that entities should
recognize liabilities for insurance-related assessments when all of the
following criteria have been met: an assessment has been imposed or a probable
assessment will be imposed; the event obligating an entity to pay an imposed or
probable assessment has occurred on or before the date of the financial
statements; and the amount of the assessment can be reasonably estimated. This
SOP is effective for financial statements for fiscal years beginning after
December 15, 1998. The Company does not expect the adoption of this SOP to have
a material effect on the Company's results of operations.
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<PAGE> 47
BUSINESS OF THE COMPANY
BUSINESS OVERVIEW
CNA Surety is an insurance holding company that, through its subsidiaries,
develops, markets and underwrites primarily surety bonds. The Company is the
largest publicly-traded insurance holding company focused exclusively on the
surety business and is one of the leading providers of surety products in the
United States. During 1997, the insurance companies now owned by the Company
wrote over $266 million of gross written premiums, $244 million of which
consisted of surety premiums. For the three months ended March 31, 1998, the
Company wrote over $63 million of gross written premiums, $57 million of which
consisted of surety premiums.
The Company was formed to facilitate the merger of the surety business of
CNAF with Capsure's insurance subsidiaries, Western Surety and USA. Management
believes that the Merger, which occurred on September 30, 1997, resulted in the
combination of three complementary surety businesses, each with distinct
strengths, product focuses and marketing strategies. The combination of these
businesses resulted in a single, larger entity focused on serving the needs of
virtually all segments of the surety market, in terms of the types of products
offered and the size of bonds available. Based on management's knowledge of the
industry, management believes that the Company's branch system and independent
agency network are the most extensive in the surety industry, the combination of
which provides the Company with a competitive marketing advantage.
Surety products, unlike the standard two-party insurance policy, are
three-party agreements in which the Company as the issuer of the bond (the
surety) joins with a second party (the principal) in guaranteeing to a third
party (the owner/obligee) the fulfillment of some obligation on the part of the
principal. Sureties are generally entitled to recover from the principal any
losses and expenses paid to third parties.
The Company, through its principal insurance subsidiaries, Western Surety
and USA, underwrites a broad spectrum of surety bonds. Western Surety writes
small fidelity and commercial bonds and E&O liability insurance. Management
believes that Western Surety is the largest writer of smaller commercial surety
bonds and attributes Western Surety's volume to its strong capabilities in
marketing, distribution and service. In addition, Western Surety underwrites
contract surety bonds, primarily for mid to large sized contract accounts, and
assumes, on a reinsurance basis, international surety and credit insurance
written by CNA Re (London). USA specializes in the underwriting of small
contract and commercial surety bonds. Western Surety and USA are currently rated
A+ (Superior) and A (Excellent), respectively, by A.M. Best. A.M. Best ratings
are based upon factors relevant to policyholders, agents, insurance brokers and
intermediaries and are not directed to the protection of investors.
The Company principally markets its products in all 50 states, as well as
the District of Columbia and Puerto Rico. Its products are marketed primarily
through independent producers, including multi-line agents and brokers, many of
whom belong to the National Association of Surety Bond Producers. The Company
enjoys broad national distribution of its products through approximately 36,000
of the approximately 44,000 independent property and casualty insurance agencies
in the United States.
The Company's primary focus is on evaluating the risk and determining if
the principal meets its underwriting requirements for the bond. Accordingly, the
Company's surety bond premiums primarily reflect the type and class of risk and
related costs associated with both processing the bond transaction and
investigating the applicant including, if necessary, an analysis of the
applicant's creditworthiness and ability to perform.
The Company is led by an experienced management team with an average of
over twenty years of experience, whose core expertise is in surety underwriting
and claims management. Management's underwriting philosophy is disciplined and
focused on consistent underwriting profitability. The extent and sophistication
of underwriting activity, including the amount of bonding authority granted to
independent agents, varies depending on the class of business and the type of
bond. For example, contractor accounts and large commercial surety customers
undergo extensive credit, financial and managerial review and analysis on a
regular basis. Similarly, certain classifications of bonds, such as fiduciary
and court appeal bonds, also receive extensive underwriting. On the other hand,
the Company requires comparatively little underwriting
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<PAGE> 48
information for certain low-exposure risks such as notary bonds. The Company's
underwriting has resulted in combined ratios of 79.7%, 81.0% and 87.4%,
excluding the effects of favorable loss reserve development, for the three
months ended March 31, 1998 and on a pro forma basis for the years ended
December 31, 1997 and 1996, respectively. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations . . ."
CORPORATE STRATEGY
CNA Surety's corporate objective is to be the leading provider of surety
and surety-related products in the United States and in selected international
markets and to be the surety of choice for customers and independent agents and
brokers. The Merger was an integral step towards achieving this objective and,
in management's view, has enhanced the Company's position as a market leader in
addition to providing increased opportunities for long-term revenue and earnings
growth. Elements of management's operating strategy designed to achieve its
corporate objective include the following:
Leverage the Company's Broad Product Line and Distribution Network
Management intends to use the Company's expanded product offerings, and
extensive distribution network, to leverage its existing marketing capabilities.
For example, the Company has introduced Western Surety's small commercial
products and USA's small contractor products to the 41 CNA Surety branch offices
of the Company, which prior to the Merger did not have access to these product
offerings. Similarly, the Company has introduced CNA Surety's larger contract
and commercial bond expertise and greater financial capacity to Western Surety's
and USA's broad independent agency distribution system. In addition, Western
Surety's and USA's marketing representatives now receive support, training, and
education from CNA Surety branch office personnel. Management believes that,
over time, the development of more extensive relationships with its independent
agency force will enhance the Company's growth opportunities and operating
efficiencies.
Pursue Cross-Marketing Opportunities between the Company and CNAF
Management believes that the Company's relationship with CNAF, its
principal stockholder, provides significant opportunities for the Company.
Management believes that CNAF's 100-year history, leading position in the
property and casualty insurance market, financial strength and name recognition
provide CNA Surety with a strong marketing advantage in the medium to large
surety marketplace. In addition, with a leading position in providing property
and casualty insurance to the construction sector, risk management services to
"Fortune 1000" clients and professional liability products to architects and
engineers, CNAF is well positioned to generate new business opportunities for
CNA Surety.
In an effort to capitalize on these cross-marketing opportunities, the
Company and CNAF have instituted various referral programs which will allow the
Company to access CNAF's clients that may have a need for surety products. These
referrals are transmitted to the Company's home and branch offices, allowing the
Company's representatives to pursue these leads.
Expand in the International Markets
The Company recently began its expansion into the European markets through
a relationship with CNA Re (London). Through this relationship, the Company
participates, on a 50% quota share basis, in an international book of
predominately credit insurance and surety business. While credit insurance is a
relatively small market in the United States, credit insurance has a far more
prominent role in Western Europe, where direct writers and reinsurers often
market surety-related products along with credit insurance. Therefore,
management believes that the relationship with CNA Re (London) will serve as an
entree into the large European credit market and, thereby, enhance CNA Surety's
ability to build a surety business in Western Europe.
The Company is also partnering with other members of CNAF's international
organization to establish an infrastructure to market surety bonds
internationally. CNA Surety management believes that these actions will build
name recognition in the international marketplace.
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<PAGE> 49
Promote the Company's Specialty and Service-Based Orientation
As a provider of specialty surety products, management believes that the
Company is better positioned than its competitors to deliver exceptional service
to its agents and customers. The Company has developed specialized technology
targeted specifically toward the surety market. For example, due to Western
Surety's historical focus on the small commercial surety market, which requires
immediate response, the Company has developed business systems and processing
expertise that efficiently supports the surety needs of smaller customers and
minimizes the handling costs associated with the low premium, high volume nature
of the small commercial surety business. The Company expects to utilize this
experience and service orientation to better compete in the broader commercial
surety market.
Expand in the Private Sector
Based upon the Company's extensive knowledge of the surety business, its
focus almost exclusively on one sector of the insurance market, the experience
of its management team and its long-standing relationships with insurance agents
producing surety premiums, management believes that it is well positioned to
develop surety-related products for market niches that it believes are
underserved with regard to surety products. For example, the Company has
identified private construction as a market largely untapped with respect to
surety products. While surety bonds are widely used in the public construction
market, surety bonds are not yet as frequently used in the private construction
sector. Potential opportunities for this sector include not only the use of
existing surety bond products but also the development of new product offerings
tailored to the specific requirements of the private construction sector.
Consider Strategic Acquisitions
Management will continue to consider strategic acquisitions, as part of its
long-term approach to growing its business. CNA Surety's focus will be primarily
on specialty providers of surety-related products that bring geographic
diversity or product expertise or expansion to the Company.
PRODUCT INFORMATION
According to the SAA industry estimates, approximately 80% of the
approximately $2.7 billion United States surety market is represented by bonds
required by federal statutes, state laws, and local ordinances. These bonding
requirements range from federal construction projects, where the contractor is
required to post performance and payment bonds which guarantee performance of
contracts to the government as well as payment of bills to subcontractors and
suppliers, to license and permit bonds which guarantee compliance with legal
requirements for business operations.
Products and Policies
Unlike a standard, two-party insurance policy, surety bonds are three-party
agreements in which the issuer of the bond (the surety) joins with a second
party (the principal) in guaranteeing to a third party (the owner/obligee) the
fulfillment of some obligation on the part of the principal. The surety is the
party who guarantees fulfillment of the principal's obligation to the obligee.
In addition, sureties are generally entitled to recover from the principal any
losses and expenses paid to third parties. The surety's responsibility is to
evaluate the risk and determine if the principal meets the underwriting
requirements for the bond. Accordingly, surety bond premiums primarily reflect
the type and class of risk and related costs associated with both processing the
bond transaction and investigating the applicant including, if necessary, an
analysis of the applicant's creditworthiness and ability to perform.
The surety business is comprised of contract surety business and commercial
surety business, although the products comprising each are sold through the same
distribution system.
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Contract bond guarantee obligations include the following:
Bid bonds: used by contractors submitting proposals on potential contracts.
Performance bonds: guarantee to the owner the performance of the
contractor's obligations according to the terms and conditions of the contract.
Payment bonds: guarantee payment of the contractor's obligations under the
contract for labor, subcontractors, and materials supplied to the project.
Payment bonds are utilized in public projects where liens are not permitted.
Other examples of contract bonds are completion, maintenance and supply
bonds.
Commercial surety business is comprised of bonds covering obligations
typically required by law or regulation, such as the following:
License and Permit bonds: required by statutes or ordinances for a number
of purposes, including guaranteeing the payment of certain taxes and fees and
providing consumer protection as a condition to granting licenses related to
selling real estate or motor vehicles and contracting services.
Judicial and Fiduciary bonds: required by statutes, courts or legal
documents for the protection of those on whose behalf a fiduciary acts. Examples
of such fiduciaries include executors and administrators of estates, and
guardians of minors and incompetents.
Public Official bonds: required by statutes and ordinances to guarantee the
lawful and faithful performance of the duties of office by public officials.
Fidelity bonds: cover losses arising from employee dishonesty. Examples of
purchasers of fidelity bonds are law firms, insurance agencies and janitorial
service companies.
In 1997, the Company expanded into the international surety and credit
insurance market through a 50% U.S. dollar denominated quota share treaty with
CNA Re (London), an affiliate of CCC. Western Surety assumed $10.1 million of
premium through this relationship in the fourth quarter of 1997 and $2.5 million
in the first quarter of 1998. The assumed business is predominately
European-based risks, a substantial portion of which is credit insurance and the
remainder of which is surety and fidelity.
The following table sets forth the pro forma gross written premiums for
1997 and 1996 by type of commercial surety bond and the percentage of each type
to total pro forma gross written premiums for the Company for such years:
<TABLE>
<CAPTION>
PRO FORMA GROSS WRITTEN PREMIUMS
---------------------------------------------
YEARS ENDED DECEMBER 31,
---------------------------------------------
1997 % OF TOTAL 1996 % OF TOTAL
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
License and permit.................................... $ 64,614 24.3% $ 61,163 24.3%
Judicial and fiduciary................................ 26,555 10.0 25,512 10.1
Public official....................................... 17,703 6.6 16,819 6.7
International and other............................... 11,788 4.4 1,907 0.8
-------- ---- -------- ----
Total Commercial............................ $120,660 45.3% $105,401 41.9%
======== ==== ======== ====
</TABLE>
The Company also writes E&O policies through its subsidiary Western Surety
for three classes of insureds: notaries public, tax preparers and insurance
agents and brokers. The notary public E&O policy is marketed as a companion
product to the notary public bond and the tax preparer E&O policy is marketed to
small tax return preparation firms. Western Surety introduced an insurance
agents' and brokers' E&O insurance product in 1994 and had expanded this product
to 39 states as of December 31, 1997.
The following tables set forth, for each principal class of bonds, gross
written premiums and net written premiums, and the respective percentages of the
total for the first quarter of 1998 and 1997 and for the years ended December
31, 1997 and 1996. All tables in this section contain information reflecting the
pro forma
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<PAGE> 51
combined operations of CNA Surety, including Western Surety and USA results
prior to the Merger Date. As such, the financial information is not necessarily
indicative of the financial results that would have occurred under the ownership
and management of CNA Surety:
<TABLE>
<CAPTION>
GROSS WRITTEN PREMIUMS
-------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
THREE MONTHS ENDED MARCH 31, YEARS ENDED DECEMBER 31,
------------------------------------------- ---------------------------------------------
1998 % OF TOTAL 1997 % OF TOTAL 1997 % OF TOTAL 1996 % OF TOTAL
(PRO FORMA) (PRO FORMA) (PRO FORMA)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Commercial........... $30,689 48.1% $28,166 47.1% $120,660 45.3% $105,401 41.9%
Contract............. 26,200 41.0 25,120 42.0 123,014 46.2 124,477 49.6
Fidelity............. 4,434 6.9 4,241 7.1 15,762 5.9 15,134 6.0
E&O and other........ 2,525 4.0 2,252 3.8 6,982 2.6 6,402 2.5
------- ----- ------- ----- -------- ----- -------- -----
$63,848 100.0% $59,779 100.0% $266,418 100.0% $251,414 100.0%
======= ===== ======= ===== ======== ===== ======== =====
</TABLE>
<TABLE>
<CAPTION>
NET WRITTEN PREMIUMS
-------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
THREE MONTHS ENDED MARCH 31, YEARS ENDED DECEMBER 31,
------------------------------------------- ---------------------------------------------
1998 % OF TOTAL 1997 % OF TOTAL 1997 % OF TOTAL 1996 % OF TOTAL
(PRO FORMA) (PRO FORMA) (PRO FORMA)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Commercial........... $30,257 49.0% $26,213 46.7% $118,160 46.0% $ 97,407 41.4%
Contract............. 25,240 40.8 23,963 42.7 118,138 45.9 118,268 50.3
Fidelity............. 4,411 7.1 4,230 7.5 15,750 6.1 15,090 6.4
E&O and other........ 1,928 3.1 1,722 3.1 5,019 2.0 4,421 1.9
------- ----- ------- ----- -------- ----- -------- -----
$61,836 100.0% $56,128 100.0% $257,067 100.0% $235,186 100.0%
======= ===== ======= ===== ======== ===== ======== =====
</TABLE>
The following table sets forth for each principal class of bonds, the
number of bonds and policies in force and the respective percentage of the total
for the past two years:
<TABLE>
<CAPTION>
DOMESTIC BONDS/POLICIES IN FORCE
------------------------------------------------
(AMOUNTS IN THOUSANDS, AVERAGE LIMIT IN DOLLARS)
------------------------------------------------
AS OF DECEMBER 31,
------------------------------------------------
1997 % OF TOTAL 1996 % OF TOTAL
(PRO FORMA)
<S> <C> <C> <C> <C>
Commercial.................................... 1,475 82.2% 1,470 84.1%
Contract...................................... 30 1.7 26 1.5
Fidelity...................................... 95 5.3 94 5.4
E&O and other................................. 193 10.8 157 9.0
-------- ----- -------- -----
Total Bonds......................... 1,793 100.0% 1,747 100.0%
======== ===== ======== =====
Average domestic bond penalty/policy
limit(1).................................... $ 25,082 $ 24,883
======== ========
</TABLE>
- - ---------------
(1) The average bond penalty is a measure of the average limit of liability
associated with contract and commercial surety bonds in force at each
reporting period.
In 1997, the agency with which the Company did the most business generated
approximately $2.8 million of gross written premiums, or 1.1% of aggregate gross
written premiums. The ten agencies which did the most business with the Company
produced a total of $15.3 million or 5.8% of aggregate gross written premiums.
MARKETING
The Company markets its products in all 50 states, as well as the District
of Columbia and Puerto Rico. Its products are marketed primarily through
independent producers, including multi-line agents and brokers such as surety
specialists, many of whom are members of the National Association of Surety Bond
Producers.
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<PAGE> 52
CNA Surety enjoys broad national distribution of its products, which are
marketed through approximately 36,000 of the approximately 44,000 independent
property and casualty insurance agencies in the United States. In addition, the
Company employs 61 full-time salaried marketing representatives to continually
service its vast producer network. Relationships with these independent
producers are maintained through the Company's 49 local branch offices.
The following table sets forth the distribution of the pro forma combined
domestic business of the Company by state, based upon gross written premiums in
each of the last two years:
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
----------------
1997 1996
---- ----
<S> <C> <C>
Pro Forma Gross Written Premiums by State:
Texas..................................................... 12.7% 13.3%
California................................................ 7.0 7.8
Florida................................................... 5.6 5.8
New York.................................................. 4.5 4.8
Illinois.................................................. 4.0 4.1
Pennsylvania.............................................. 3.8 3.6
Michigan.................................................. 3.3 3.1
Louisiana................................................. 3.2 3.5
All Other................................................. 55.9 54.0
----- -----
Total....................................................... 100.0% 100.0%
===== =====
</TABLE>
Contract Surety
With respect to the contract surety business, the core focus for the
Company is contractors with less than $50 million in contracted work in
progress. This segment is comprised of small contractors (less than $5 million
in work in progress), medium contractors ($5-$25 million) and the lower end of
the large contractors ($25-$150 million). These small and medium contractors, as
a group, represent a significant portion of the United States construction
market. The Company has a small number of accounts with contracted work in
progress in excess of $150 million, the majority of which have been clients of
the Predecessor Operations for more than ten years. Some of these accounts are
maintained on a "co-surety" or joint insurer basis with other sureties in order
to manage aggregate exposure.
The Company's USA subsidiary expects to continue to focus its marketing
efforts on serving the needs of the small contractor. Contract bonds
underwritten by USA are primarily contractor performance and payment bonds in
amounts under $3.0 million. CNA Surety intends to leverage Western Surety's
diverse agency relationships and its nationwide branch structure to expand the
geographic and agency distribution of USA's small contract surety business.
CNA Surety also participates in the non-standard contract surety market,
utilizing the federal government's Small Business Administration ("SBA") surety
bond guarantee programs. The SBA programs provide 70%-90% coverage in exchange
for 10%-30% of the premium.
Commercial Surety
A large portion of the commercial surety market is comprised of small
obligations represented by licenses and permits that are routine in nature and
require minimal underwriting. Customers are focused principally on prompt and
efficient service. Western Surety will continue to focus its marketing efforts
on this small commercial bond market. Western Surety emphasizes one-day response
service, easy-to-use forms and an extensive array of commercial bond products.
In addition, independent agents are provided pre-executed bond forms, powers of
attorney, and facsimile authorizations that allow them to issue many standard
bonds in their offices.
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<PAGE> 53
While a large portion of the commercial surety market is represented by
small entities, the Company also intends to seek to service the bonding needs of
larger, "Fortune 1000" firms, where a high level of technical and underwriting
skill is required. These larger customers are sophisticated, professional buyers
of commercial surety bonds who demand exceptional service and business expertise
at a reasonable cost. The Company maintains a specific underwriting staff in its
Chicago home office and other underwriting centers across the country dedicated
to the "Fortune 1000" market.
CNA Surety's insurance subsidiaries also will direct their marketing to
particular industries or classes of bonds on a broad basis. For instance, the
Company maintains programs directed at notary bonds, mortgage broker compliance
bonds, games of chance bonds (guaranteeing payment of prizes from promotional
games) and grain warehouse dealers bonds (protecting funds associated with grain
storage).
UNDERWRITING
The underwriting philosophy of the Company is disciplined and focused on
consistent underwriting profitability. The extent and sophistication of
underwriting activity varies by type of risk. Contractor accounts and large
commercial surety customers undergo extensive credit, financial and managerial
review and analysis on a regular basis. Certain classifications of bonds, such
as fiduciary and court appeal bonds, also require more extensive underwriting.
The Company also targets various products in the surety and fidelity bond
market which are characterized by relatively low-risk exposure and small bond
amounts. The underwriting criteria, including the extent of bonding authority
granted to independent agents, will vary depending on the class of business and
the type of bond. For example, relatively little underwriting information is
typically required of certain low-exposure risks such as notary bonds.
REINSURANCE
CNA Surety's insurance subsidiaries, in the ordinary course of business,
cede insurance to other insurance companies to limit their exposure to loss,
provide greater diversification of risk and minimize aggregate exposures.
Because the ceding of insurance does not ordinarily discharge the primary
liability of the original insurer, CNA Surety management only places their
reinsurance with qualified carriers after conducting a detailed review of the
nature of the obligation and a thorough assessment of the reinsurers' credit
qualifications and claims settlement performance and capabilities. The
reinsurance coverages and terms are tailored to the specific risk
characteristics of the underlying products of the Company.
For contract and commercial surety business, exclusive of USA business, an
excess of loss reinsurance program is in effect. It provides for coverage on a
per principal basis, equal to $55 million in excess of a $5 million retention.
For the USA business only, the Company has per principal reinsurance coverage of
85% of losses up to $4.9 million in excess of $100,000. The Company is party to
the Excess of Loss Contract and the Second Excess of Loss Contract (collectively
referred to herein as the "Excess of Loss Contracts") with CCC which together
provide coverage in excess of $60 million, on a per principal basis. See
"Certain Relationships and Related Transactions." The Company limits its net
retention on its insurance agents and brokers E&O liability insurance product to
20% through a third party quota share reinsurance agreement. At March 31, 1998,
CNA Surety had a reinsurance receivable balance from CCC of $46.8 million. This
balance was primarily comprised of direct premium receivables of CCC with
respect to the surety business ceded to Western Surety.
At March 31, 1998, CNA Surety's largest non-affiliate reinsurance
receivable, including prepaid reinsurance premiums of $1.1 million, was
approximately $3.0 million with Transatlantic Reinsurance Company, which is
rated A+ (Superior) by A.M. Best.
RESERVES FOR UNPAID LOSSES AND LAE
The estimated liability for unpaid losses and LAE includes, on an
undiscounted basis, estimates of (a) the ultimate settlement value of reported
claims, (b) IBNR claims, (c) future expenses to be incurred in
52
<PAGE> 54
the settlement of claims and (d) claim recoveries, exclusive of reinsurance
recoveries which are reported as an asset. These estimates are determined based
on the Company's and surety industry loss experience as well as consideration of
current trends and conditions. The estimated liability for unpaid losses and LAE
is an estimate and there is the potential that actual future loss payments will
differ significantly from initial estimates. The methods of determining such
estimates and the resulting estimated liability are regularly reviewed and
updated. Changes in the estimated liability are reflected in operating income in
the year in which such changes are determined to be needed.
CNA Surety's insurance subsidiaries employ accepted reserving approaches in
establishing the estimated liability for unpaid losses and LAE that give
consideration to the inherent difficulty and variability in the estimation
process. In addition, CNA Surety utilizes independent actuarial firms of
national standing to conduct periodic reviews of claim procedures and loss
reserving practices, and annually obtains actuarial certification as to the
reasonableness of actuarial assumptions used and the sufficiency of year-end
reserves for each of its principal insurance subsidiaries.
The following table sets forth activity in the reserves for unpaid losses
and LAE and highlights the impact of favorable development of the estimated
liability established in prior periods:
<TABLE>
<CAPTION>
PREDECESSOR OPERATIONS
SEPTEMBER 30 -----------------------
(DATE OF INCEPTION) NINE MONTHS ENDED YEARS ENDED
THROUGH DECEMBER 31, SEPTEMBER 30, DECEMBER 31,
-------------------- ----------------- -----------------------
1997 1997(1) 1996 1995
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Reserves at beginning of period:
Gross................................ $122,281 $119,151 $138,657 $ 48,818
Ceded reinsurance.................... 7,273 15,467 24,531 13,770
-------- -------- -------- --------
Net reserves at beginning of period.... 115,008 103,684 114,126 35,048
Net reserves of CIC at May 10, 1995,
date of acquisition.................. -- -- -- 64,780
-------- -------- -------- --------
Total net reserves..................... 115,008 103,684 114,126 99,828
-------- -------- -------- --------
Net incurred loss and LAE:
Provision for insured events of
current period.................... 12,781 23,484 42,748 43,286
Decrease in provision for insured
events of prior periods........... (647) (35,000) (9,742) (10,846)
-------- -------- -------- --------
Total net incurred losses.............. 12,134 (11,516) 33,006 32,440
-------- -------- -------- --------
Net payments attributable to:
Current period events................ 4,256 4,307 7,728 1,648
Prior periods events................. 161 3,780 35,720 16,494
-------- -------- -------- --------
Total net payments..................... 4,417 8,087 43,448 18,142
-------- -------- -------- --------
Net reserves of Capsure at the Merger
Date................................. -- 30,927 -- --
Net reserves at end of period.......... 122,725 115,008 103,684 114,126
Ceded reinsurance at end of period..... 7,656 7,273 15,467 24,531
-------- -------- -------- --------
Gross reserves at end of period........ $130,381 $122,281 $119,151 $138,657
======== ======== ======== ========
</TABLE>
- - ---------------
(1) Amounts are for Predecessor Operations except for the net reserves of
Capsure and ceded reinsurance and gross reserves at the end of the period,
which are for CNA Surety.
53
<PAGE> 55
The following table sets forth a reconciliation of the consolidated loss
reserves reported in accordance with GAAP, and the reserves reported to state
insurance regulatory authorities in accordance with SAP for the year ended
December 31, 1997 (dollars in thousands):
<TABLE>
<S> <C>
Net reserves at end of year, GAAP basis..................... $122,725
Ceded reinsurance, net of salvage and subrogation........... 7,656
--------
Gross reserves at end of year, GAAP basis................... 130,381
Estimated salvage and subrogation recoverable (gross of
reinsurance), not anticipated under SAP................... 8,070
Estimated reinsurance recoverable netted against gross
reserves for SAP.......................................... (8,692)
--------
Net reserves at end of year, SAP basis...................... $129,759
========
</TABLE>
54
<PAGE> 56
The loss reserve development table below illustrates the change over time
of reserves established for the Company's estimated losses and LAE at the end of
various calendar years. The first section shows the reserves as originally
reported at the end of the stated year. The second section shows the cumulative
amounts paid as of the end of successive years with respect to that reserve
liability. The third section shows re-estimates of the original recorded reserve
as of the end of each successive year which is the result of management's
expanded awareness of additional facts and circumstances that pertain to the
unsettled claims. The last section compares the latest re-estimated reserve to
the reserve originally established, and indicates whether or not the original
reserve was adequate or inadequate to cover the estimated costs of unsettled
claims.
The loss reserve development table is cumulative as of each December 31,
and, therefore, ending balances should not be added since the amount at the end
of each calendar year includes activity for both the current and prior years.
The loss reserve development table reflects, on a pro forma basis, the reserves
of the Predecessor Operations and Capsure since 1987 and CIC since its
acquisition in May of 1995. Such historical development is not necessarily
indicative of the financial results that would have occurred under the ownership
and management of CNA Surety nor of future operating results.
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
----------------------------------------------------------------------------------------
1987 1988 1989 1990 1991 1992 1993 1994 1995
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net reserves for losses and
LAE....................... $50,609 $60,959 $58,685 $69,733 $60,425 $61,998 $64,627 $70,398 $147,911
Net Paid (cumulative) as of:
One year later.............. 12,532 11,700 7,618 13,456 16,287 17,636 12,923 12,018 42,552
Two years later............. 20,510 15,221 13,540 22,330 24,295 25,854 19,671 18,149 43,179
Three years later........... 22,251 17,823 18,033 26,835 29,857 29,495 21,990 21,229 --
Four years later............ 23,928 20,723 20,758 31,591 31,273 30,582 23,070 -- --
Five years later............ 26,152 22,575 22,089 32,133 31,909 30,817 -- -- --
Six years later............. 27,312 23,271 25,441 32,352 32,354 -- -- -- --
Seven years later........... 27,717 24,515 23,457 32,993 -- -- -- -- --
Eight years later........... 28,616 24,529 23,849 -- -- -- -- -- --
Nine years later............ 28,606 24,877 -- -- -- -- -- -- --
Ten years later............. 29,013 -- -- -- -- -- -- -- --
Net Reserves Re-estimated
as of:
End of initial year......... 50,609 60,959 58,685 69,733 60,425 61,998 64,627 70,398 147,911
One year later.............. 48,426 49,285 53,486 50,822 58,644 58,603 54,568 51,471 132,267
Two years later............. 43,530 44,495 39,131 51,330 51,511 54,585 44,749 44,135 103,466
Three years later........... 41,032 36,635 39,978 46,439 46,826 47,911 38,972 38,829 --
Four years later............ 38,256 37,200 34,357 42,946 42,212 42,542 28,094 -- --
Five years later............ 38,006 32,134 31,405 40,747 39,945 33,699 -- -- --
Six years later............. 34,184 29,816 31,777 38,131 36,164 -- -- -- --
Seven years later........... 33,899 29,392 26,646 36,179 -- -- -- -- --
Eight years later........... 32,932 26,831 25,464 -- -- -- -- -- --
Nine years later............ 30,634 25,514 -- -- -- -- -- -- --
Ten years later............. 29,580 -- -- -- -- -- -- -- --
------- ------- ------- ------- ------- ------- ------- ------- --------
Total net (deficiency)
redundancy................ $21,029 $35,445 $33,221 $33,554 $24,261 $28,299 $36,533 $31,569 $44,445
======= ======= ======= ======= ======= ======= ======= ======= ========
Cumulative redundancy
(deficiency) as a
percentage of original
estimate.................. 41.6% 58.1% 56.6% 48.1% 40.2% 45.6% 56.5% 44.8% 30.0%
======= ======= ======= ======= ======= ======= ======= ======= ========
<CAPTION>
AS OF DECEMBER 31,
-------------------
1996 1997
<S> <C> <C>
Net reserves for losses and
LAE....................... $137,064 $122,725
Net Paid (cumulative) as of:
One year later.............. 9,866 --
Two years later............. -- --
Three years later........... -- --
Four years later............ -- --
Five years later............ -- --
Six years later............. -- --
Seven years later........... -- --
Eight years later........... -- --
Nine years later............ -- --
Ten years later............. -- --
Net Reserves Re-estimated
as of:
End of initial year......... 137,064 122,725
One year later.............. 96,178 --
Two years later............. -- --
Three years later........... -- --
Four years later............ -- --
Five years later............ -- --
Six years later............. -- --
Seven years later........... -- --
Eight years later........... -- --
Nine years later............ -- --
Ten years later............. -- --
-------- --------
Total net (deficiency)
redundancy................ $ 40,886(1) --
======== ========
Cumulative redundancy
(deficiency) as a
percentage of original
estimate.................. 29.8% --
======== ========
</TABLE>
- - ---------------
(1) The $40,886 release of prior year reserves is comprised of $35,000 of
Predecessor Operations favorable reserve development and $5,239 of Capsure
favorable reserve development in the nine month period of 1997 prior to the
Merger and $647 of CNA Surety favorable reserve development for the period
from September 30, 1997 (date of inception) through December 31, 1997.
55
<PAGE> 57
CLAIMS
The Company maintains a dedicated staff of in-house claim specialists. All
claim handling is centralized in the three home office underwriting
locations -- Chicago, Sioux Falls and Houston. The disposition of claims and
other claim-related activity is done in accordance with established policies,
procedures and expense controls. Indemnity and subrogation rights exist on a
significant portion of the business written, enabling the Company to pursue loss
recovery.
ASBESTOS AND ENVIRONMENTAL MATTERS
The Company does not bond contractors that specialize in environmental
remediation work. The Company does, however, bond several accounts that have
incidental environmental exposure with respect to which the Company provides
limited bonding programs. In the commercial surety market, the Company provides
bonds to large corporations that are in the business of mining various minerals
and are obligated to post reclamation bonds that guarantee that property which
was disturbed during mining is returned to an acceptable condition when the
mining is completed. While no environmental responsibility is overtly provided
by commercial or contract bonds, some risk of environmental exposure may exist
if the surety were to assume certain rights of ownership in the property in the
completion of a defaulted project or through salvage recovery.
To date, the Company has not received any environmental claim notices nor
is management aware of any potential environmental claims.
COMPETITION
The surety and fidelity market is highly competitive. According to 1997
data published by the SAA, the U.S. market aggregates approximately $3.6 billion
in direct written premiums, comprised of approximately $2.7 billion in surety
premiums and approximately $0.9 billion in fidelity premiums. The large
diversified insurance companies hold the largest market shares. For example, the
20 largest surety companies account for nearly 73% of the surety market. On a
pro forma basis for 1997, according to such data, CNA Surety was the largest
direct writer of surety products.
Primary competitors of CNA Surety are approximately 20 national, multi-line
companies participating in the surety market throughout the country. Management
believes that its principal strengths are capacity, diverse product offering,
service and accessibility and long-term relationships with agents and accounts.
While the surety industry has experienced slow premium growth, competition has
increased as a result of ten years of profitable underwriting experience. This
competition has typically manifested itself through reduced premium rates and
greater tolerance for relaxation of underwriting standards. Management believes
such competition will continue.
A.M. BEST RATINGS
A.M. Best ratings are based on an evaluation of a company's financial
strength (leverage/capitalization, capital structure/holding company, quality
and appropriateness of reinsurance program, adequacy of loss/policy reserves,
and quality and diversification of assets), operating performance
(profitability, revenue composition, and management experience and objectives)
and market profile (market risk, competitive market position, spread of risk,
and event risk) as compared to A.M. Best's quantitative and qualitative
standards. Western Surety and USA are currently rated A+ (Superior) and A
(Excellent), respectively, by A.M. Best. CCC is currently rated A (Excellent) by
A.M. Best. A.M. Best's letter ratings range from A++ (Superior) to C- (Weak)
with A++ being highest. An A+ (Superior) rating is assigned to those companies
which A.M. Best believes, on balance, have superior financial strength,
operating performance and market profile when compared to the standards
established by A.M. Best. A+ (Superior) rated insurers have been shown to be
among the strongest in ability to meet policyholder and other contractual
obligations. A rating of A (Excellent) is assigned to those companies which A.M.
Best believes have, on balance, excellent financial strength, operating
performance and market profile when compared to the standards established by
A.M. Best.
56
<PAGE> 58
REGULATION
CNA Surety's insurance subsidiaries are subject to varying degrees of
regulation and supervision in the jurisdictions in which they transact business
under statutes which delegate regulatory, supervisory and administrative powers
to state insurance regulators. In general, an insurer's state of domicile has
principal responsibility for such regulation which is designed generally to
protect policyholders rather than investors and relates to matters such as the
standards of solvency which must be maintained; the licensing of insurers and
their agents; the examination of the affairs of insurance companies, including
periodic financial and market conduct examinations; the filing of annual and
other reports, prepared on a statutory basis, on the financial condition of
insurers or for other purposes; establishment and maintenance of reserves for
unearned premiums and losses; and requirements regarding numerous other matters.
Licensed or admitted insurers generally must file with the insurance regulators
of such states, or have filed on its behalf, the premium rates and bond and
policy forms used within each state. In some states, approval of such rates and
forms must be received from the insurance regulators in advance of their use.
Western Surety is domiciled in South Dakota and licensed in all 50 states
and the District of Columbia. SBCA is domiciled in South Dakota and licensed in
23 states. USA is domiciled in Texas and licensed in 42 states and the District
of Columbia.
Insurance regulations also generally require registration and periodic
disclosure of certain information concerning ownership, financial condition,
capital structure, general business operations and any material transactions or
agreements by or among affiliates. Such regulation also typically restricts the
ability of any one person to acquire 10% or more, either directly or indirectly,
of a company's stock without prior approval of the applicable insurance
regulatory authority. In addition, dividends and other distributions to
stockholders generally may be paid only out of unreserved and unrestricted
statutory earned surplus. Such distributions may be subject to prior regulatory
approval, including a review of the implications on RBC requirements. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations... -- Liquidity and Capital Resources."
CNA Surety's insurance subsidiaries are subject to periodic financial and
market conduct examinations. These examinations are generally performed by the
domiciliary state insurance regulatory authorities. The South Dakota Department
of Commerce and Regulation -- Division of Insurance (the "South Dakota
Department") recently concluded its financial and market conduct examination of
Western Surety for the five year period ended December 31, 1996. The South
Dakota Department made a finding of non-compliance with respect to the Company's
practices regarding return of premiums and recommended that Western Surety
change its current procedures regarding the return of premium. The Company is
disputing the South Dakota Department's interpretation of the applicable
statutes and intends to seek an agreement with the South Dakota Department not
to take action against the Company until remedial legislation can be passed
regarding the applicable statutes, which would eliminate any non-compliance by
the Company with such statutes. Although CNA Surety management disputes such
recommendation, management does not believe that such changes in procedures, if
ultimately required, will have a material adverse effect on the Company.
The South Dakota Department's previous examination of Western Surety was as
of December 31, 1991 covering both financial and market conduct procedures. The
Texas Department of Insurance conducted its last examination of USA as of
December 31, 1996. This examination included financial matters. There were no
significant issues noted which required corrective action by any of the
insurance subsidiaries.
Certain states in which CNA Surety's insurance subsidiaries conduct their
business require insurers to join a guaranty association. Guaranty associations
provide protection to policyholders of insurers licensed in such states against
the insolvency of those insurers. In order to provide the associations with
funds to pay certain claims under policies issued by insolvent insurers, the
guaranty associations charge members assessments based on the amount of direct
premiums written in that state. Such assessments were not material to the
Predecessor Operations nor to Capsure's results of operations.
Western Surety and USA each qualifies as an acceptable surety for federal
and other public works project bonds pursuant to U.S. Department of Treasury
regulations. The underwriting limitations of Western Surety and USA, based on
each insurer's statutory surplus, are currently $3.4 million and $1.2 million
per bond, respectively. Pursuant to the Quota Share Treaty and the Services and
Indemnity Agreement with CCC, the
57
<PAGE> 59
Company is permitted to issue bonds utilizing CCC's $345.3 million per bond U.S.
Treasury underwriting limitation. See "Certain Relationships and Related
Transactions."
INVESTMENTS
CNA Surety's insurance company investment practices must comply with
insurance laws and regulations and must also comply with certain covenants under
CNA Surety's $130 million Credit Facility. Generally, insurance laws and
regulations prescribe the nature and quality of, and set limits on, the various
types of investments which may be made by CNA Surety's insurance subsidiaries.
See "Regulation" in this Section.
The Company's investment portfolios generally are managed to maximize after
tax investment returns, while minimizing credit risks with investments
concentrated in high quality, fixed income securities. The Company's portfolios
are managed to provide diversification by limiting exposures to any one issue or
issuer, and to provide liquidity by investing in the public securities markets.
The portfolios are structured to support the Company's operations and consider
the expected duration of liabilities and short-term cash needs.
An investment committee of the Board establishes investment policy and
oversees the management of each portfolio. A professional independent investment
adviser has been engaged to assist in the management of each of the Company's
insurance subsidiaries investment portfolio pursuant to established investment
committee guidelines. The insurance subsidiaries pay an advisory fee based on
the market value of the assets under management.
The estimated fair value and amortized cost of fixed income securities held
by the Company as March 31, 1998, by investment category, and the gross
unrealized gains and losses were as follows:
<TABLE>
<CAPTION>
AMORTIZED GROSS GROSS ESTIMATED
COST OR UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
FIXED INCOME SECURITIES:
U.S. Treasury securities and obligations of U.S.
Government corporations and agencies:
U.S. Treasury....................................... $ 59,060 $ 220 $ -- $ 59,280
U.S. Agency......................................... 63,701 388 (148) 63,941
CMOs................................................ 34,551 103 (70) 34,584
Mortgage pass-through securities.................... 32,198 61 (3) 32,256
Obligations of states and political subdivisions...... 79,784 206 (525) 79,465
Corporate bonds....................................... 58,706 331 (362) 58,675
Non-agency CMOs....................................... 29,391 40 (120) 29,311
Asset-backed securities:
Second mortgages/home equity loans.................. 20,101 206 (5) 20,302
Credit card receivables............................. 6,483 24 -- 6,507
Other underlying assets............................. 5,075 4 (4) 5,075
-------- ------ ------- --------
Total fixed income securities....................... $389,050 $1,583 $(1,237) $389,396
======== ====== ======= ========
</TABLE>
Short-term investments are generally comprised of U.S. Treasury bills,
corporate notes, money market funds and investment grade commercial paper
equivalents.
58
<PAGE> 60
The amortized cost and estimated fair value of fixed income securities at
March 31, 1998, by contractual maturity, are shown below. Actual maturities will
differ from contractual maturities as securities may be called or prepaid with
or without call or prepayment penalties:
<TABLE>
<CAPTION>
AMORTIZED ESTIMATED
COST FAIR VALUE
--------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
FIXED INCOME SECURITIES:
Due within one year......................................... $ 2,732 $ 2,733
Due after one year but within five years.................... 110,156 110,750
Due after five years but within ten years................... 76,281 75,847
Due after ten years......................................... 72,083 72,032
-------- --------
261,252 261,362
Mortgage pass-through securities, CMOs and
asset-backed securities................................... 127,798 128,034
-------- --------
$389,050 $389,396
======== ========
</TABLE>
The following table sets forth the rating assigned by S&P or Moody's of the
fixed income securities portfolio of the Company as of March 31, 1998:
<TABLE>
<CAPTION>
CREDIT RATING FAIR VALUE PERCENT
------------- ----------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
AAA/Aaa..................................................... $302,482 77.7%
AA/Aa....................................................... 23,557 6.0
A/A......................................................... 51,286 13.2
BBB......................................................... 12,071 3.1
-------- -----
Total............................................. $389,396 100.0%
======== =====
</TABLE>
As of March 31, 1998, 100% of the Company's fixed income securities were
considered investment grade by S&P and/or Moody's, and 84% were rated at least
AA by those agencies. In addition, the Company's investments in fixed income
securities did not contain any significant geographic or industry concentration
of credit risk.
NET OPERATING LOSS TAX CARRYFORWARDS
In July 1986, Capsure emerged from voluntary bankruptcy proceedings under
Chapter 11 of the United States Bankruptcy Code. Prior to its emergence, Capsure
was primarily involved in oil and gas production, exploration and development
and providing supplies to the oil and gas industry. Due to a significant
downturn in the oil and gas industry in the early 1980s, Capsure generated
significant losses and was unable to meet its obligations, resulting in its
voluntary bankruptcy filing. Upon emergence from bankruptcy, Capsure had
approximately $300 million in NOLs. The IRS has not audited Capsure's tax
returns for the years in which it reported net operating losses.
Capsure had approximately $100.7 million of these NOLs available at the
Merger Date to reduce its future federal taxable income, of which $50.7 million
expired on December 31, 1997. Under Section 382 of the Code, significant
restrictions on CNA Surety's ability to utilize Capsure's NOL carryovers apply
because of the ownership change as a result of the Merger.
EMPLOYEES
As of December 31, 1997, the Company employed approximately 840 persons.
Since its emergence from bankruptcy in 1986 through the time of the Merger,
Capsure did not experience any work stoppages nor had the Predecessor Operations
ever experienced a work stoppage. Since the formation of CNA Surety and the
59
<PAGE> 61
Merger, CNA Surety has not experienced any work stoppages and CNA Surety
believes its relations with its employees are good.
LEGAL PROCEEDINGS
The Company is a party to numerous lawsuits arising in the normal course of
business. The Company believes the resolution of these lawsuits will not have a
material adverse effect on its financial condition, results of operations or
cash flows.
PROPERTIES
CNA Surety leases its executive offices and its shared branch locations
with CCC under an Administrative Services Agreement. CNA Surety currently uses
approximately 72,500 square feet and related personal property at 41 branch
locations and its home and executive offices (15,243 square feet), in Chicago,
Illinois. CNA Surety's annual rent for this space is approximately $1.6 million.
CNA Surety may terminate its use of these locations as set forth in the
Administrative Services Agreement, without penalty, by providing CCC with 60
days written notice.
Western Surety leases office space for its executive offices at 101 South
Phillips Avenue, Sioux Falls, South Dakota 57104, under a lease expiring in
2002. Western Surety's office space, consisting of approximately 81,600 square
feet, is leased from a partnership in which Western Surety owns a 50% interest.
The annual rent, which is subject to annual adjustments, was $1.5 million as of
December 31, 1997. Western Surety also leases a 7,900 square foot branch office
in Dallas, Texas. Annual rent for the branch office was $0.2 million and the
lease expires in 1999. USA leases office space for its executive offices at 950
Echo Lane, Suite 250, Houston, Texas 77024, under a lease terminating in the
year 2000 with an annual rent of $0.2 million. USA also leases space for 7
branch offices for an additional annual rent of approximately $0.1 million.
60
<PAGE> 62
MANAGEMENT OF THE COMPANY
The directors and executive officers of the Company are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Giorgio Balzer............................ 58 Director
Philip H. Britt........................... 52 Director
David T. Cumming.......................... 54 Director
Rod F. Dammeyer........................... 58 Director
Melvin Gray............................... 65 Director
Joe P. Kirby.............................. 44 Director
Roy E. Posner............................. 65 Director
Adrian M. Tocklin......................... 46 Director
Robert T. Van Gieson...................... 53 Director and Chairman of the Board
Mark C. Vonnahme.......................... 49 President, Chief Executive Officer and Director
Robert E. Ayo............................. 57 Vice President and Chief Underwriting Officer -
Contract Surety
Michael Dougherty......................... 39 Vice President and Chief Marketing Officer
Melita Geoghegan.......................... 51 Vice President and Chief Human Resources Officer
Thomas P. Greasel......................... 59 Vice President and Chief Claims Officer
John S. Heneghan.......................... 36 Vice President and Chief Financial Officer
Dan L. Kirby.............................. 51 Executive Vice President - Legislative Affairs
Paul T. Lively............................ 49 Vice President - Business Development and Secretary
John L. McReynolds........................ 57 President and Chief Operating Officer of USA
Stephen T. Pate........................... 51 President and Chief Operating Officer of Western
Surety
Thomas A. Pottle.......................... 38 Vice President and Chief Operations Officer
Sharon A. Sartori......................... 42 Vice President and Chief Underwriting Officer -
Commercial Surety
William Pate.............................. 34 Director-Designee
</TABLE>
The following is certain additional information concerning each director
and executive officer of the Company, including positions and offices with the
Company, present principal occupation or employment and material occupations and
employment for the past five years.
GIORGIO BALZER, Director of CNA Surety since September 30, 1997. Chairman and
Chief Executive Officer, Businessmen's Assurance Company of America since 1990;
U.S. representative for Assicurazioni Generali, S.p.A. Director of Commerce
Bancshares, Inc.
PHILIP H. BRITT, Director of CNA Surety since March 1998. Senior Vice President,
Insurance Industry Division of First Chicago NBD Corporation since April 1988;
various other positions with First Chicago NBD Corporation - The First National
Bank of Chicago from 1982 through April 1988. Member of the Association of
Insurance and Financial Analysts.
DAVID T. CUMMING, Director of CNA Surety since December 1996. Secretary of the
Company from December 1996 until September 30, 1997; Executive Vice President -
Mergers and Acquisitions, CNA Commercial Insurance, a business unit of CNAF,
since January 1998; Deputy General Counsel of all insurance subsidiaries of
CNAF, including CCC and CIC, from 1993 until January 1998.
ROD F. DAMMEYER, Director of CNA Surety since September 30, 1997. Managing
Partner of EGI Corporate Investments, a division of Equity Group Investments,
Inc. ("EGI"), since January 1996; Director since 1985 and Vice Chairman of
Anixter International, Inc. ("Anixter") since February 1998; President from 1985
until February 1998 and Chief Executive Officer from 1993 until February 1998 of
Anixter. Director of ANTEC Corporation, Groupo Azucarero Mexico, IMC Global
Inc., Jacor Communications, Inc., Metal Management,
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Inc., Stericycle, Inc., TeleTech Holdings, Inc., Transmedia Network, Inc., and
Trustee of several Van Kampen American Capital, Inc. closed-end mutual funds.
MELVIN GRAY, Director of CNA Surety since September 30, 1997. Chairman and Chief
Executive Officer since 1982 and various other positions since 1962 of Graycor,
Inc. Member Board of Advisors of the Construction Industry Institute.
JOE P. KIRBY, Director of CNA Surety since September 30, 1997. Director of
Western Surety since 1979; President from 1979 until 1995 and Chief Executive
Officer of Western Surety from 1979 until September 30, 1997. Mr. Kirby is the
brother of Dan L. Kirby.
ROY E. POSNER, Retired. Director of CNA Surety since September 30, 1997. Chief
Financial Officer and Senior Vice President of Loews Corporation, the parent
corporation of CNAF, from 1985 until February 1997.
ADRIAN M. TOCKLIN, Director of CNA Surety since September 30, 1997 and Chairman
of the Board from September 30, 1997 until March 1998. President, CNA
Diversified Operations, a business unit of CNAF, from May 1995 until April 1998.
President and Chief Operating Officer of The Continental Corporation
("Continental") and all of its insurance subsidiaries from June 1994 until May
1995; Executive Vice President of Continental from September 1992 until June
1994; various other positions with Continental since December 1974; Director of
SONAT, Inc. and Trustee of George Washington University.
ROBERT T. VAN GIESON, Director of CNA Surety and Chairman of the Board since
March 1998. President and Chief Executive Officer, CNA Global Operations, a
business unit of CNAF, since December 1997; President and Chief Executive
Officer, CNA Global Operations Group, from July 1996 until December 1997;
Chairman and Chief Executive Officer of Chubb Insurance Co. of Europe from 1990
until 1996; Director of First Insurance Company of Hawaii, Associated Aviation
Underwriters, and International Insurance Society.
MARK C. VONNAHME, Director, President and Chief Executive Officer of CNA Surety
since September 1997. Group Vice President and Senior Surety Officer of all CNAF
insurance subsidiaries, including CCC and CIC, from August 1993 until September
30, 1997. Vice President, Contract Surety Division of CCC from January 1993
until August 1993; and Assistant Vice President, Contract Surety Division of
CCC, from 1991 until January 1993. Director of Surety Association of America.
ROBERT E. AYO, Vice President and Chief Underwriting Officer - Contract Surety
of CNA Surety since September 30, 1997. Vice President and Chief Contract
Underwriting Officer, Surety of all insurance subsidiaries of CNAF, including
CCC and CIC, from March 1995 until September 30, 1997; Assistant Vice President
and Underwriting Manager, Contract Surety of CCC, from January 1993 until March
1995; Underwriting Manager, Contract Surety of CCC from 1985 until January 1993.
MICHAEL A. DOUGHERTY, Vice President and Chief Marketing Officer of CNA Surety
since November 1997. Senior Vice President Aon Risk Services of Illinois from
April 1992 until November 1997.
MELITA H. GEOGHEGAN, Vice President and Chief Human Resources Officer of CNA
Surety since September 30, 1997. Assistant Vice President of Human Resources,
Surety Division of CCC from 1996 until September 30, 1997, and various positions
with CCC from 1993 to 1996.
THOMAS P. GREASEL, Vice President and Chief Claims Officer of CNA Surety since
September 30, 1997. Vice President and Director of Surety Claims for CCC from
1993 until September 30, 1997.
JOHN S. HENEGHAN, Vice President and Chief Financial Officer of CNA Surety since
September 30, 1997. Vice President of Capsure from December 1995 and Controller
of Capsure from June 1994 until September 30, 1997; and various positions,
including Senior Audit Manager, with Deloitte & Touche LLP from 1984 until June
1994.
DAN L. KIRBY, Executive Vice President - Legislative Affairs of CNA Surety since
September 30, 1997. Vice President, General Counsel and Secretary of Western
Surety from 1974 until September 30, 1997. Mr. Kirby is the brother of Joe P.
Kirby.
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PAUL T. LIVELY, Vice President - Business Development of CNA Surety since March
1998 and Secretary of CNA Surety since May 1998. Assistant Secretary from March
1998 until May 1998. Practicing attorney from 1988 until 1997 with Querrey &
Harrow, Ltd.
JOHN L. MCREYNOLDS, President and Chief Operating Officer of USA since January
1, 1998. Executive Vice President of USA from 1984 until December 31, 1997.
STEPHEN T. PATE, President and Chief Operating Officer of Western Surety since
June 1995. Executive Vice President of Western Surety from October 1994 until
June 1995; President, Surety Profit Center of CIC from April 1993 until October
1994; and Regional Vice President, Surety of CIC from June 1991 until April
1993.
THOMAS A. POTTLE, Vice President and Chief Operations Officer of CNA Surety
since September 1997. Secretary of CNA Surety from September 30, 1997 until May
1998. Assistant Vice President and Surety Controller of CNA from 1996 until
September 1997; Surety Controller of CCC from September 1994 until 1996; and
various positions with CCC from 1986 until September 1994.
SHARON A. SARTORI, Vice President and Chief Underwriting Officer - Commercial
Surety of CNA Surety since November 1997. Commercial Surety Territorial
Underwriting Officer of CNA Surety from September 30, 1997 until November 1997;
and various positions, including Assistant Vice President and Territorial
Underwriting Officer, of CCC from 1993 until September 30, 1997.
WILLIAM PATE, Director - Designee. Director - Mergers and Acquisitions of EGI
since February 1994 and Associate, Credit Suisse First Boston prior to February
1994. Mr. Pate has been designated and has consented to become a Director
immediately after the effectiveness of the Registration Statement of which this
Prospectus forms a part.
BOARD AND COMMITTEES
The Board has an Executive Committee which consists of Ms. Tocklin and
Messrs. Van Gieson and Vonnahme. The Executive Committee possesses and may
exercise the full and complete authority of the Board in the management and
business affairs of the Company during the intervals between the meetings of the
Board. All action by the Executive Committee is reported to the Board at its
next meeting and such action is subject to revision and alteration by the Board,
provided that no rights of third persons can be prejudicially affected by the
subsequent action of the Board. Vacancies on the Executive Committee are filled
by the Board. However, during the temporary absence of a member of the Executive
Committee, due to illness or inability to attend a meeting or for other cause,
the remaining member(s) of the Executive Committee may appoint a member of the
Board to act in the place and with all the authority of such absent member.
CNA Surety also has an Audit Committee which consists of Messrs. Dammeyer,
Gray and Posner (Chair). The Audit Committee is authorized and has the power to
review such procedures of the Company and its subsidiaries regarding the
appointment of the independent auditors, the scope and fees of prospective
annual audits and results thereof, compliance with the accounting and financial
policies of the Company, management's procedures and policies relative to the
adequacy of CNA Surety's internal accounting controls and review of any and all
related party agreements and arrangements between CNA Surety and its affiliates,
as well as any disputes that may arise thereunder.
CNA Surety also has a Compensation Committee which consists currently of
Messrs. Balzer, Britt and J. Kirby (Chair). The Compensation Committee reviews
and administers all compensation matters for the five most highly compensated
executive officers of the Company as well as its stock option plans.
Finally, CNA Surety also has an Investment Committee which consists of
Messrs. J. Kirby, Posner, Van Gieson, and Vonnahme and Ms. Tocklin. The
Investment Committee establishes investment policies and oversees the management
of the Company's investment portfolios.
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<PAGE> 65
EXECUTIVE COMPENSATION
The following tables show information with respect to the annual
compensation (including option grants) for services rendered to CNA Surety (or
its predecessors) for the year ended December 31, 1997 by the chief executive
officer and those persons who were, at December 31, 1997, the four other most
highly compensated executive officers of CNA Surety. CNA Surety began operations
following the Merger which was consummated on September 30, 1997. Accordingly,
compensation for prior years has been omitted.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
NUMBER OF
SECURITIES
OTHER ANNUAL UNDERLYING ALL OTHER
SALARY(1) BONUS(1) COMPENSATION(1) OPTIONS COMPENSATION(1)
NAME AND PRINCIPAL POSITION YEAR ($) ($) ($) GRANTED(#) ($)
- - --------------------------- ---- --------- --------- --------------- ---------- ---------------
<S> <C> <C> <C> <C> <C> <C>
Mark C. Vonnahme............ 1997 264,519 114,700(2) 13,646(3) 30,000 27,260(4)
President and Chief
Executive Officer of CNA
Surety
John T. Knox................ 1997 253,120 300,000(5) 0 20,000 705,577(6)
Former President and Chief
Executive Officer of USA and
Former Director of the
Company
Dan L. Kirby................ 1997 239,807 125,000 444(7) 15,000 524,557(8)
Vice President, Legislative
Affairs of CNA Surety
Stephen T. Pate............. 1997 262,500 312,500(5) 5,970(9) 20,000 4,800(10)
President and Chief
Operating Officer of Western
Surety
Robert E. Ayo............... 1997 165,384 99,100(2) 326(11) 20,000 12,984(12)
Vice President and Chief
Underwriting Officer,
Contract Surety of CNA
Surety
</TABLE>
- - ---------------
(1) Includes salary, bonus, other annual and all other compensation paid prior
to the Merger, on September 30, 1997, by CCC and Capsure for Messrs.
Vonnahme and Ayo and for Messrs. Knox, Kirby and Pate, respectively.
(2) Includes transaction completion bonus of $4,700 for Mr. Vonnahme and $3,000
for Mr. Ayo.
(3) Includes $11,646 for health club and country club dues and $2,000 for
income tax preparation.
(4) Includes $15,173 of CCC distributions from the CNAF supplemental savings
plan, $6,720 of 401(k) plan company matching contributions to both the CNA
and CNA Surety sponsored plans, $3,610 CCC paid automobile lease, $721 of
CCC paid contributions on a life insurance policy owned by him and a $1,036
CCC paid retirement gift.
(5) Includes transaction and retention bonuses paid by Capsure of $250,000 for
Mr. Knox and $312,500 for Mr. Pate.
(6) Includes $671,216 paid by the Company in connection with the termination of
his employment contract, $22,782 for Company paid automobile lease, $6,959
for Company paid contributions on a life insurance policy owned by him and
$4,620 of 401(k) plan company matching contributions.
(7) Includes $444 of reimbursements of health club dues.
(8) Includes $519,757 in connection with the exercise of Capsure stock options
and $4,800 for 401(k) plan company matching contributions.
(9) Includes $384 of reimbursements of health club dues and $5,586 for Company
paid country club membership dues.
(10) For 401(k) plan Company matching contributions.
(11) For CCC reimbursement of health club dues.
(12) Includes $6,219 of 401(k) plan company matching contributions to both the
CNA and CNA Surety sponsored plans, $3,691 CCC paid automobile lease,
$2,038 of CCC paid contributions on a life insurance policy owned by him
and a $1,036 CCC paid retirement gift.
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<PAGE> 66
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS POTENTIAL REALIZABLE VALUE
-------------------------------- AT ASSUMED ANNUAL RATES
NUMBER OF % OF TOTAL OF STOCK PRICE
SECURITIES GRANTED TO APPRECIATION FOR OPTION
UNDERLYING EMPLOYEES EXERCISE OR TERM
OPTIONS GRANTED DURING BASE PRICE EXPIRATION --------------------------
NAME (#)(1) FISCAL YEAR(2) ($/SH) DATE 5%($) 10%($)
---- --------------- -------------- ----------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Mark C. Vonnahme......... 30,000 6.5% 15.875 10/03/07 299,550 758,550
Robert E. Ayo............ 20,000 4.3% 15.875 10/03/07 199,700 505,700
Dan L. Kirby............. 15,000 3.2% 15.875 10/03/07 149,775 379,275
John T. Knox............. 20,000(3) 4.3% 15.875 10/03/07 0(3) 0
Stephen T. Pate.......... 20,000 4.3% 15.875 10/03/07 199,700 505,700
</TABLE>
- - ---------------
(1) The options granted during 1997 are exercisable after October 3, 2000.
(2) 463,500 non-qualified stock options were granted to employees of the Company
during the three month period ending December 31, 1997.
(3) These options were forfeited as a result of Mr. Knox's resignation as
President and Chief Executive Officer of USA effective December 31, 1997.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTION VALUE
<TABLE>
<CAPTION>
VALUE OF
UNEXERCISED
NUMBER OF IN-THE-MONEY
UNEXERCISED OPTIONS OPTIONS AT
AT FY-END (#) FY-END ($)
SHARES ACQUIRED VALUE (1)EXERCISABLE/ (1)EXERCISABLE/
NAME ON EXERCISE (#) REALIZED($) UNEXERCISABLE UNEXERCISABLE
---- --------------- ----------- ------------------- ---------------
<S> <C> <C> <C> <C>
Mark C. Vonnahme..................... 0 0 0/30,000 0/0
Robert E. Ayo........................ 0 0 0/20,000 0/0
Dan L. Kirby......................... 39,190 519,757 15,000/15,000 169,064/0
John T. Knox......................... 0 0 40,718/0 511,520/0
Stephen T. Pate...................... 0 0 11,250/23,750 139,922/46,641
</TABLE>
- - ---------------
(1)Exercisable options for Messrs. D. Kirby, Knox and Pate relate to options
issued under CNA Surety's Replacement Stock Option Plan in connection with
the Merger. The Replacement Stock Option Plan reserved shares for issuance to
former Capsure option holders with the same price, rights, benefits, terms
and conditions as the Capsure options replaced.
COMPENSATION OF DIRECTORS
Directors, except for employees of the Company or its affiliates, are
compensated at the annual rate of $25,000, paid in quarterly installments, and
receive $1,500 for each meeting of the Board and committees of the Board which
they attend. The CNA Surety Corporation Non-Employee Directors Deferred
Compensation Plan (the "Plan") provides that non-employee Directors may elect
under the Plan to defer receipt of their annual compensation and have such
compensation deemed invested in stock units, which may then be distributed under
certain circumstances in the form of Common Stock.
EMPLOYMENT CONTRACTS
The Company entered into an employment agreement with Mark C. Vonnahme on
October 3, 1997. The agreement runs from October 1, 1997 through December 31,
1999, with automatic one-year renewals unless the Company or Mr. Vonnahme
provides the other party with thirty days written notice of intent not to renew.
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<PAGE> 67
The agreement provides for a minimum annual base salary of $300,000 that may be
adjusted annually by the Board, an annual bonus, a long-term incentive
compensation program, and stock options. As part of the agreement, Mr. Vonnahme
has agreed to certain confidentiality, non-competition, and non-solicitation
provisions.
The Company also entered into a two-year employment agreement with Dan L.
Kirby, effective October 1, 1997. The agreement provides for an annual base
salary of $200,000 and provides for additional compensation in the form of an
annual bonus, a long-term incentive compensation program, and stock options. The
agreement also provides a severance payment, equal to the discounted present
value of the salary that Mr. Kirby would have received through the term of the
agreement, if the Company terminates his employment without cause. As part of
the agreement, Mr. Kirby has agreed to certain confidentiality, non-
competition, and non-solicitation provisions.
The Company also maintained predecessor employment agreements with John T.
Knox, Jr. and Stephen T. Pate, entitling each to annual base salaries of
$262,500. Mr. Knox resigned as President and Chief Executive Officer of USA,
effective December 31, 1997 and received payment in the amount of $671,216 for
the discounted value of the base salary on the remaining term of his employment
contract. Although Mr. Pate's employment agreement expired on April 14, 1998,
Mr. Pate continues to be employed by the Company in the same capacities without
the benefit of an employment agreement.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The members of CNA Surety's Compensation Committee are Messrs. Balzer,
Britt and J. Kirby.
Mr. J. Kirby is a director of CNA Surety and was a former officer and
director of Capsure. Mr. J. Kirby is the brother of D. Kirby, who is currently
an officer of CNA Surety and was a director of Capsure.
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<PAGE> 68
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
CCC and the CNA Surety insurance subsidiaries have entered into various
reinsurance agreements designed to protect against adverse loss reserve
development related to the Predecessor Operations' reserves at the Merger Date,
and to help preserve, through the year 2000, the profitability of the
Predecessor Operations and certain additional accounts. The reinsurance
agreements, together with the Services and Indemnity Agreement that is described
below, also effected the transfer of the Predecessor Operations to CNA Surety's
insurance subsidiaries. The reinsurance agreements entered into in connection
with the Merger are: (i) the Quota Share Treaty; (ii) the Stop Loss Contract;
and (iii) the Excess of Loss Contract.
Surety Quota Share Treaty
Through the Quota Share Treaty, CCC and CIC as of the Merger Date (i)
transferred the Predecessor Operations from CCC to Western Surety, including the
net loss reserves, allocated and unallocated LAE reserves, and the reserves for
IBNR losses (collectively, the "Reserves") and unearned premium reserves as of
the Merger Date as well as cash and other statutorily admitted assets equal to
such Reserves plus unearned premium reserves and (ii) provided a guarantee to
Western Surety regarding the adequacy of the Reserves transferred to Western
Surety on the Merger Date.
Specifically, CCC transferred to Western Surety 100% of the net liabilities
of then existing Predecessor Operations under surety bonds written or renewed by
CCC prior to the Merger Date. CCC effected the transfer of the existing
Predecessor Operations by paying Western Surety an amount in cash and other
statutorily net admitted assets (insurance premium receivables minus expenses
accrued for statutory reporting purposes) equal to (i) CCC's net unearned
premium reserves relating to the in-force Predecessor Operations as of the
Merger Date, plus (ii) the Reserves for all Predecessor Operations' business
written or assumed prior to the Merger Date, and minus (iii) a ceding commission
of $29 million to be retained by CCC, which reimbursed CCC for acquisition
expenses incurred by CCC in connection with the net unearned premium reserves
being transferred. CCC transferred to Western Surety all of the Predecessor
Operations' business written or renewed by CCC after the Merger Date by
transferring the related liabilities of such business and paying to Western
Surety an amount in cash equal to CCC's net written premiums on all such
business, minus a quarterly ceding commission to be retained by CCC equal to
$50,000 plus 28% of net written premiums on such business. For the quarter ended
March 31, 1998, CCC and CIC paid Western Surety, net of commissions and
reinsurance loss payments, $22.5 million under the Quota Share Treaty and the
Company had a reinsurance receivable balance from CCC and CIC of $46.8 million.
This balance is primarily comprised of direct premium receivables of CCC and CIC
with respect to the surety business ceded to Western Surety.
CCC also agreed to guarantee the Reserves transferred to Western Surety by
agreeing to pay to Western Surety within 30 days following the end of each
calendar quarter the amount of any adverse development on such Reserves, as
reestimated as of the end of such calendar quarter.
The Quota Share Treaty has a term of five years from the Merger Date.
Notwithstanding the Quota Share Treaty's term, the provisions of the Quota Share
Treaty shall continue to apply until all obligations of the parties have been
performed, including the guarantee with respect to the adequacy of the Reserves.
CCC shall be responsible for losses on business covered by the Quota Share
Treaty which are discovered within three years after its termination.
Aggregate Stop Loss Reinsurance Contract
The Stop Loss Contract entered into on the Merger Date will protect CNA
Surety from adverse loss experience on certain business underwritten after the
Merger Date. The Stop Loss Contract between CNA Surety's insurance subsidiaries
and CCC limits the CNA Surety insurance subsidiaries' prospective net loss
ratios with respect to certain accounts and lines of insured business for at
least three fiscal years following the Merger Date. In the event the CNA Surety
insurance subsidiaries' accident year net loss ratio exceeds the Loss Ratio Cap
of 24% in each of 1997 through 2000 on certain insured accounts, the Stop Loss
Contract requires CCC at the end of each calendar quarter following the Merger
Date, to pay to the CNA Surety
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<PAGE> 69
insurance subsidiaries a dollar amount equal to (i) the amount, if any, by which
their actual accident year net loss ratio exceeds the applicable Loss Ratio Cap,
multiplied by (ii) the applicable net earned premiums.
The Loss Ratio Cap only applies to the results of insureds that were
accounts of the Predecessor Operations as of the Merger Date as well as similar
accounts at any time following the Merger Date but prior to the termination of
the Stop Loss Contract. Although the Stop Loss Contract remains in effect until
December 31, 2000, the provisions shall continue until all obligations of the
parties have been performed. In consideration for the coverage provided by the
Stop Loss Contract, the CNA Surety insurance subsidiaries must pay to CCC an
annual premium equal to $20,000. The CNA Surety insurance subsidiaries paid CCC
the initial annual premium. There was no amount due to the CNA Surety insurance
subsidiaries from CCC under the Stop Loss Contract as of March 31, 1998.
Surety Excess of Loss Reinsurance Contract and Surety Second Excess of Loss
Contract
The Excess of Loss Contracts collectively provide CNA Surety with the
capacity to underwrite large surety bond exposures by providing the insurance
subsidiaries with reinsurance support from CCC. Historically, CCC's substantial
capital base has enabled it to underwrite and retain large aggregate surety bond
exposures. The Excess of Loss Contract executed by CCC and the CNA Surety
insurance subsidiaries on the Merger Date and the Second Excess of Loss Contract
subsequently entered into by such parties retroactive to October 1, 1997, cede
to CCC certain liabilities in excess of the capacity provided by the CNA Surety
insurance subsidiaries' reinsurance program.
Specifically, under the Excess of Loss Contract, CCC provides the insurance
subsidiaries with $75 million of coverage in excess of the $55 million of
coverage provided to the insurance subsidiaries by third party reinsurers, which
is in turn in excess of the $5 million of coverage per principal to be retained
by the insurance subsidiaries. The Second Excess of Loss Contract is structured
to commence additional coverage immediately after the foregoing coverage of $75
million per principal, in excess of $60 million, provided by the Excess of Loss
Contract. Consequently, under the Excess of Loss Contracts, CCC will be
obligated to pay to the CNA Surety insurance subsidiaries, on a quarterly basis,
the amount of any loss in excess of the $5 million per principal retained by CNA
Surety's insurance subsidiaries. Over the last five years, no more than ten
Predecessor Operations' accounts have had exposures that would have been
reinsured under the Excess of Loss Contract.
The Excess of Loss Contracts collectively provide coverage for losses
discovered on surety bonds in force as of the Merger Date and for losses
discovered on new and renewal business written, renewed or assumed during the
term of the Excess of Loss Contracts. CCC is also obligated to act as a joint
insurer, or "co-surety," for business covered by the Excess of Loss Contracts
when requested by the CNA Surety insurance subsidiaries.
The term of the Excess of Loss Contract commenced immediately following the
Merger Date and continues for a period of five years. Although executed
subsequent to the Excess of Loss Contract, the term of the Second Excess of Loss
Contract has been structured to provide retroactive effectiveness in order to
parallel the term of the Excess of Loss Contract. For a period of three years
following the termination of the Excess of Loss Contracts, CCC will be liable
for applicable losses discovered with respect to business covered prior to the
date of termination of the Excess of Loss Contracts. In consideration for the
reinsurance coverage provided by the Excess of Loss Contracts, the insurance
subsidiaries will pay to CCC, on a quarterly basis, a premium equal to 1% of the
net written premiums applicable to the Excess of Loss Contracts, subject to a
minimum premium of $20,000 and $5,000 per quarter under the Excess of Loss
Contract and the Second Excess of Loss Contract, respectively. The CNA Surety
insurance subsidiaries have paid CCC $80,000 for all minimum quarterly premiums
due under the Excess of Loss Contract through September 30, 1998. Although fully
executed, as a related party transaction, the Second Excess of Loss Contract is
subject to ratification by the Audit Committee of the Board. CNA Surety
management has no reason to believe that such ratification will not be obtained.
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Services and Indemnity Agreement
The Services and Indemnity Agreement between CCC and CNA Surety's insurance
subsidiaries authorizes CNA Surety's insurance subsidiaries to perform certain
underwriting, claims, agency and accounting functions on behalf of CCC as they
relate to the business assumed under the Quota Share Treaty for a period of five
years from the Merger Date. In consideration for the provision of the foregoing
services, CCC agreed to pay the insurance subsidiaries a quarterly fee of
$50,000. CCC has paid Western Surety $100,000 for services rendered under the
Services and Indemnity Agreement for the period from September 30, 1997 through
March 31, 1998.
In addition, the Services and Indemnity Agreement prohibits any changes or
modifications to it or any of the reinsurance agreements without the written
approval of CCC and the audit committee of the CNA Surety Board.
Administrative Services Agreement
Pursuant to the Reorganization Agreement, CNA Surety entered into an
Administrative Services Agreement with CCC to allow for the continued use by CNA
Surety of real and personal property currently owned or leased by CCC. In
addition, CNA Surety may purchase many of the services provided by CCC to the
Predecessor Operations. The Administrative Services Agreement has a three-year
term and commenced as of the Merger Date.
The Administrative Services Agreement provides that the rental and service
fees charged by CCC thereunder can be no less favorable than that charged to the
Predecessor Operations. Such charges may be increased annually in an amount not
more than the increase in the consumer price index during the previous 12
months. CNA Surety has the authority to choose, at its discretion, to receive
any or all of the services offered under the Administrative Services Agreement.
CNA Surety, however, is under no obligation to purchase any services under the
Administrative Services Agreement. The aggregate maximum annual cost for the use
of the real and personal property and for services available under the agreement
is approximately $7.9 million. Administrative services are provided at specified
rates, subject to inflationary increases. For the quarter ended March 31, 1998,
the Company incurred $2.3 million for rents and services provided under the
agreement. The Company paid CCC $2.3 million during the quarter ended March 31,
1998 and $1.1 million of accrued expenses was reflected in other liabilities in
CNA Surety's Consolidated Balance Sheet at March 31, 1998.
Services provided and offered under the Administrative Services Agreement
include the following: telecommunications, computer access and support, human
resource assistance, accounting, legal, financial and administrative support,
marketing, strategic management and direction, investment advice and various
other business services.
The Company currently uses approximately 72,500 square feet of space and
related personal property in CCC's 41 branch locations and home office in
Chicago, Illinois. CNA Surety may terminate its use of these locations as set
forth in the Administrative Services Agreement, without penalty, by providing
CCC with 60 days written notice.
The Administrative Services Agreement also provides for prior notice of any
termination of the underlying leases of real property from third parties and an
option to CNA Surety to purchase the personal property owned by CCC and leased
to CNA Surety under the Administrative Services Agreement at the end of three
years for the price of $1.
Reinsurance Arrangement with CNA Re (London)
In the fourth quarter of 1997, an affiliate of CCC entered into a 50% U.S.
dollar quota share reinsurance treaty with CNA Re (London), a subsidiary of
CNAF. The treaty was effective as of January 1, 1997 and provides facultative or
treaty reinsurance cover on credit insurance, surety and guarantee, and fidelity
and computer crime classes of business, predominantly on European risks. The
business assumed by CCC under this treaty was retroceded to Western Surety under
terms of the Quota Share Treaty. For the three months ended March 31, 1998, the
Company assumed $2.5 million in international premiums.
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Trademark License Agreement
In connection with the Merger, CNAF and the Company entered into a
Trademark License Agreement pursuant to which the Company obtained the right to
use the "CNA" mark or some derivation thereof for an unlimited period of time,
subject to termination in the event of a change in control of CNA Surety. The
license is a royalty-free license to CNA Surety and may not be assigned by CNA
Surety.
Continuing Covenants of CNAF
The Reorganization Agreement contains certain ongoing agreements, including
an agreement by CCC and CNA Surety to cause the bylaws of CNA Surety to require
approval by 75% of the holders of Common Stock for CNA Surety in order to (i)
enter into certain business combinations, (ii) accept proposals to sell all or
substantially all of the Company's assets, (iii) amend the bylaw provisions
requiring such supermajority voting or (iv) amend the certificate of
incorporation.
70
<PAGE> 72
PRINCIPAL AND SELLING STOCKHOLDERS
In connection with the Merger, CNA Surety entered into a registration
rights agreement with Equity Capsure Limited Partnership ("Equity Capsure"), the
major stockholder of Capsure, granting certain registration rights. Pursuant to
the exercise of such registration rights, CNA Surety is registering for sale
shares of Common Stock held by the former partners of Equity Capsure. The
Selling Stockholders consist of (i) certain trusts, partnerships or other
entities that hold shares of Common Stock following the distribution of shares
of Common Stock by Equity Capsure to its partners; (ii) Samuel Zell, the former
Chief Executive Officer and Chairman of the Board of Directors of Capsure; (iii)
John T. Knox, Jr., the former President of USA; and (iv) Bruce A. Esselborn, the
former President of Capsure. The Selling Stockholders will pay all underwriting
discounts, commissions and transfer taxes relating to the shares of Common Stock
offered for sale by the Selling Stockholders hereunder, as well as the fees and
disbursement of their legal counsel. All other fees and expenses in connection
with the registration of the shares of Common Stock hereunder shall be borne by
CNA Surety.
The following table sets forth, as of May 22, 1998, the beneficial
ownership of Common Stock of (i) each of the Selling Stockholders, (ii) each
stockholder who is known by the Company to beneficially own more than 5% of such
outstanding Common Stock, (iii) each of CNA Surety's directors, those executive
officers named in the Summary Compensation Table and all executive officers and
directors of CNA Surety as a group. Information regarding the directors and
executive officers and their security holdings has been furnished by them to CNA
Surety. The table also sets forth the number of shares of Common Stock being
offered by the Selling Stockholders and the number and percentage of outstanding
shares to be owned by each person and group after adjustment for completion of
the Offering.
<TABLE>
<CAPTION>
AMOUNT AND NATURE OF AMOUNT AND NATURE OF
BENEFICIAL OWNERSHIP BENEFICIAL OWNERSHIP
PRIOR TO OFFERING(1) SHARES OF AFTER THE OFFERING
---------------------- COMMON STOCK --------------------
NAME AND ADDRESS OF BENEFICIAL OWNERS SHARES PERCENT OFFERED SHARES PERCENT
- - ------------------------------------- ---------- ------- ------------ ---------- -------
<S> <C> <C> <C> <C> <C>
CNAF(2)............................... 27,096,337(3) 62.5%(3) -- 27,096,337 62.5%
Samstock, L.L.C.(4)................... 1,988,769 4.6% 1,988,769 0 --
Samstock/SZRT, L.L.C.(5).............. 578,649 1.3% 578,649 0 --
Anda Partnership(6)................... 498,684 1.1% 498,684 0 --
LFT Partnership(7).................... 486,760 1.1% 486,760 0 --
Samuel Zell........................... 65,000 * 65,000 0 --
The Ann and Robert H. Lurie Family
Foundation(8)....................... 486,760 1.1% 486,760 0 --
Bruce A. Esselborn(9)................. 83,507 * 83,507 0 --
John T. Knox, Jr.(10)................. 331,363 * 200,000 131,363 *
David T. Cumming...................... 3,500(11) * -- 3,500 *
Melvin Gray........................... 1,000(12) * -- 1,000 *
Joe P. Kirby.......................... 76,910 * -- 76,910 *
Roy Posner............................ 250 * -- 250 *
Adrian M. Tocklin..................... 1,000 * -- 1,000 *
Mark C. Vonnahme...................... 1,100(13) * -- 1,100 *
Robert E. Ayo......................... 100 * -- 100 *
Dan L. Kirby.......................... 78,252 * -- 78,252 *
Stephen T. Pate....................... 11,450 * -- 11,450 *
All directors and executive officers
as a group (21 persons) including
the above named persons............. 635,976 1.5% 635,976 1.5%
</TABLE>
- - ---------------
* Less than 1%
(1) The number of shares of the Common Stock indicated as beneficially owned
are reported on the basis of regulations of the Commission governing the
determination of beneficial ownership of securities.
(footnotes continued on next page)
71
<PAGE> 73
(2) CNAF is an 84% owned subsidiary of Loews Corporation. The address for CNAF
is: CNA Plaza, Chicago, Illinois, 60685. CNAF and Loews Corporation each
disclaim beneficial ownership of these shares.
(3) The Reorganization Agreement provided that CCC and its affiliates would
have beneficial ownership of 61.75% of the outstanding Common Stock on a
fully-diluted basis immediately following the Merger. Although CCC and its
affiliates have not increased their ownership in CNA Surety, the beneficial
ownership for CCC reported in this table is higher than 61.75% because the
rules under the Exchange Act require disclosure of ownership on other than
a fully-diluted basis.
(4) Samstock, L.L.C., a Delaware limited liability company ("Samstock"), is
wholly owned by SZ Investments, L.L.C., a Delaware limited liability
company ("SZ Investments"). SZ Investments is owned by Zell General
Partnership, Inc., an Illinois corporation, as the sole managing member,
which is wholly owned by the Samuel Zell Revocable Trust of which Mr. Zell
is trustee and beneficiary ("Zell Trust") and Alphabet Partners and ZFT
Partnership, as non-managing members. The business address for Samstock is
Two N. Riverside Plaza, Chicago, IL 60606.
(5) Samstock/SZRT, L.L.C., a Delaware limited liability company
("Samstock/SZRT") is wholly owned by the Zell Trust. The business address
for Samstock/SZRT is Two N. Riverside Plaza, Chicago, IL 60606.
(6) Anda Partnership, a Nevada general partnership ("Anda"), is composed of ten
trusts created for the benefit of Ann Lurie and her family which share
equally in the partnership. Mrs. Lurie and Mark Slezak are co-trustees of
the ten trusts. The business address for Anda is Two N. Riverside Plaza,
Chicago, IL 60606.
(7) LFT Partnership, an Illinois general partnership ("LFT"), is composed of
six trusts created for the benefit of Mrs. Lurie's six children which share
equally in the partnership. Mrs. Lurie is the sole trustee of the six
trusts. The business address of LFT is Two N. Riverside, Chicago, IL 60606.
(8) The Ann and Robert H. Lurie Family Foundation is an Illinois not-for-profit
corporation with Ann Lurie as the President, Treasurer and one of the
directors. The address for the Ann and Robert H. Lurie Family Foundation is
Two N. Riverside Plaza, Chicago, Illinois, 60606.
(9) Mr. Esselborn was a Director of the Company from September 30, 1997 until
May 1998. Mr. Esselborn was President of Capsure from June 1992 until
September 30, 1997.
(10) Mr. Knox was a Director of the Company from September 30, 1997 until March
1998. Mr. Knox was the President and Chief Executive Officer of USA from
1983 until December 31, 1997 and President and Chief Executive Officer of
Universal Surety Holding Corporation from 1986 until December 31, 1997.
(11) Includes 1,000 shares beneficially owned by Mr. Cumming's daughter and 500
shares beneficially owned by his wife.
(12) Shares are held in trust in Mr. Gray's name.
(13) Includes 1,000 shares owned jointly by Mr. Vonnahme and his wife with whom
he shares voting and investment power.
72
<PAGE> 74
DESCRIPTION OF CAPITAL STOCK
CNA Surety is authorized to issue two classes of shares: common and
preferred.
COMMON STOCK
The number of shares of Common Stock authorized by CNA Surety's certificate
of incorporation is 100 million, $.01 par value per share. As of May 27, 1998,
43,446,119 shares of Common Stock were issued and outstanding. All issued and
outstanding shares of Common Stock offered hereby are validly issued, fully paid
and non-assessable. The holders of Common Stock are entitled to one vote for
each share held of record on each matter submitted to a vote of stockholders and
are not entitled to cumulative voting. Holders of Common Stock have no
preemptive rights and have no rights to convert their Common Stock into any
other securities. Holders of Common Stock are entitled to such dividends if,
when and as declared by the Board out of funds legally available therefore. See
"Dividend Policy."
The shares of Common Stock being offered in the Offering are to be listed
on the NYSE, subject to official notice of issuance.
Certain of CNAF's operating subsidiaries' ownership of approximately 62.5%
of the outstanding Common Stock may permit it to elect the members of the Board
who will control the future direction and operations of the Company, including
decisions regarding the issuance of securities, dividends, acquisitions and the
sale of the Company.
Upon liquidation or dissolution of the Company, after satisfaction of any
liquidation preferences of any outstanding preferred stock, holders of Common
Stock are entitled to receive, pro rata in accordance with their full
liquidation interests, all assets remaining available for distribution to
stockholders.
The Company has appointed Boston EquiServe, LLP as its transfer agent and
registrar.
PREFERRED STOCK
The Board has the authority to issue up to 20 million shares of preferred
stock of CNA Surety, $0.01 par value per share, and to determine the price,
rights, preferences, privileges and restrictions, including voting rights, of
such stock without further stockholder approval. As of May 27, 1998, no shares
of preferred stock had been issued or were outstanding.
73
<PAGE> 75
UNDERWRITING
Subject to certain terms and conditions contained in the Underwriting
Agreement, the syndicate of Underwriters named below, for whom Donaldson, Lufkin
& Jenrette Securities Corporation and Smith Barney Inc. are acting as
representatives (the "Representatives"), have severally agreed to purchase from
the Selling Stockholders, and if the Over-Allotment Option is exercised, from
CNA Surety, an aggregate of 4,388,129 shares of Common Stock. The number of
shares of Common Stock that each Underwriter has agreed to purchase is set forth
opposite its name below:
<TABLE>
<S> <C>
Donaldson, Lufkin & Jenrette Securities
Corporation......................................
--------
Smith Barney Inc. .................................
--------
</TABLE>
The Underwriting Agreement provides that the obligations of the several
Underwriters to purchase shares of Common Stock are subject to the approval of
certain legal matters by counsel and to certain other conditions. If any of the
shares of Common Stock are purchased by the Underwriters pursuant to the
Underwriting Agreement, all such shares of Common Stock (other than the shares
of Common Stock covered by the Over-Allotment Option) must be so purchased.
CNA Surety and the Selling Stockholders have agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act, or to contribute to payments that the Underwriters may be
required to make in respect thereof.
CNA Surety has been advised by the Representatives that the Underwriters
propose to offer the Common Stock to the public initially at the price set forth
on the cover page of this Prospectus and to certain dealers (who may include the
Underwriters) at such price less a concession not to exceed $ per
share. The Underwriters may allow, and such dealers may reallow, discounts not
in excess of $ per share to any other Underwriter and certain other dealers.
CNA Surety has granted to the Underwriters an option to purchase up to
658,219 additional shares of Common Stock, at the public offering price less
underwriting discounts and commissions, solely to cover over-allotments. Such
option may be exercised at any time until 30 days after the effective date of
the Registration Statement of which this Prospectus is part. To the extent that
the Underwriters exercise such option each of the Underwriters will be
committed, subject to certain conditions, to purchase a number of option shares
proportionate to such Underwriter's initial commitment as indicated in the
preceding table.
CNAF, CNA Surety, the Selling Stockholders, and the directors and the
executive officers of CNA Surety have agreed that they will not directly or
indirectly offer, sell, contract to sell, or otherwise dispose of or transfer
any shares of Common Stock owned by them without the prior written consent of
Donaldson, Lufkin & Jenrette Securities Corporation, for a period of 180 days
after the date of this Prospectus except in certain non-public transactions in
which the acquiror or acquirors of such shares agree(s) to such restrictions. In
addition, CNA Surety has agreed that for a period of 180 days after the date of
this Prospectus it will not, without the prior written consent of Donaldson,
Lufkin & Jenrette Securities Corporation, offer, sell, contract to sell, grant
any option to purchase or otherwise dispose of any shares of Common Stock or any
securities convertible into or exercisable or exchangeable for such Common Stock
or in any other manner transfer all or a portion of the economic consequences
associated with such Common Stock, except for (i) shares of Common Stock offered
hereby, (ii) shares of Common Stock issued pursuant to the exercise of options
outstanding on the date of this Prospectus, (iii) options or other stock-based
awards granted or shares of Common Stock after the date of this Prospectus
pursuant to CNA Surety's employee stock plans and other plans and (iv) shares or
options issued in acquisitions in which the acquiror or acquirors of such shares
agree(s) to such restrictions.
In connection with the Offering, the Underwriters may engage in
transactions that stabilize, maintain or otherwise affect the price of the
Common Stock. Specifically, the Underwriters may overallot the Offering,
creating a syndicate short position. In addition, the Underwriters may bid for,
and purchase, shares of Common Stock in the open market to cover syndicate
shorts or to stabilize the price of the Common Stock. Finally, the underwriting
syndicate may reclaim selling concessions allowed for distributing the Common
74
<PAGE> 76
Stock in the Offering, if the syndicate repurchases previously distributed
Common Stock in syndicate covering transactions, in stabilization transactions
or otherwise. Any of these activities may stabilize or maintain the market price
of the Common Stock above independent market levels. The Underwriters are not
required to engage in these activities and may end any of these activities at
any time.
EXPERTS
The consolidated financial statements of CNA Surety Corporation and
subsidiaries as of December 31, 1997 and for the period from September 30, 1997
(date of inception) through December 31, 1997 and related financial statement
schedules and the special purpose Statement of Certain Assets and Liabilities of
Predecessor Operations as of December 31, 1996 and the special-purpose
Statements of Certain Revenues and Direct Operating Expenses for each of the two
years in the period ended December 31, 1996 and for the nine-month period ended
September 30, 1997, have been audited by Deloitte & Touche LLP, independent
auditors, as set forth in their report thereon and included herein. The Deloitte
& Touche LLP report on the special purpose financial statements expresses an
unqualified opinion and includes an explanatory paragraph with respect to the
basis of presentation. Such financial statements and related financial statement
schedules are included in this Prospectus in reliance upon such report given
upon the authority of such firm as experts in accounting and auditing.
The consolidated financial statements for Capsure as of December 31, 1996
and 1995 and for each of the three years in the period ended December 31, 1996
have been audited by Coopers & Lybrand L.L.P., independent auditors, as set
forth in their report thereon and as included herein. Such financial statements
and related financial statement schedules are included in this Prospectus in
reliance upon such report given upon the authority of such firm as experts in
accounting and auditing.
LEGAL MATTERS
The validity of the Common Stock to be offered hereby in the event that the
Underwriters exercise the Over-Allotment Option and certain matters in
connection herewith will be passed upon for the Company by Seyfarth, Shaw,
Fairweather & Geraldson, Chicago, Illinois, counsel for the Company. Certain
legal matters in connection with this Offering are being passed upon for the
Underwriters by Simpson Thacher & Bartlett, New York, New York.
75
<PAGE> 77
GLOSSARY OF SELECTED INSURANCE TERMS
The following terms when used in this Prospectus have the following
meanings:
Bid Bonds.................. Contract bonds used by owners to prequalify
contractors submitting proposals on potential
contracts.
Combined Ratio............. The sum of the Loss Ratio and the Expense Ratio.
Commercial Surety Bonds.... Surety bonds that are not contract bonds.
Contract Bonds............. Bonds which secure the payment and/or performance
of an obligation under a written contract.
Expense Ratio.............. The percentage of premium income that goes to cover
acquisition and underwriting costs and is computed
as acquisition and underwriting expenses divided by
earned premiums.
Fidelity Bonds............. Bonds which cover losses arising from employee
dishonesty.
Judicial and Fiduciary
Bonds...................... Bonds required by statutes, courts or legal
documents for the protection of those on whose
behalf a fiduciary acts.
LAE........................ Loss adjustment expenses, including both allocated
and unallocated adjustment expenses.
License and Permit Bonds... Bonds required by statutes or ordinances for a
number of purposes, including guaranteeing the
payment of certain taxes and fees and providing
consumer protection as a condition to granting
licenses related to selling real estate or motor
vehicles and contracting services.
Loss Ratio................. The percentage of incurred loss and loss adjustment
expenses to earned premiums.
Non-Standard Contract
Market................... Bonds that have higher risks or special exposures,
such as bonds written through the Small Business
Administration programs.
Notary Public Bonds........ Bonds required by statutes to protect against
losses resulting from the improper actions of
notaries public.
Payment Bonds.............. Contract bonds which guarantee payment of the
contractor's obligation under the contract for
labor, subcontractors and materials supplied to the
project. Because liens may not be placed on public
jobs, the payment bond may be the only protection
for those supplying labor or materials to a public
job.
Performance Bonds.......... Contract bonds which guarantee to the owner the
obligations of the contractor according to the
terms and conditions of the contract.
Public Official Bonds...... Bonds required by statutes and ordinances to
guarantee the lawful and faithful performance of
the duties of office by public officials.
Surety Bonds............... Three party agreements where the issuer of the bond
(the surety) joins with the second party (the
principal) in guaranteeing to a third party (the
obligee) the fulfillment of some obligation on the
part of the principal.
76
<PAGE> 78
INDEX TO FINANCIAL STATEMENT SCHEDULES.
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
PART I. YEAR ENDED DECEMBER 31, 1997:
(A) FINANCIAL:
Independent Auditors' Report................................ F-3
Consolidated Balance Sheet as of December 31, 1997 and
Statement of Certain Assets and Liabilities of Predecessor
as of December 31, 1996................................... F-4
Consolidated Statement of Income for the Period from
September 30, 1997 (date of inception) through December
31, 1997 and Statements of Certain Revenues and Direct
Operating Expenses of Predecessor for the Nine Months
Ended September 30, 1997 and Years Ended December 31, 1996
and 1995.................................................. F-5
Consolidated Statement of Changes in Stockholders' Equity
for the Period from September 30, 1997 (date of inception)
through December 31, 1997................................. F-6
Consolidated Statement of Cash Flows for the Period from
September 30, 1997 (date of inception) through December
31, 1997.................................................. F-7
Notes to Consolidated Financial Statements.................. F-8
(B) FINANCIAL STATEMENT SCHEDULES:
Schedule I -- Summary of Investments........................ F-26
Schedule II -- Condensed Financial Information of
Registrant................................................ F-27
Schedule III -- Supplementary Insurance Information......... F-31
Schedule IV -- Reinsurance.................................. F-32
Schedule V -- Valuation and Qualifying Accounts............. F-33
Schedule VI -- Supplemental Information Concerning
Property-Casualty Insurance Operations.................... F-34
PART II. THREE MONTHS ENDED MARCH 31, 1998 (UNAUDITED):
(A) FINANCIAL:
Independent Accountants' Review Report...................... F-35
Condensed Consolidated Balance Sheets as of March 31, 1998
and December 31, 1997..................................... F-36
Condensed Consolidated Statement of Income for the Three
Months Ended March 31, 1998 and Condensed Statement of
Certain Revenues and Direct Operating Expenses of
Predecessor for the Three Months Ended March 31, 1997..... F-37
Condensed Consolidated Statement of Stockholders' Equity for
the Three Months Ended March 31, 1998..................... F-38
Condensed Consolidated Statement of Cash Flows for the Three
Months Ended March 31, 1998............................... F-39
Notes to Condensed Consolidated Financial Statements as of
March 31, 1998............................................ F-40
</TABLE>
F-1
<PAGE> 79
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
PART III. CAPSURE FINANCIAL STATEMENTS:
(A) YEAR ENDED DECEMBER 31, 1996
(a)(1) Financial:
Report of Independent Accountants........................... F-44
Consolidated Balance Sheets as of December 31, 1996 and
1995...................................................... F-45
Consolidated Statements of Income for the Years Ended
December 31, 1996, 1995 and 1994.......................... F-46
Consolidated Statements of Changes in Stockholders' Equity
for the Years Ended December 31, 1996, 1995 and 1994...... F-47
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1996, 1995 and 1994.......................... F-48
Notes to Consolidated Financial Statements.................. F-49
(a)(2) Financial Statement Schedules:
Schedule I -- Summary of Investments........................ F-66
Schedule II -- Condensed Financial Information of
Registrant................................................ F-67
Schedule III -- Supplementary Insurance Information......... F-71
Schedule IV -- Reinsurance.................................. F-72
Schedule V -- Valuation and Qualifying Accounts............. F-73
Schedule VI -- Supplemental Information Concerning
Property -- Casualty Insurance Operations................. F-74
(B) SIX MONTHS ENDED JUNE 30, 1997:
(b)(1) Financials:
Consolidated Balance Sheets at June 30, 1997 and December
31, 1996.................................................. F-75
Consolidated Statements of Income for the Periods Ended June
30, 1997 and 1996......................................... F-76
Consolidated Statements of Cash Flows for the Six Months
Ended June 30, 1997 and 1996.............................. F-77
Notes to Consolidated Financial Statements at June 30,
1997...................................................... F-78
</TABLE>
F-2
<PAGE> 80
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders of
CNA Surety Corporation
We have audited the consolidated balance sheet of CNA Surety Corporation
and subsidiaries as of December 31, 1997, and the related consolidated
statements of income, changes in stockholders' equity, and cash flows from
September 30, 1997 (date of inception) through December 31, 1997. We have also
audited the accompanying special-purpose statement of certain assets and
liabilities of CCC Surety Operations (Predecessor), a business unit of CNA
Financial Corporation, as of December 31, 1996 and the special-purpose
statements of certain revenues and direct operating expenses for each of the two
years in the period ended December 31, 1996 and for the nine month period ended
September 30, 1997. Our audit also included the financial statement schedules
listed in the Index at Item 16, Part I. These financial statements and financial
statement schedules are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
financial statement schedules based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
The accompanying special-purpose financial statements were prepared to
present certain assets and liabilities and certain revenues and direct operating
expenses of CCC Surety Operations and are not intended to be a complete
presentation of CCC Surety Operations. Note 1 to the consolidated financial
statements describes the basis of presentation of these special-purpose
financial statements.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of CNA Surety Corporation and
subsidiaries as of December 31, 1997, and the results of their operations and
their cash flows from September 30, 1997 (date of inception) through December
31, 1997, in conformity with generally accepted accounting principles.
Furthermore, in our opinion, such special-purpose financial statements present
fairly, in all material respects, certain assets and liabilities of CCC Surety
Operations as of December 31, 1996, and certain revenues and direct operating
expenses for each of the two years in the period ended December 31, 1996 and for
the nine month period ended September 30, 1997, in conformity with generally
accepted accounting principles. Also, in our opinion, such financial statement
schedules, when considered in relation to the basic consolidated financial
statements taken as a whole, present fairly in all material respects the
information set forth therein.
Deloitte & Touche LLP
Chicago, Illinois
February 27, 1998
F-3
<PAGE> 81
CNA SURETY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET AND STATEMENT
OF CERTAIN ASSETS AND LIABILITIES OF PREDECESSOR
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
PREDECESSOR
1997 1996
-------- -----------
<S> <C> <C>
ASSETS
Invested assets and cash:
Fixed income securities, at fair value (amortized cost:
$265,545).............................................. $266,301 $ --
Short-term investments, at cost (approximates fair
value)................................................. 147,235 --
Other investments, at fair value.......................... 6,001 --
Cash...................................................... 130 --
-------- --------
419,667 --
Deferred policy acquisition costs........................... 64,144 37,689
Receivable from affiliates.................................. -- 131,478
Insurance receivables:
Premiums.................................................. 9,683 30,379
Reinsurance, including $47,856 from affiliates in 1997
(See Note 14).......................................... 55,151 20,069
Intangible assets, net of accumulated amortization of $1,447
and $619 at December 31, 1997 and 1996, respectively...... 161,962 6,897
Prepaid reinsurance premiums................................ 4,150 6,312
Other assets................................................ 12,423 --
-------- --------
Total assets........................................... $727,180 $232,824
======== ========
LIABILITIES
Reserves:
Unpaid losses and loss adjustment expenses................ $130,381 $119,151
Unearned premiums......................................... 173,836 95,677
-------- --------
304,217 214,828
Long-term debt.............................................. 118,000 --
Deferred income taxes, net.................................. -- 4,540
Payable for securities purchased............................ 10,609 --
Other liabilities........................................... 37,622 13,456
-------- --------
Total liabilities...................................... 470,448 232,824
-------- --------
Commitments and contingencies (See Note 9)
STOCKHOLDERS' EQUITY
Preferred stock, par value $0.01 per share, 20,000 shares
authorized; none issued and outstanding................... -- --
Common stock, par value $0.01 per share, 100,000 shares
authorized; none issued at December 31, 1996 and 43,320
shares issued and outstanding at December 31, 1997........ 433 --
Additional paid-in capital.................................. 244,829 --
Retained earnings........................................... 10,996 --
Unrealized gain on securities, net of deferred income
taxes..................................................... 474 --
-------- --------
Total stockholders' equity............................. 256,732 --
-------- --------
Total liabilities and stockholders' equity............. $727,180 $232,824
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE> 82
CNA SURETY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME AND STATEMENTS OF
CERTAIN REVENUES AND DIRECT OPERATING EXPENSES OF PREDECESSOR
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
SEPTEMBER 30, PREDECESSOR
DATE OF -------------------------------------
INCEPTION, NINE YEARS ENDED
THROUGH MONTHS ENDED DECEMBER 31,
DECEMBER 31, SEPTEMBER 30, --------------------
1997 1997 1996 1995
------------- ------------- -------- --------
<S> <C> <C> <C> <C>
Revenues:
Net earned premiums.................... $65,433 $108,564 $149,069 $130,603
Net investment income.................. 5,766 -- -- --
Net realized investment gains.......... 85 -- -- --
------- -------- -------- --------
71,284 108,564 149,069 130,603
------- -------- -------- --------
Expenses:
Net losses and loss adjustment
expenses............................ 12,134 (11,516) 33,006 32,440
Net commissions, brokerage and other
underwriting........................... 38,213 59,674 81,615 71,591
Interest expense....................... 1,831 -- -- --
Amortization of intangible assets...... 1,447 -- -- --
------- -------- -------- --------
53,625 48,158 114,621 104,031
------- -------- -------- --------
Income before income taxes (Excess of net
earned premiums over direct operating
expenses, before income taxes for
Predecessor)........................... 17,659 60,406 34,448 26,572
Income taxes............................. 6,663 21,241 12,188 9,385
------- -------- -------- --------
Net income (Excess of net earned premiums
over direct operating expenses, net of
income taxes for Predecessor).......... $10,996 $ 39,165 $ 22,260 $ 17,187
======= ======== ======== ========
Earnings per share....................... $ 0.25
=======
Earnings per share, assuming dilution.... $ 0.25
=======
Weighted average shares outstanding...... 43,302
=======
Weighted average shares outstanding,
assuming dilution...................... 43,552
=======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE> 83
CNA SURETY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
SEPTEMBER 30,
DATE OF
INCEPTION,
THROUGH
DECEMBER 31,
1997
-------------
<S> <C>
Common Stock:
Beginning Balance......................................... $ --
Common stock issued for Capsure acquisition and as part of
the Merger............................................. 433
--------
Balance, December 31...................................... $ 433
========
Additional Paid-In Capital:
Beginning Balance......................................... $ --
Increase due to Capsure acquisition (See Note 2).......... 181,629
Capital contribution and the effects of reinsurance
agreements (See Note 2)................................ 62,859
Other..................................................... 341
--------
Balance, December 31...................................... $244,829
========
Retained Earnings:
Beginning Balance......................................... $ --
Net income................................................ 10,996
--------
Balance, December 31...................................... $ 10,996
========
Change in Net Unrealized Gain/(Loss) on Securities,
Net of Deferred Income Taxes:
Beginning Balance...................................... $ --
Change from September 30, 1997 (date of inception)
through December 31, 1997............................. 474
--------
Balance, December 31...................................... $ 474
========
</TABLE>
<TABLE>
<CAPTION>
COMMON STOCK
----------------------
ISSUED IN TREASURY
------- -----------
<S> <C> <C>
Shares:
Beginning Balance......................................... -- --
Increase due to common stock issued for Capsure
acquisition
and as part of the Merger.............................. 43,294 --
Issued through exercise of stock options.................. 26 --
------- -------
Balance, December 31, 1997................................ 43,320 --
======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE> 84
CNA SURETY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
SEPTEMBER 30,
DATE OF
INCEPTION,
THROUGH
DECEMBER 31,
1997
-------------
<S> <C>
OPERATING ACTIVITIES:
Net income................................................ $ 10,996
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization.......................... 1,915
Accretion of bond discount, net........................ 172
Net realized investment gains.......................... (85)
Changes in:
Reinsurance receivables................................ (12,930)
Reserve for unearned premiums.......................... 9,233
Reserve for unpaid losses and loss adjustment
expenses.............................................. 8,100
Deferred income taxes, net............................. 4,038
Other assets and liabilities........................... 7,559
---------
Net cash provided by operating activities................... 28,998
---------
INVESTING ACTIVITIES:
Securities available-for-sale:
Purchases -- fixed income securities................... (149,580)
Maturities -- fixed income securities.................. 8,654
Sales -- fixed income securities....................... 5,146
Change in short-term investments.......................... (117,919)
Other, net................................................ (586)
---------
Net cash used in investing activities....................... (254,285)
---------
FINANCING ACTIVITIES:
Proceeds from long-term debt.............................. 118,000
Collection of receivable from affiliates, net............. 116,939
Principal payments on long-term debt...................... (54,000)
Capital contribution from CCC............................. 52,250
Closing dividend to Capsure stockholders.................. (10,591)
Other..................................................... 126
---------
Net cash provided by financing activities................... 222,724
---------
Increase (decrease) in cash................................. (2,563)
Cash at beginning of period................................. 2,693
---------
Cash at end of period....................................... $ 130
=========
Supplemental Disclosure of Cash Flow Information:
Cash paid during the period for:
Interest............................................... $ 1,704
Income taxes........................................... $ --
Non-cash investing activities:
Common stock and options issued in connection with
Capsure acquisition................................... $ 182,062
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-7
<PAGE> 85
CNA SURETY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
Formation of CNA Surety Corporation and Merger
In December 1996, CNA Financial Corporation ("CNAF") and Capsure Holdings
Corp. ("Capsure") agreed to merge (the "Merger") the surety business of CNAF
with Capsure's insurance subsidiaries, Western Surety Company ("Western Surety")
and Universal Surety of America ("USA"), which are owned by a newly-formed
holding company, 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. Loews Corporation owns approximately 84% 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. The combined
surety operations of CCC and CIC are referred to herein as CCC Surety Operations
("Predecessor").
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. CCC also agreed to provide
certain administrative services at specified rates, subject to inflationary
increases, for three years after the Merger, if CNA Surety chooses to purchase
such services.
Immediately after the Merger, CCC and CIC owned, on a diluted basis, 61.75%
of CNA Surety's common stock and the stockholders and option holders of Capsure
owned 38.25% of CNA Surety's common stock on a diluted basis. The reorganization
agreement provides for a mechanism, referred to as the "Lookback Adjustment",
which could adjust the number of shares of CNA Surety common stock owned by CCC
in the event that either or both of Capsure's and the CCC Surety Operations'
actual net written premiums for 1997 vary from certain targets. See Note 16 for
a discussion of the Lookback Adjustment.
Principles of Consolidation
The consolidated financial statements include the accounts of CNA Surety
Corporation and all majority-owned subsidiaries. The consolidated financial
statements include the actual combined consolidated operating results of CCC
Surety Operations and Capsure since the Merger Date.
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. Western Surety writes, on a direct basis or as business assumed from CCC
and CIC, small fidelity and noncontract 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, as a licensed
insurer in all 50 states and the District of Columbia. Western Surety's
affiliated company, Surety Bonding Company of America ("SBCA"), writes
principally small commercial surety business and is licensed in 22 states. USA
specializes in the underwriting of small contract and commercial surety bonds.
USA is licensed in 41 states and the District of Columbia with most of its
business generated in Texas.
F-8
<PAGE> 86
CNA SURETY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Predecessor Financial Information
The accompanying Statement of Certain Assets and Liabilities as of December
31, 1996 reflects assets and liabilities identified as being attributable to the
business of CCC Surety Operations, the Predecessor. Because CNAF did not
customarily allocate the investment portfolio or capital of its operating
subsidiaries to its business units like CCC Surety Operations, the Statement of
Certain Assets and Liabilities does not include investments or capital. The
receivable from affiliates is calculated at an amount necessary to balance all
other identified assets with the total of all identified liabilities.
The accompanying Statements of Certain Revenues and Direct Operating
Expenses for the years ended December 31, 1996 and 1995, reflect premiums
earned, losses incurred, loss adjustment expenses (allocated and unallocated)
and other direct operating expenses of CCC Surety Operations. Such operating
revenues and costs as investment income, realized gains and losses on
investments and certain general and administrative expenses, which are indirect
or overhead in nature, are not reflected in operating results since such items
were not historically allocated to CCC Surety Operations by CNAF or its
subsidiaries.
Since the accompanying Predecessor financial statements exclude certain
assets, liabilities, revenues, and expenses, as described in the preceding two
paragraphs, these financial statements are not intended to be a complete
presentation of CCC Surety Operations. Those assets, liabilities, revenues and
costs that are reflected in the accompanying financial statements have been
determined in accordance with generally accepted accounting principles.
Investments
The Company has the ability to hold all fixed income securities to
maturity. However, the Company may dispose of securities prior to their
scheduled maturity due to changes in interest rates, prepayments, tax and credit
considerations, liquidity or regulatory capital requirements, or other similar
factors. As a result, the Company considers all of its fixed income securities
(bonds and redeemable preferred stocks) and equity securities as
available-for-sale. These securities are reported at fair value, with unrealized
gains and losses, net of deferred income taxes, reported as a separate component
of stockholders' equity. Cash flows from purchases, sales and maturities are
reported gross in the investing activities section of the cash flow statement.
The amortized cost of fixed income securities is determined based on cost
and the cumulative effect of amortization of premiums and accretion of discounts
to maturity. Such amortization and accretion is included in investment income.
For mortgage-backed and certain asset-backed securities, the Company recognizes
income using the effective yield method based on estimated cash flows.
Investment gains or losses realized on the sale of securities are determined
using the specific identification method. Investments with an other than
temporary decline in value are written down to fair value, resulting in losses
that are included in investment gains and losses.
Short-term investments are carried at amortized cost which approximates
fair value.
Deferred Policy Acquisition Costs
Policy acquisition costs, consisting of commissions and other underwriting
expenses which vary with, and are directly related to, the production of
business, net of reinsurance commission income, are deferred and amortized as a
charge to income as the related premiums are earned.
F-9
<PAGE> 87
CNA SURETY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Intangible Assets
The Merger of CCC Surety Operations and Capsure has been accounted for by
CNA Surety as an acquisition of Capsure, using purchase accounting. Intangible
assets represent goodwill and identified intangibles arising from the
acquisition of Capsure and goodwill arising from the May 1995 acquisition of CIC
by CNAF that was allocated to the surety business of CIC. Intangible assets are
amortized on a straight line basis generally over 30 years.
Management assesses the recoverability of intangible assets based upon
estimates of undiscounted future operating cash flows whenever significant
events or changes in circumstances suggest that the carrying amount of an asset
may not be recoverable.
Reserves for Unpaid Losses and Loss Adjustment Expenses
The estimated liability for unpaid losses and loss adjustment expenses
includes, on an undiscounted basis, estimates of (a) the ultimate settlement
value of reported claims, (b) incurred but not reported ("IBNR") claims, (c)
future expenses to be incurred in the settlement of claims and (d) claim
recoveries, exclusive of reinsurance recoveries which are reported as an asset.
These estimates are determined based on the Company's and surety industry loss
experience as well as consideration of current trends and conditions. The
estimated liability for unpaid losses and loss adjustment expenses is an
estimate and there is the potential that actual future loss payments will differ
significantly from initial estimates. The methods of determining such estimates
and the resulting estimated liability are regularly reviewed and updated.
Changes in the estimated liability are reflected in operating income in the year
in which such changes are determined to be needed.
Insurance Premiums
Insurance premiums are recognized as revenue ratably over the terms of the
related policies. Unearned premiums represent the portion of premiums written,
before ceded reinsurance, applicable to the unexpired terms of policies in force
calculated on a daily pro rata basis. Premium revenues are net of amounts ceded
to reinsurers.
Reinsurance
The Company assumes and cedes insurance with other insurers and reinsurers.
Premiums and loss and loss adjustment expenses that are ceded under reinsurance
arrangements reduce the respective revenues and expenses. Amounts recoverable
from reinsurers are estimated in a manner consistent with the claim liability
associated with the reinsured policy and are reported as reinsurance receivable
rather than netted against the estimated liability for unpaid losses and loss
adjustment expenses. Losses and loss adjustment expenses incurred are net of
estimated recoveries under reinsurance contracts.
Stock-Based Compensation
As allowed under Statement of Financial Accounting Standards ("SFAS") No.
123, "Accounting for Stock-Based Compensation," the Company accounts for its
stock option plans in accordance with Accounting Principles Board ("APB")
Opinion No. 25, "Accounting for Stock Issued to Employees." The Company has not
issued stock options where the exercise price is less than the fair market value
of the Company's common stock on the date of grant and, accordingly, no
compensation expense has been recognized.
F-10
<PAGE> 88
CNA SURETY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Income Taxes
Deferred income taxes are established for the future tax effects of
temporary differences between the tax and financial reporting bases of assets
and liabilities using currently enacted tax rates. Such temporary differences
primarily relate to net operating tax loss carryforwards ("NOLs"), deferred
policy acquisition costs and intangible assets. The effect on deferred taxes of
a change in tax rates is recognized in income in the period of enactment. In
addition, deferred tax assets are valued based upon the expectation of future
realization on a "more likely than not" basis.
Earnings Per Share
Earnings per common share is computed based on the weighted average number
of shares outstanding during the period. Diluted earnings per common share is
computed based on the weighted average number of shares outstanding plus the
dilutive effect of common stock equivalents which is computed using the treasury
stock method.
Accounting Changes
In February 1997, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 128, "Earnings Per Share." SFAS No. 128 is effective for both interim
and annual periods ending after December 15, 1997. SFAS No. 128 replaces APB
Opinion No. 15, "Earnings Per Share." APB Opinion No. 15 required that entities
with simple capital structures present a single earnings per common share
("EPS") on the face of the income statement, whereas those with complex capital
structures had to present both primary and fully diluted EPS. SFAS No. 128
simplifies the computation of EPS by replacing the presentation of primary EPS
with a presentation of basic EPS and requires dual presentation of basic and
diluted EPS by entities with complex capital structures. Basic EPS includes no
dilution and is computed by dividing income available to common stockholders by
the weighted average number of common shares outstanding for the period, whereas
primary EPS includes the dilutive effect of common stock equivalents, such as
stock options. Diluted EPS reflects the potential dilution of securities that
could share in the earnings of an entity, similar to fully diluted EPS. The
Company has adopted SFAS No. 128 in the accompanying consolidated financial
statements issued for periods ending after December 15, 1997.
In February 1997, the FASB issued SFAS No. 129, "Disclosure of Information
about Capital Structure," which establishes standards for disclosing information
about an entity's capital structure. The Statement consolidates existing
disclosure requirements for ease of retrieval and greater visibility to
nonpublic entities. The new Statement contains no change in disclosure
requirements for companies previously subject to the requirements of APB Opinion
No. 10, "Omnibus Opinion -- 1966," APB Opinion No. 15, "Earnings per Share," and
FASB Statement No. 47 "Disclosure of Long-Term Obligations," and as such the
adoption of SFAS No. 129 did not have any effect on the Company's reporting.
SFAS No. 129 applies to all entities and is effective for financial statements
issued for periods ending after December 15, 1997.
Reclassifications
Certain reclassifications have been made to the Predecessor financial
statements to conform with the presentation in the 1997 Consolidated Financial
Statements.
F-11
<PAGE> 89
CNA SURETY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. CAPSURE ACQUISITION
The purchase price for Capsure has been allocated to Capsure's assets that
were acquired and to Capsure's liabilities that were assumed based on the
estimated fair value of such assets and liabilities at the Merger Date. The
purchase price for the outstanding shares of Capsure common stock was determined
as follows (dollars in thousands):
<TABLE>
<S> <C>
Traded value of Capsure shares to be exchanged at $11.00 per
share..................................................... $178,177
Value of Capsure options.................................... 2,527
CCC Surety Operations merger-related costs.................. 1,358
--------
Total purchase price........................................ $182,062
========
The purchase price was allocated as follows (dollars in
thousands):
Capsure net assets at historical cost....................... $100,875
Fair value adjustments:
Purchased intangibles..................................... (73,844)
Intangibles arising from Merger........................... 155,031
--------
Purchase price.............................................. $182,062
========
CNA Surety's beginning stockholders' equity was comprised of
the following (dollars in thousands):
Purchase price.............................................. $182,062
Capital contribution of $52,250 from CCC and
the effects of reinsurance agreements..................... 62,859
--------
Stockholders' equity........................................ $244,921
========
</TABLE>
Unaudited Pro Forma Results
The following table of unaudited pro forma information has been prepared as
if the acquisition of Capsure had been consummated on January 1, 1996. This
unaudited pro forma financial information gives effect to the following: (i)
adjustment to the Capsure statement of operations, as reported, to reflect the
income effects as if the $10 per share special distribution was made on January
1, 1996; (ii) consummation of the Merger and the related transactions and the
contribution of capital to and the incurrence of additional debt by CNA Surety;
(iii) purchase accounting adjustments to reflect Capsure's assets and
liabilities at fair value; (iv) estimated indirect and overhead expenses for the
CCC Surety Operations; and (v) estimated interest expense related to the
additional debt (dollars are in thousands, except per share amounts):
<TABLE>
<CAPTION>
THREE MONTHS ENDED YEARS ENDED
DECEMBER 31, DECEMBER 31,
------------------- --------------------
UNAUDITED UNAUDITED
1997 1996 1997 1996
------- --------- -------- --------
ACTUAL PRO FORMA PRO FORMA
<S> <C> <C> <C> <C>
Revenues........................... $71,284 $62,754 $258,682 $250,194
Net income......................... $10,996 $ 4,345 $ 34,375 $ 22,432
Earnings per share................. $ 0.25 $ 0.10 $ 0.79 $ 0.52
</TABLE>
F-12
<PAGE> 90
CNA SURETY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The foregoing unaudited pro forma operating results include non-recurring
charges, primarily merger-related costs of Capsure, of $22.0 million, net of tax
(or $0.51 per share) for the year ended December 31, 1997 and $1.1 million, net
of tax (or $0.03 per share) and $5.7 million, net of tax (or $0.13 per share) of
non-recurring charges and merger-related costs of Capsure for the three and
twelve month periods ended December 31, 1996, respectively.
This unaudited pro forma financial information is intended for information
purposes only and is not necessarily indicative of the results of operations
which would have been achieved and reported had the Merger and related
transactions been consummated on the dates assumed, nor is it necessarily
indicative of the future consolidated operating results of CNA Surety.
The Company paid a closing dividend on October 6, 1997 to the former
Capsure stockholders of record as of September 29, 1997. The dividend was
conditioned upon the consummation of the Merger in accordance with the
reorganization agreement. The $10.6 million ($0.65 per common share) closing
dividend was the aggregate amount of $3.5 million plus $58,600 per day from and
including June 1, 1997 through and including the day immediately preceding the
Merger Date.
3. INVESTMENTS
The estimated fair value and amortized cost of fixed income securities held
by CNA Surety at December 31, 1997, by investment category, were as follows
(dollars in thousands):
<TABLE>
<CAPTION>
AMORTIZED GROSS GROSS ESTIMATED
COST OR UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
Fixed income securities:
U.S. Treasury securities and obligations of
U.S.
Government corporations and agencies:
U.S. Treasury............................ $ 59,140 $ 218 $ (3) $ 59,355
U.S. Agency.............................. 51,331 298 -- 51,629
Collateralized mortgage obligations...... 37,550 151 (134) 37,567
Mortgage pass-through securities......... 34,217 42 (89) 34,170
Obligations of states and political
subdivisions................................ 3,556 14 -- 3,570
Corporate bonds............................... 26,644 350 (154) 26,840
Non-agency collateralized mortgage
obligations................................. 19,654 41 (69) 19,626
Asset-backed securities:
Second mortgages/home equity loans....... 21,678 80 (16) 21,742
Credit card receivables.................. 6,498 15 -- 6,513
Other underlying assets.................. 5,277 18 (6) 5,289
-------- ------ ----- --------
Total fixed income securities.......... $265,545 $1,227 $(471) $266,301
======== ====== ===== ========
</TABLE>
The Company's insurance subsidiaries, as required by state law, deposit
certain securities with state insurance regulatory authorities. At December 31,
1997, fixed income securities on deposit had an aggregate carrying value of $6.3
million.
Short-term investments are generally comprised of U.S. Treasury bills,
corporate notes, money market funds and investment grade commercial paper
equivalents.
F-13
<PAGE> 91
CNA SURETY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The amortized cost and estimated fair value of fixed income securities at
December 31, 1997, by contractual maturity, are shown below. Actual maturities
will differ from contractual maturities as borrowers may have the right to call
or prepay obligations with or without call or prepayment penalties (dollars in
thousands):
<TABLE>
<CAPTION>
AMORTIZED ESTIMATED
COST FAIR VALUE
--------- ----------
<S> <C> <C>
FIXED INCOME SECURITIES:
Due within one year......................................... $ -- $ --
Due after one year but within five years.................... 112,097 112,616
Due after five years but within ten years................... 1,000 1,015
Due after ten years......................................... 27,574 27,763
-------- --------
140,671 141,394
Mortgage pass-through securities, collateralized mortgage,
obligations and asset-backed securities................... 124,874 124,907
-------- --------
$265,545 $266,301
======== ========
</TABLE>
Major categories of net investment income and net realized investment gains
(losses) for the period from September 30, 1997 (date of inception) through
December 31, 1997 were as follows (dollars in thousands):
<TABLE>
<CAPTION>
<S> <C>
Investment income:
Fixed income securities................................... $3,061
Short-term investments.................................... 2,707
Other..................................................... 112
------
Total investment income................................... 5,880
Investment expenses......................................... (114)
------
Net investment income....................................... $5,766
======
Gross realized investment gains:
Fixed income securities................................... $ 90
Other..................................................... 11
Gross realized investment losses:
Other (16)
------
Net realized investment gain................................ $ 85
======
</TABLE>
Net unrealized gain on securities included in stockholders' equity at
December 31, 1997 was comprised of the follow (dollars in thousands):
<TABLE>
<CAPTION>
GAINS LOSSES NET
------ ------ -----
<S> <C> <C> <C>
Fixed income securities................................. $1,227 $(471) $ 756
Other................................................... -- (27) (27)
------ ----- -----
$1,227 $(498) 729
------ -----
Deferred income taxes................................... (255)
-----
Net unrealized gain on securities....................... $ 474
=====
</TABLE>
F-14
<PAGE> 92
CNA SURETY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
4. LONG-TERM DEBT
CNA Surety has a five-year unsecured revolving credit facility that
provides for borrowings of up to $130 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 applicable margin. The margin, including
the facility fee, varies based on CNA Surety's leverage ratio (debt to total
capitalization) and ranges from 0.25% to 0.40%. The consolidated balance sheet
reflects total long-term debt of $118 million, comprised of borrowings of $54
million to retire pre-existing Capsure debt, $51 million of borrowings of which
$50 million was contributed to Western Surety in connection with the Merger and
$13 million of borrowings to pay the closing dividend and other merger-related
costs. The weighted average interest rate on outstanding borrowings was 6.17% at
December 31, 1997.
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 December 31, 1997, the
Company was in compliance with all restrictions or covenants contained in the
credit facility agreement. The credit facility provides for the payment of all
outstanding principal balances after five years 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.
5. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table summarizes fair value information about financial
instruments, whether or not recognized in the balance sheet, for which it is
practicable to estimate that value. In cases where quoted market prices are not
available, fair values may be based on estimates using present value or other
valuation techniques. These techniques are significantly affected by the
assumptions used, including the discount rates and estimates of future cash
flows. Accordingly, the estimates presented herein are subjective in nature and
are not necessarily indicative of the amounts that the Company could realize in
a current market exchange. This information excludes certain financial
instruments and all nonfinancial instruments such as insurance contracts from
fair value disclosure. Thus, these fair value amounts cannot be aggregated to
determine the underlying economic value of the Company.
The carrying amounts and estimated fair values of financial instruments at
December 31, 1997 were as follows (dollars in thousands):
<TABLE>
<CAPTION>
CARRYING ESTIMATED
AMOUNT FAIR VALUE
-------- ----------
<S> <C> <C>
Fixed income securities..................................... $266,301 $266,301
Short-term investments...................................... 147,235 147,235
Other investments........................................... 6,001 6,001
Cash........................................................ 130 130
Long-term debt.............................................. 118,000 118,000
</TABLE>
The following methods and assumptions were used by the Company in
estimating fair values of financial instruments:
Investments -- The estimated fair values for the fixed income securities
are based upon quoted market prices, where available. For fixed income
securities not actively traded, the estimated fair values are determined using
values obtained from independent pricing services or, in the case of private
placements, by discounting expected future cash flows using a current market
rate applicable to the yield, credit quality and maturity of the investments.
F-15
<PAGE> 93
CNA SURETY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Cash, Short-Term Investments and Other Investments -- The carrying value
for these instruments approximates their estimated fair values.
Long-Term Debt -- The estimated fair value of the Company's long-term debt
is based on the quoted market prices for the same or similar issues or on the
current rates offered to the Company for debt of the same remaining maturity.
6. DEFERRED POLICY ACQUISITION COSTS
Policy acquisition costs deferred and the related amortization of deferred
policy acquisition costs was as follows (dollars in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30,
DATE OF PREDECESSOR
INCEPTION, NINE(1) YEARS ENDED
THROUGH MONTHS ENDED DECEMBER 31,
DECEMBER 31, SEPTEMBER 30, --------------------
1997 1997 1996 1995
------------- ------------- -------- --------
<S> <C> <C> <C> <C>
Balance at beginning of period........... $ 69,094 $ 37,689 $ 42,727 $ 24,314
Deferred policy acquisition costs of CIC
at May 10, 1995, date of acquisition... -- -- -- 21,503
Costs deferred........................... 20,931 48,126 61,344 55,153
Amortization............................. (25,881) (48,075) (66,382) (58,243)
Deferred policy acquisition costs of
Capsure
at September 30, 1997, date of
Merger................................. -- 31,354 -- --
-------- -------- -------- --------
Balance at end of period................. $ 64,144 $ 69,094 $ 37,689 $ 42,727
======== ======== ======== ========
</TABLE>
- - ---------------
(1) Amounts are for Predecessor except for the deferred policy acquisition costs
of Capsure acquired and the balance at the end of the period which is for
CNA Surety.
7. REINSURANCE
The Company's insurance subsidiaries, in the ordinary course of business,
cede reinsurance to other insurance companies to limit their exposure to loss.
Reinsurance arrangements are used to limit maximum loss, provide greater
diversification of risk and minimize exposure on larger risks. Reinsurance
contracts do not ordinarily relieve the Company of its primary obligations to
claimants. Therefore, a contingent liability exists with respect to reinsurance
ceded to the extent that any reinsurer is unable to meet the obligations assumed
under the reinsurance agreements. The Company evaluates the financial condition
of its reinsurers, establishes allowances for uncollectible amounts and monitors
concentrations of credit risk. At December 31, 1997, CNA Surety's largest
unaffiliated reinsurance receivable, including prepaid reinsurance premiums of
$1.0 million, was approximately $2.7 million with a company rated A+ (Superior)
by A.M. Best Company, Inc.
F-16
<PAGE> 94
CNA SURETY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The effect of reinsurance on premiums written and earned was as follows
(dollars in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, PREDECESSOR
DATE OF INCEPTION, ---------------------------------------------------------------
THROUGH YEARS ENDED DECEMBER 31,
DECEMBER 31, NINE MONTHS ENDED -----------------------------------------
1997 SEPTEMBER 30, 1997 1996 1995
------------------- ------------------- ------------------- -------------------
WRITTEN EARNED WRITTEN EARNED WRITTEN EARNED WRITTEN EARNED
-------- -------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Direct.......................... $24,561 $27,159 $114,969 $112,751 $152,517 $158,160 $135,803 $145,176
Assumed from affiliates......... 50,691 40,653 -- -- -- -- -- --
Assumed from non-
affiliates.................... -- -- 1,106 2,034 2,691 2,429 802 885
Ceded........................... (1,263) (2,379) (7,445) (6,221) (11,304) (11,520) (14,593) (15,458)
------- ------- -------- -------- -------- -------- -------- --------
Net premiums.................... $73,989 $65,433 $108,630 $108,564 $143,904 $149,069 $122,012 $130,603
======= ======= ======== ======== ======== ======== ======== ========
</TABLE>
Assumed premiums from affiliates primarily is comprised of all surety
business written or renewed, net of reinsurance, by CCC and CIC after the Merger
Date that is reinsured by Western Surety pursuant to intercompany reinsurance
and related agreements.
The effect of reinsurance on losses and loss adjustment expenses incurred
was as follows (dollars in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, PREDECESSOR
DATE OF ---------------------------------
INCEPTION, NINE YEARS ENDED
THROUGH MONTHS ENDED DECEMBER 31,
DECEMBER 31, SEPTEMBER 30, -----------------
1997 1997 1996 1995
------------- ------------- ------- -------
<S> <C> <C> <C> <C>
Gross losses and loss adjustment expenses...... $12,613 $ (7,265) $29,952 $34,236
Reinsurance recoveries......................... (479) (4,251) 3,054 (1,796)
------- -------- ------- -------
Net losses and loss adjustment expenses........ $12,134 $(11,516) $33,006 $32,440
======= ======== ======= =======
</TABLE>
F-17
<PAGE> 95
CNA SURETY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
8. RESERVES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
Activity in the reserves for unpaid losses and loss adjustment expenses was
as follows (dollars in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30,
DATE OF PREDECESSOR
INCEPTION, NINE(1) YEARS ENDED
THROUGH MONTHS ENDED DECEMBER 31,
DECEMBER 31, SEPTEMBER 30, -------------------
1997 1997 1996 1995
------------- ------------- -------- --------
<S> <C> <C> <C> <C>
Reserves at beginning of period:
Gross........................................ $122,281 $119,151 $138,657 $ 48,818
Ceded reinsurance............................ 7,273 15,467 24,531 13,770
-------- -------- -------- --------
Net reserves at beginning of period........ 115,008 103,684 114,126 35,048
Net reserves of CIC at May 10, 1995, date of
acquisition................................ -- -- -- 64,780
-------- -------- -------- --------
Total net reserves...................... 115,008 103,684 114,126 99,828
-------- -------- -------- --------
Net incurred loss and loss adjustment
expenses:
Provision for insured events of current
period.................................. 12,781 23,484 42,748 43,286
Decrease in provision for insured events of
prior periods........................... (647) (35,000) (9,742) (10,846)
-------- -------- -------- --------
Total net incurred...................... 12,134 (11,516) 33,006 32,440
-------- -------- -------- --------
Net payments attributable to:
Current period events...................... 4,256 4,307 7,728 1,648
Prior periods events....................... 161 3,780 35,720 16,494
-------- -------- -------- --------
Total net payments...................... 4,417 8,087 43,448 18,142
-------- -------- -------- --------
Net reserves of Capsure at September 30,
1997, date of Merger....................... -- 30,927 -- --
Net reserves at end of period................ 122,725 115,008 103,684 114,126
Ceded reinsurance at end of period........... 7,656 7,273 15,467 24,531
-------- -------- -------- --------
Gross reserves at end of period......... $130,381 $122,281 $119,151 $138,657
======== ======== ======== ========
</TABLE>
- - ---------------
(1) Amounts are for Predecessor except for the net reserves of Capsure and both
ceded reinsurance and gross reserves at the end of the period which are for
CNA Surety.
Based on the CCC Surety Operations' study of reserves, management
determined that it had been overly cautious in interpreting claim data and had
discounted favorable trends. Consistent with the CCC Surety Operations' regular
study of reserve levels, the CCC Surety Operations released $35.0 million of
prior year reserves in 1997. Approximately $33.0 million of this reserve
development related to CIC and principally to accident years prior to 1996.
Asbestos and Environmental Claims
The Company does not bond contractors that specialize in environmental
remediation work. The Company does however bond several accounts that have
incidental environmental exposure with respect to which the Company provides
limited bonding programs. In the commercial surety market, the Company provides
bonds to large corporations that are in the business of mining various minerals
and are obligated to post reclamation bonds that guarantee that property which
was disturbed during mining is returned to an acceptable condition when the
mining is completed. While no environmental responsibility is overtly provided
by commercial or contract bonds, some risk of environmental exposure may exist
if the surety were to assume
F-18
<PAGE> 96
CNA SURETY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
certain rights of ownership of the property in the completion of a defaulted
project or through salvage recovery.
To date, the Company has not received any environmental claim notices nor
is management aware of any potential environmental claims.
9. COMMITMENTS AND CONTINGENCIES
At December 31, 1997 the future minimum commitment under operating leases
was as follows: 1998 -- $3.6 million; 1999 -- $2.3 million; 2000 -- $1.9
million; 2001 -- $1.4 million and 2002 and thereafter -- $0.3 million. Total
rental expense for the period from September 31, 1997 (date of inception)
through December 31, 1997 was $0.8 million.
The Company and its subsidiaries are parties to numerous 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.
10. INCOME TAXES
The components of deferred income taxes as of December 31, 1997 and 1996
were as follows (dollars in thousands):
<TABLE>
<CAPTION>
PREDECESSOR
1997 1996
------- -----------
<S> <C> <C>
Deferred tax assets:
Net operating losses...................................... $17,516 $ --
Unearned premium reserves................................. 11,737 6,256
Accrued expenses.......................................... 5,205 --
Loss and loss adjustment expense reserves................. 2,444 1,905
Other..................................................... 2,966 490
------- -------
Total gross deferred tax assets........................ 39,868 8,651
Valuation allowance....................................... 7,950 --
------- -------
Deferred tax asset, net of valuation allowance.............. 31,918 8,651
------- -------
Deferred tax liabilities:
Deferred policy acquisition costs......................... 22,450 13,191
Intangible assets......................................... 7,085 --
Unrealized gain on securities............................. 255 --
Other..................................................... 2,043 --
------- -------
Total deferred tax liabilities......................... 31,833 13,191
------- -------
Net deferred tax asset (liability).......................... $ 85 $(4,540)
======= =======
</TABLE>
The net deferred tax asset for the year ended December 31, 1997 is included
in other assets in the consolidated balance sheet.
The Internal Revenue Service ("IRS") has not audited Capsure's tax returns
for the years in which Capsure reported net operating losses ("NOLs"). Under
Section 382 of the Internal Revenue Code of 1986, as amended (the "Code"),
restrictions on the utilization of Capsure's NOLs occurred due to the change in
ownership upon consummation of the Merger on September 30, 1997. The valuation
allowance reflects the restrictions placed upon CNA Surety's ability to utilize
Capsure's available NOLs in the future.
F-19
<PAGE> 97
CNA SURETY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CNA Surety and its subsidiaries will file a consolidated federal income tax
return. As of December 31, 1997, approximately $50.0 million of consolidated
NOLs remained available to offset future taxable income of the Company and its
subsidiaries. Such carryforwards, which have an aggregate gross tax benefit of
$17.5 million, expire by tax year as follows: $39.2 million in 1998 and $7.1
million in 1999, $2.4 million in 2000, $0.9 million in 2001, and $0.4 million in
2002. Although realization is not assured, management believes that it is more
likely than not that CNA Surety will generate sufficient taxable income to
utilize approximately $9.6 million of tax benefits from its available NOLs as of
December 31, 1997. Such estimates consider the restrictions placed on the
Company's ability to utilize Capsure's NOLs, the earnings history of each of its
insurance subsidiaries and projections of future taxable income. The amount of
the deferred tax asset considered realizable, however, could be reduced in the
near term if estimates of future taxable income during the carryforward period
are reduced.
The income tax provisions consisted of the following (dollars in
thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, PREDECESSOR
DATE OF ----------------------------------
INCEPTION, NINE YEARS ENDED
THROUGH MONTHS ENDED DECEMBER 31,
DECEMBER 31, SEPTEMBER 30, -----------------
1997 1997 1996 1995
------------- ------------- ------- ------
<S> <C> <C> <C> <C>
Federal current............. $2,558 $21,466 $13,294 $7,448
Federal deferred............ 4,038 (225) (1,106) 1,937
State....................... 67 -- -- --
------ ------- ------- ------
Total income tax expense.... $6,663 $21,241 $12,188 $9,385
====== ======= ======= ======
</TABLE>
A reconciliation from the federal statutory tax rate to the effective tax
rate is as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30, PREDECESSOR
DATE OF -------------------------------
INCEPTION, NINE YEARS ENDED
THROUGH MONTHS ENDED DECEMBER 31,
DECEMBER 31, SEPTEMBER 30, --------------
1997 1997 1996 1995
------------- ------------- ----- -----
<S> <C> <C> <C> <C>
Federal statutory rate......... 35.0% 35.0% 35.0% 35.0%
Non-deductible expenses,
principally amortization of
goodwill..................... 2.4 0.2 0.4 0.3
State income tax, net of
federal
income tax benefit........... 0.2 -- -- --
Other.......................... 0.1 -- -- --
----- ----- ----- -----
Total income tax expense....... 37.7% 35.2% 35.4% 35.3%
===== ===== ===== =====
</TABLE>
11. EMPLOYEE BENEFITS
CNA Surety sponsors a tax deferred savings plan ("401(k) plan") covering
substantially all of its employees. Under the 401(k) plan, the Company matches
70% of the participating employee's contribution up to 6% of eligible
compensation (4.2% maximum matching). In addition, the Company may also make an
annual discretionary profit sharing contribution to the 401(k) plan, subject to
the approval of the Company's board of directors. The profit sharing
contribution is based on the Company's underwriting results and may be
restricted by plan and regulatory limitations. The Company contribution,
including accrued profit sharing, to the 401(k) plan was $0.6 million for the
period from September 30, 1997 (date of inception) through December 31, 1997.
F-20
<PAGE> 98
CNA SURETY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Western Surety sponsors two post-retirement benefit plans covering certain
employees. One plan provides medical benefits, and the other plan provides sick
leave termination payments. The post-retirement health care plan is contributory
and the sick leave plan is non-contributory. The actuarially determined net
periodic post-retirement costs for these plans was $0.1 million for the period
from September 30, 1997 (date of inception) through December 31, 1997. The
unfunded accumulated post-retirement benefit obligation (for retirees and fully
vested active plan participants) was $4.7 million as of December 31, 1997 and is
included in other liabilities in the consolidated balance sheet.
12. STOCKHOLDERS' EQUITY
The Company has reserved shares of its common stock for issuance to
directors, officers, employees and certain advisors of the Company through
incentive stock options, non-qualified stock options and stock appreciation
rights ("SARs") to be granted under the CNA Surety 1997 Long-Term Equity
Compensation Plan ("CNA Surety Plan"). The Company has also reserved shares of
its common stock for issuance to Capsure option holders under the CNA Surety
Corporation Replacement Stock Option Plan ("Replacement Plan"). The CNA Surety
Plan and Replacement Plan are collectively referred to as the "Plan". The
aggregate number of shares available for which options may be granted under the
Plan is 3,000,000.
Options issued under the Replacement Plan have the same exercise price,
rights, benefits, terms and conditions as the Capsure options replaced. The
number of unexercised and outstanding Capsure options issued to the holders
under the Replacement Plan on September 30, 1997 was 335,235. The exercise
prices of the replacement options range between $0.05 and $8.00 per share.
The Incentive Compensation Committee (the "Committee") of the Board of
Directors, consisting of independent members of the Board of Directors,
administers the Plan. The Committee determines the option prices. Prices may not
be less than the fair market value of the Company's common stock on the date of
grant for incentive stock options and may not be less than the par value of the
Company's common stock for non-qualified stock options.
The Plan provides for the granting of incentive stock options as defined
under the Code. All non-qualified stock options and incentive stock options
granted under the Plan expire ten years after the date of grant and in the case
of the Replacement Plan the options expire ten years from the original Capsure
grant date.
<TABLE>
<CAPTION>
WEIGHTED
SHARES SUBJECT AVERAGE OPTION
TO OPTION PRICE PER SHARE
-------------- ---------------
<S> <C> <C>
Balance at September 30, 1997......................... 335,235 $ 3.46
Options granted..................................... 463,500 $15.82
Options canceled.................................... (23,363) $15.58
Options exercised................................... (26,000) $ 4.86
-------
Balance at December 31. 1997 749,372 $10.68
=======
</TABLE>
As of December 31, 1997, 237,422 shares were exercisable under the Plan.
The number of shares available for granting of options under the Plan were
2,224,628 at December 31, 1997.
The following table summarizes information about stock options outstanding
at December 31, 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------------------------- --------------------------------
WEIGHTED AVERAGE WEIGHTED AVERAGE WEIGHTED AVERAGE
RANGE OF NUMBER REMAINING EXERCISE NUMBER EXERCISE
EXERCISE PRICES OUTSTANDING CONTRACTUAL LIFE PRICE EXERCISABLE PRICE
- - ---------------- ----------- ---------------- ---------------- ----------- ----------------
<S> <C> <C> <C> <C> <C>
$0.05 to $15.875 749,372 7.8 years $10.68 237,422 $3.40
======= ========== ====== ======= =====
</TABLE>
F-21
<PAGE> 99
CNA SURETY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The weighted average fair market value (at grant date) per option granted
during the period from September 30, 1997 (date of inception) through December
31, 1997 was $6.62. The fair value of these options was estimated at grant date
using a Black-Scholes option pricing model with the following weighted average
assumptions for the period from September 30, 1997 (date of inception) through
December 31, 1997; risk free interest rate of 5.76%; dividend yield of 0%;
expected option life of 6 years; and volatility of 30.6%.
The Company adopted the financial disclosure provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation" with respect to its stock-based
incentive plans. The Company applies APB Opinion No. 25, "Accounting for Stock
Issued to Employees," and related interpretations, in accounting for its plans
as allowed for under the provisions of SFAS No. 123. Accordingly, no
compensation cost has been recognized for its stock-based incentive plans as the
exercise price of the granted options equals the market price at the grant date.
Had compensation cost for these plans been determined on the fair value at the
grant date for options granted, consistent with the provisions of SFAS No. 123,
the Company's pro forma net income for the period from September 30, 1997 (date
of inception) through December 31, 1997 would have been $10.9 million and net
income and diluted net income per share would have been $0.25.
13. STATUTORY FINANCIAL DATA
CNA Surety's insurance subsidiaries file financial statements prepared in
accordance with statutory accounting practices prescribed or permitted by
applicable insurance regulatory authorities. Prescribed statutory accounting
practices include state laws, regulations and general administrative rules, as
well as guidance provided in a variety of publications of the National
Association of Insurance Commissioners ("NAIC"). Permitted statutory accounting
practices encompass all accounting practices that are not prescribed. The
permitted statutory accounting practices of CNA Surety's insurance subsidiaries
did not have a material effect on reported statutory surplus or income. The
principal differences between statutory financial statements and financial
statements prepared in accordance with generally accepted accounting principles
are that statutory financial statements do not reflect deferred policy
acquisition costs and deferred income taxes and fixed income securities are
generally carried at amortized cost in statutory financial statements.
The NAIC has promulgated Risk Based Capital ("RBC") requirements for
property and casualty insurance companies to evaluate the adequacy of statutory
capital and surplus in relation to investment and insurance risks such as asset
quality, loss reserve adequacy, and other business factors. The RBC information
is used by state insurance regulators as an early warning mechanism to identify
insurance companies that potentially are inadequately capitalized. In addition,
the formula defines new minimum capital standards that supplement the current
system of fixed minimum capital and surplus requirements on a state-by-state
basis. Regulatory compliance is determined by a ratio (the "Ratio") of the
enterprise's regulatory total adjusted capital, as defined by the NAIC, to its
authorized control level RBC, as defined by the NAIC. Generally, a Ratio in
excess of 200% of authorized control level RBC requires no corrective actions by
the company or regulators. As of December 31, 1997, each of CNA Surety's
insurance subsidiaries had a Ratio that was in excess of the minimum RBC
requirements.
CNA Surety's insurance subsidiaries are subject to regulation and
supervision by the various state insurance regulatory authorities in which they
conduct business. Such regulation is generally designed to protect policyholders
and includes such matters as maintenance of minimum statutory surplus and
restrictions on the payment of dividends. Generally, statutory surplus of each
insurance subsidiary in excess of a statutorily prescribed minimum is available
for payment of dividends to the parent company. However, such distributions as
dividends may be subject to prior regulatory approval. Without prior regulatory
approval in 1998, CNA Surety's insurance subsidiaries may pay stockholder
dividends of $16.3 million in the aggregate. Combined statutory surplus for the
insurance subsidiaries at December 31, 1997 was $142.4 million.
F-22
<PAGE> 100
CNA SURETY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
14. RELATED PARTY TRANSACTIONS
CCC and the insurance subsidiaries of the Company have entered into various
reinsurance agreements designed to protect against adverse loss reserve
development related to the CCC Surety Operations reserves at the Merger Date,
and help preserve, through the year 2000, the profitability of CCC Surety
Operations and certain additional accounts. The reinsurance agreements together
with the Services and Indemnity Agreement, that is described below, also affect
the transfer of the CCC Surety Operations to the insurance subsidiaries. The
reinsurance agreements entered into at the Merger Date are: (i) the Surety Quota
Share Treaty (the "Quota Share Treaty"); (ii) the Aggregate Stop Loss
Reinsurance Contract (the "Stop Loss Contract"); and (iii) the Surety Excess of
Loss Reinsurance Contract (the "Excess of Loss Contract").
The Services and Indemnity Agreement provides the insurance subsidiaries
with the authority to perform various administrative, management, underwriting
and claim functions in order to conduct the business of the CCC Surety
Operations and to be reimbursed by CCC for services rendered. In consideration
for the provision of the foregoing services, CCC has agreed to pay the insurance
subsidiaries a quarterly fee of $50,000. At December 31, 1997, CCC owed the
insurance subsidiaries $50,000 for the period from September 30, 1997 (date of
inception) through December 31, 1997.
Through the Quota Share Treaty, CCC and CIC ceded, as of the Merger Date,
and subsequently paid on October 1, 1997, to Western Surety all of its net
unearned premiums and loss and loss adjustment expense reserves, net of $29.0
million of ceded commissions. The payment totaled $116.9 million.
Through the Quota Share Treaty, CCC and CIC will also transfer to Western
Surety all of the CCC Surety Operations' business written or renewed by CCC and
CIC after the Merger Date. CCC and CIC will transfer the related liabilities of
such business and pay to Western Surety an amount in cash equal to CCC's and
CIC's net written premiums written on all such business, minus a quarterly
ceding commission to be retained by CCC and CIC equal to $50,000 plus 28% of net
written premiums written on such business. CCC and CIC paid Western Surety, net
of commissions and reinsured loss payments, $21.2 million during the period from
September 30, 1997 (date of inception) through December 31, 1997. As of December
31, 1997, CNA Surety had a reinsurance receivable balance from CCC and CIC of
$47.9 million. This balance is primarily comprised of direct premium receivables
of CCC and CIC with respect to the surety business ceded to Western Surety.
CCC has guaranteed the loss and loss adjustment expenses transferred to
Western Surety by agreeing to pay Western Surety, within 30 days following the
end of each calendar quarter, the amount of any adverse development on such
reserves, as reestimated as of the end of such calendar quarter. There was not
any adverse reserve development for the period from September 30, 1997 (date of
inception) through December 31, 1997. The Quota Share Treaty has a term of five
years from the Merger Date.
The Stop Loss Contract protects the insurance subsidiaries from adverse
loss experience on certain business underwritten after the Merger Date. The Stop
Loss Contract between the insurance subsidiaries and CCC limits the insurance
subsidiaries' prospective net loss ratios with respect to certain accounts and
lines of insured business for at least three fiscal years following the Merger
Date. In the event the insurance subsidiaries' accident year net loss ratio
exceeds 24% in each of 1997 through 2000 on certain insured accounts (the "Loss
Ratio Cap"), the Stop Loss Contract requires CCC at the end of each calendar
quarter following the Merger Date, to pay to the insurance subsidiaries a dollar
amount equal to (i) the amount, if any, by which their actual accident year net
loss ratio exceeds the applicable Loss Ratio Cap, multiplied by (ii) the
applicable net earned premiums. In consideration for the coverage provided by
the Stop Loss Contract, the insurance subsidiaries will pay to CCC an annual
premium of $20,000. The insurance subsidiaries paid CCC the annual premium
during the period from September 30, 1997 (date of inception) through December
31, 1997 and no amount was due to the insurance subsidiaries from CCC under the
Stop Loss Contract for the period from September 30, 1997 (date of inception)
through December 31, 1997.
F-23
<PAGE> 101
CNA SURETY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Excess of Loss Contract provides the insurance subsidiaries of CNA
Surety with the capacity to underwrite large surety bond exposures by providing
reinsurance support from CCC. The Excess of Loss Contract provides $75 million
of coverage in excess of the $55 million of coverage provided to the insurance
subsidiaries by third party reinsurers for losses discovered on surety bonds in
force at the Merger Date and for losses discovered on new and renewal business
written or assumed during the term of the Excess of Loss Contract. CCC is also
obligated to act as a joint insurer, or "co-surety," for business covered by the
Excess of Loss Contract when requested by the insurance subsidiaries. In
consideration for the reinsurance coverage provided by the Excess of Loss
Contract, the insurance subsidiaries will pay to CCC, on a quarterly basis, a
premium equal to 1% of the net written premiums applicable to the Excess of Loss
Contract, subject to a minimum premium of $20,000 per quarter. The insurance
subsidiaries paid CCC $80,000 for all minimum quarterly premiums due through
September 30, 1998 during the period from September 30, 1997 (date of inception)
through December 31, 1997. The Excess of Loss Contract has a term of five years
from the Merger Date.
CNA Surety also entered into an Administrative Services Agreement with CCC
as of the Merger Date. The agreement allows the Company continued use of certain
real and personal property owned or leased by CCC. The Company may cancel,
without penalty, any lease under the agreement by giving CCC sixty days notice.
The Company can also purchase many of the administrative services provided to
the CCC Surety Operations by CCC. CNA Surety, however, is under no obligation to
purchase any services under the Administrative Services Agreement. The aggregate
maximum annual cost for the use of real and personal property and for services
available under the agreement is approximately $7.9 million. Administrative
services are provided at specified rates, subject to inflationary increases. For
the period from September 30, 1997 to December 31, 1997, the Company was charged
$2.5 million for rents and services provided under the agreement. The Company
paid CCC $1.4 million and $1.1 million was reflected in other liabilities in the
Company's Consolidated Balance Sheet at December 31, 1997.
F-24
<PAGE> 102
CNA SURETY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
15. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following is a summary of the results of operations of CNA Surety for
the period from September 30, 1997 (date of inception) through December 31, 1997
and a summary of unaudited quarterly results of the Predecessor for the nine
months ended September 30, 1997 and year ended December 31, 1996. (dollars in
thousands, except per share amounts.)
CNA SURETY
<TABLE>
<CAPTION>
INCEPTION TO
DECEMBER 31
------------
<S> <C> <C> <C> <C>
1997
Revenues............................. $71,284
=======
Income before income taxes........... $17,659
Income taxes......................... 6,663
-------
Net income........................... $10,996
=======
Basic and diluted earnings per common
share............................. $ 0.25
=======
</TABLE>
PREDECESSOR
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
----------- ------- ------- -------
<S> <C> <C> <C> <C>
1997
Net earned premiums.................. $33,829 $36,155 $38,580 $ --
======= ======= ======= =======
Excess of net earned premiums over
direct operating costs............ $41,878 $ 8,174 $10,354 $
Income taxes......................... 14,690 2,894 3,657 --
------- ------- ------- -------
Excess of net earned premiums over
direct operating costs, net of
income taxes...................... $27,188 $ 5,280 $ 6,697 $ --
======= ======= ======= =======
1996
Net earned premiums.................. $37,029 $37,504 $37,769 $36,767
======= ======= ======= =======
Excess of net earned premiums over
direct operating costs............ $ 6,696 $ 8,527 $13,472 $ 5,753
Income taxes......................... 2,377 3,017 4,748 2,046
------- ------- ------- -------
Excess of net earned premiums over
direct operating costs, net of
income taxes...................... $ 4,319 $ 5,510 $ 8,724 3,707
======= ======= ======= =======
</TABLE>
16. LOOKBACK ADJUSTMENT
The reorganization agreement provides for a mechanism, referred to as the
"Lookback Adjustment", which may adjust the number of shares of CNA Surety
common stock owned by CNAF operating companies in the event that either or both
of Capsure's and the CCC Surety Operations' actual net written premiums for 1997
vary from certain targets. Application and interpretation of the provisions of
the Lookback Adjustment are presently under review, the ultimate outcome of
which is currently not known. Based on the facts currently available, the total
number of shares of CNA Surety common stock will either not change or be reduced
by approximately 2.5%. Such a change in total outstanding shares would have no
effect on net income; however, earnings per share for the period from September
30, 1997 (date of inception) through December 31, 1997 would have increased from
$0.25 to $0.26 and the ownership of the Company by CNAF operating companies
would be reduced from 61.75% to 60.79%.
F-25
<PAGE> 103
SCHEDULE I
CNA SURETY CORPORATION AND SUBSIDIARIES
SUMMARY OF INVESTMENTS
OTHER THAN INVESTMENTS IN RELATED PARTIES
AS OF DECEMBER 31, 1997
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
FAIR CARRYING
COST VALUE VALUE
-------- -------- --------
<S> <C> <C> <C>
FIXED INCOME SECURITIES:
Bonds:
U.S. Government and government agencies and
authorities......................................... $182,238 $182,721 $182,721
States, municipalities and political subdivisions...... 3,556 3,570 3,570
All other corporate bonds.............................. 79,751 80,010 80,010
-------- -------- --------
Total fixed income securities....................... 265,545 266,301 266,301
-------- -------- --------
Short-term investments................................... 147,235 147,235
Other investments........................................ 6,027 6,001
-------- --------
Total investments................................... $418,807 $419,537
======== ========
</TABLE>
F-26
<PAGE> 104
SCHEDULE II
CNA SURETY CORPORATION
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY)
BALANCE SHEET
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
AS OF
DECEMBER 31,
1997
------------
<S> <C>
ASSETS
Investments in and advances to Capsure Holdings Corp. and
subsidiaries.............................................. $368,843
Short-term investments...................................... 7,021
Cash........................................................ 26
Deferred income taxes....................................... 1,107
Other assets................................................ 314
--------
$377,311
========
LIABILITIES
Long-term debt.............................................. $118,000
Other liabilities........................................... 2,579
--------
120,579
--------
STOCKHOLDERS' EQUITY
Common stock................................................ 433
Additional paid-in capital.................................. 244,829
Retained earnings........................................... 10,996
Unrealized gain on securities, net of deferred income
taxes..................................................... 474
--------
Total stockholders' equity.................................. 256,732
--------
$377,311
========
</TABLE>
See Note to Condensed Financial Information.
F-27
<PAGE> 105
SCHEDULE II
CNA SURETY CORPORATION
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY) -- (CONTINUED)
STATEMENT OF INCOME
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
SEPTEMBER 30,
DATE OF
INCEPTION,
THROUGH
DECEMBER 31,
1997
-------------
<S> <C>
Revenues:
Net investment income..................................... $ 33
Net realized investment gains (losses).................... --
Other income.............................................. --
-------
33
-------
Expenses:
Interest expense.......................................... 1,831
Corporate expense......................................... 1,364
-------
3,195
-------
Loss from operations before income taxes and equity in net
income of subsidiaries.................................... (3,162)
Income taxes................................................ (1,107)
-------
Loss before equity in net income of subsidiaries -- Parent
only...................................................... (2,055)
Equity in net income of subsidiaries........................ 13,051
-------
Net income.................................................. $10,996
=======
</TABLE>
See Note to Condensed Financial Information.
F-28
<PAGE> 106
SCHEDULE II
CNA SURETY CORPORATION
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY) -- (CONTINUED)
STATEMENT OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
SEPTEMBER 30,
DATE OF
INCEPTION,
THROUGH
DECEMBER 31,
1997
-------------
<S> <C>
OPERATING ACTIVITIES:
Net loss.................................................. $ (2,055)
Cash dividends from subsidiaries....................... 4,970
Tax payments received from subsidiaries................ 2,449
Federal and state income tax payments.................. --
Adjustments to reconcile net loss to net cash provided
by operating activities:
Deferred income taxes, net........................... (1,107)
Other assets and liabilities......................... (261)
---------
Net cash provided by operating activities................... 3,996
---------
INVESTING ACTIVITIES:
Net advances to subsidiaries.............................. (65,075)
Capital contribution to Western Surety Company............ (50,000)
Change in short-term investments.......................... (7,021)
---------
Net cash used in investing activities....................... (122,096)
---------
FINANCING ACTIVITIES:
Proceeds from long-term debt.............................. 118,000
Other..................................................... 126
---------
Net cash provided by financing activities................... 118,126
---------
Increase in cash............................................ 26
Cash at beginning of period................................. --
---------
Cash at end of period....................................... $ 26
=========
</TABLE>
See Note to Condensed Financial Information
F-29
<PAGE> 107
SCHEDULE II
CNA SURETY CORPORATION
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY) -- (CONTINUED)
NOTE TO CONDENSED FINANCIAL INFORMATION
1. BASIS OF PRESENTATION
The condensed financial information of the parent company includes the
accounts of CNA Surety Corporation ("CNA Surety"). On September 30, 1997 CNA
Surety was formed as part of the merger of Capsure Holdings Corp. and its
subsidiaries (Western Surety Company and Universal Surety of America) and the
surety business of CNA Financial Corporation. The merger was accounted for as a
purchase of Capsure.
F-30
<PAGE> 108
SCHEDULE III
CNA SURETY CORPORATION AND SUBSIDIARIES AND PREDECESSOR
SUPPLEMENTARY INSURANCE INFORMATION
CNA SURETY CORPORATION AS OF DECEMBER 31, 1997 AND FOR THE
PERIOD SEPTEMBER 30, 1997 (DATE OF INCEPTION) THROUGH DECEMBER 31, 1997 AND
PREDECESSOR AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND
YEARS ENDED DECEMBER 31, 1996 AND 1995
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
SEPTEMBER 30, PREDECESSOR
DATE OF -------------------------------------
INCEPTION, NINE YEARS ENDED
THROUGH MONTHS ENDED DECEMBER 31,
DECEMBER 31, SEPTEMBER 30, --------------------
1997 1997 1996 1995
------------- ------------- -------- --------
<S> <C> <C> <C> <C>
Deferred policy acquisition costs........ $ 64,144 $ 37,740 $ 37,689 $ 42,727
======== ======== ======== ========
Future policy benefits, losses, claims
and loss expenses...................... $130,381 $ 88,914 $119,151 $138,657
======== ======== ======== ========
Unearned premiums........................ $173,836 $ 94,577 $ 95,677 $101,059
======== ======== ======== ========
Other policy claims and benefits
payable................................ $ -- $ -- $ -- $ --
======== ======== ======== ========
Net premium revenue...................... $ 65,433 $108,564 $149,069 $130,603
======== ======== ======== ========
Net investment income.................... $ 5,766 $ -- $ -- $ --
======== ======== ======== ========
Benefits, claims, losses and settlement
expenses............................... $ 12,134 $(11,516) $ 33,006 $ 32,440
======== ======== ======== ========
Amortization of deferred policy
acquisition costs...................... $ 25,881 $ 48,075 $ 66,382 $ 58,243
======== ======== ======== ========
Other operating expenses................. $ 12,332 $ 11,599 $ 15,233 $ 13,348
======== ======== ======== ========
Net premiums written..................... $ 73,989 $108,630 $143,904 $122,012
======== ======== ======== ========
</TABLE>
F-31
<PAGE> 109
SCHEDULE IV
CNA SURETY CORPORATION AND SUBSIDIARIES AND PREDECESSOR
REINSURANCE
CNA SURETY CORPORATION FOR THE PERIOD SEPTEMBER 30, 1997
(DATE OF INCEPTION) THROUGH DECEMBER 31, 1997 AND
PREDECESSOR FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND
YEARS ENDED DECEMBER 31, 1996 AND 1995
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
PERCENTAGE
CEDED TO ASSUMED OF AMOUNT
GROSS OTHER FROM OTHER NET ASSUMED
AMOUNT COMPANIES COMPANIES AMOUNT TO NET
-------- --------- ---------- -------- ----------
<S> <C> <C> <C> <C> <C>
CNA SURETY CORPORATION
SEPTEMBER 30, 1997
(DATE OF INCEPTION) THROUGH
DECEMBER 31, 1997
Premiums:
Property and casualty
insurance.................... $ 27,159 $ 2,379 $40,653 $ 65,433 62.1%
-------- ------- ------- -------- ----
Total premiums............... $ 27,159 $ 2,379 $40,653 $ 65,433 62.1%
======== ======= ======= ======== ====
PREDECESSOR
NINE MONTHS ENDED
SEPTEMBER 30, 1997
Premiums:
Property and casualty
insurance.................... $112,751 $ 6,221 $ 2,034 $108,564 1.9%
-------- ------- ------- -------- ----
Total premiums............... $112,751 $ 6,221 $ 2,034 $108,564 1.9%
======== ======= ======= ======== ====
YEAR ENDED DECEMBER 31, 1996
Premiums:
Property and casualty
insurance.................... $158,160 $11,520 $ 2,429 $149,069 1.6%
-------- ------- ------- -------- ----
Total premiums............... $158,160 $11,520 $ 2,429 $149,069 1.6%
======== ======= ======= ======== ====
YEAR ENDED DECEMBER 31, 1995
Premiums:
Property and casualty
insurance.................... $145,176 $15,458 $ 885 $130,603 0.7%
-------- ------- ------- -------- ----
Total premiums............... $145,176 $15,458 $ 885 $130,603 0.7%
======== ======= ======= ======== ====
</TABLE>
F-32
<PAGE> 110
SCHEDULE V
CNA SURETY CORPORATION AND SUBSIDIARIES AND PREDECESSOR
VALUATION AND QUALIFYING ACCOUNTS
CNA SURETY CORPORATION FOR THE PERIOD SEPTEMBER 30, 1997
(DATE OF INCEPTION) THROUGH DECEMBER 31, 1997 AND
PREDECESSOR FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND
YEARS ENDED DECEMBER 31, 1996 AND 1995
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
ADDITIONS
------------------------
BALANCE AT CHARGED TO CHARGED TO BALANCE
BEGINNING OF COSTS AND OTHER AT END OF
PERIOD(1) EXPENSES ACCOUNTS DEDUCTIONS(2) PERIOD
------------ ---------- ---------- ------------- ---------
<S> <C> <C> <C> <C> <C>
CNA SURETY CORPORATION
SEPTEMBER 30, 1997 (DATE OF
INCEPTION) THROUGH DECEMBER
31, 1997
Allowance for possible losses
on premiums receivable.... $893 $(46) $ -- $ -- $847
==== ==== ==== ==== ====
Allowance for possible losses
on reinsurance
receivable................ $ -- $ -- $ -- $ -- $ --
==== ==== ==== ==== ====
PREDECESSOR
NINE MONTHS ENDED SEPTEMBER 30,
1997
Allowance for possible losses
on premiums receivable.... $ -- $ -- $ -- $ -- $ --
==== ==== ==== ==== ====
Allowance for possible losses
on reinsurance
receivable................ $ -- $ -- $ -- $ -- $ --
==== ==== ==== ==== ====
YEAR ENDED DECEMBER 31, 1996
Allowance for possible losses
on premiums receivable.... $ -- $ -- $ -- $ -- $ --
==== ==== ==== ==== ====
Allowance for possible losses
on reinsurance
receivable................ $ -- $ -- $ -- $ -- $ --
==== ==== ==== ==== ====
YEAR ENDED DECEMBER 31, 1995
Allowance for possible losses
on premiums receivable.... $ -- $ -- $ -- $ -- $ --
==== ==== ==== ==== ====
Allowance for possible losses
on reinsurance
receivable................ $ -- $ -- $ -- $ -- $ --
==== ==== ==== ==== ====
</TABLE>
- - ---------------
(1) Acquired balance of Capsure Holdings Corp. on September 30, 1997.
(2) Accounts charged against allowance.
F-33
<PAGE> 111
SCHEDULE VI
CNA SURETY CORPORATION AND SUBSIDIARIES AND PREDECESSOR
SUPPLEMENTAL INFORMATION CONCERNING PROPERTY-CASUALTY
INSURANCE OPERATIONS
CNA SURETY CORPORATION AS OF DECEMBER 31, 1997 AND FOR THE
PERIOD SEPTEMBER 30, 1997 (DATE OF INCEPTION) THROUGH DECEMBER 31, 1997 AND
PREDECESSOR AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND
YEARS ENDED DECEMBER 31, 1996 AND 1995
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
SEPTEMBER 30, PREDECESSOR
DATE OF -------------------------------------
INCEPTION, NINE YEAR ENDED
THROUGH MONTHS ENDED DECEMBER 31,
DECEMBER 31, SEPTEMBER 30, --------------------
1997 1997 1996 1995
------------- ------------- -------- --------
<S> <C> <C> <C> <C>
Deferred policy acquisition costs........ $ 64,144 $ 37,740 $ 37,689 $ 42,727
======== ======== ======== ========
Reserves for unpaid claims and claim
adjustment expenses.................... $130,381 $ 88,914 $119,151 $138,657
======== ======== ======== ========
Discount (if any) deducted............... $ -- $ -- $ -- $ --
======== ======== ======== ========
Unearned premiums........................ $173,836 $ 94,577 $ 95,677 $101,059
======== ======== ======== ========
Net earned premiums...................... $ 65,433 $108,564 $149,069 $130,603
======== ======== ======== ========
Net investment income.................... $ 5,766 $ -- $ -- $ --
======== ======== ======== ========
Net claims and claim adjustment expenses
incurred related to:
Current year........................ $ 12,781 $ 23,484 $ 42,748 $ 43,286
======== ======== ======== ========
Prior years......................... $ (647) $(35,000) $ (9,742) $(10,846)
======== ======== ======== ========
Amortization of deferred policy
acquisition costs...................... $ 25,881 $ 48,075 $ 66,382 $ 58,243
======== ======== ======== ========
Net paid claims and claim adjustment
expenses............................... $ 4,417 $ 8,087 $ 43,448 $ 18,142
======== ======== ======== ========
Net premiums written..................... $ 73,989 $108,630 $143,904 $122,012
======== ======== ======== ========
</TABLE>
F-34
<PAGE> 112
INDEPENDENT ACCOUNTANTS' REVIEW REPORT
To the Board of Directors and Stockholders of
CNA Surety Corporation
Chicago, IL
We have reviewed the accompanying condensed consolidated balance sheet of
CNA Surety Corporation and subsidiaries as of March 31, 1998, and the related
condensed consolidated statements of income, stockholders' equity and cash flows
for the three-month period ended March 31, 1998. We have also reviewed the
accompanying special-purpose statements of certain revenues and direct operating
expenses of CCC Surety Operations ("Predecessor"), a business unit of CNA
Financial Corporation, for the three-month period ended March 31, 1997. 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 generally accepted auditing standards, 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 generally accepted accounting principles.
Deloitte & Touche LLP
May 12, 1998
F-35
<PAGE> 113
CNA SURETY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
(UNAUDITED)
MARCH 31, DECEMBER 31,
1998 1997
----------- ------------
<S> <C> <C>
ASSETS
Invested assets and cash:
Fixed income securities, at fair value (amortized cost:
$389,050 and $265,545)................................. $389,396 $266,301
Short-term investments, at cost which approximates fair
value.................................................. 28,734 147,235
Other investments, at fair value.......................... 6,045 6,001
Cash...................................................... 3,424 130
-------- --------
427,599 419,667
Deferred policy acquisition costs........................... 67,520 64,144
Insurance receivables:
Premiums.................................................. 10,473 9,683
Reinsurance, including receivable from affiliates of
$46,819 at March 31, 1998 and $47,856 at December 31,
1997................................................... 55,008 55,151
Intangible assets, net of accumulated amortization.......... 160,487 161,962
Prepaid reinsurance premiums................................ 4,742 4,150
Other assets................................................ 15,042 12,423
-------- --------
Total assets...................................... $740,871 $727,180
======== ========
LIABILITIES
Reserves:
Unpaid losses and loss adjustment expenses................ $132,100 $130,381
Unearned premiums......................................... 177,520 173,836
-------- --------
309,620 304,217
Long-term debt.............................................. 118,000 118,000
Deferred income taxes, net.................................. 1,624 --
Payable for securities purchased............................ 7,527 10,609
Other liabilities........................................... 37,577 37,622
-------- --------
Total liabilities................................. 474,348 470,448
-------- --------
Commitments and contingencies (Note 6)
STOCKHOLDERS' EQUITY
Preferred stock, par value $0.01 per share, 20,000 shares
authorized; none issued and outstanding................... -- --
Common stock, par value $0.01 per share, 100,000 shares
authorized; 43,379 and 43,320 shares issued and
outstanding at March 31, 1998 and at December 31, 1997,
respectively.............................................. 245,567 245,262
Retained earnings........................................... 20,811 10,996
Accumulated other comprehensive income...................... 145 474
-------- --------
Total stockholders' equity........................ 266,523 256,732
-------- --------
Total liabilities and stockholders' equity........ $740,871 $727,180
======== ========
</TABLE>
See Independent Accountants' Review Report and notes to financial statements.
F-36
<PAGE> 114
CNA SURETY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF INCOME AND CONDENSED STATEMENT OF
CERTAIN REVENUES AND DIRECT OPERATING EXPENSES OF PREDECESSOR
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
-----------------------
1998 1997
------- -------------
(PREDECESSOR)
<S> <C> <C>
Revenues:
Net earned premiums....................................... $58,745 $33,829
Net investment income..................................... 6,789 --
Net realized investment gains............................. -- --
------- -------
65,534 33,829
------- -------
Expenses:
Net losses and loss adjustment expenses................... 11,218 (27,612)
Net commissions, brokerage and other underwriting
expenses............................................... 35,039 19,563
Interest expense.......................................... 1,821 --
Amortization of intangible assets......................... 1,475 --
------- -------
49,553 (8,049)
------- -------
Income before income taxes (Excess of net earned premiums
over direct operating expenses, before income taxes, for
Predecessor).............................................. 15,981 41,878
Income taxes................................................ 6,166 14,690
------- -------
Net income (Excess of net earned premiums over direct
operating expenses, net of income taxes, for
Predecessor).............................................. $ 9,815 $27,188
======= =======
Basic net income per share.................................. $ 0.23
=======
Diluted net income per share................................ $ 0.23
=======
Basic weighted average shares outstanding................... 43,348
=======
Diluted weighted average shares outstanding................. 43,570
=======
</TABLE>
See Independent Accountants' Review Report and notes to financial statements.
F-37
<PAGE> 115
CNA SURETY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
ACCUMULATED
OTHER TOTAL
COMMON COMPREHENSIVE RETAINED COMPREHENSIVE STOCKHOLDERS'
STOCK INCOME (LOSS) EARNINGS INCOME (LOSS) EQUITY
-------- -------------- -------- -------------- -------------
<S> <C> <C> <C> <C> <C>
Balance, January 1, 1998........... $245,262 $10,996 $ 474 $256,732
Comprehensive income:
Net income....................... $9,815 9,815 9,815
Change in unrealized gains on
investments, net of income
taxes......................... (329) (329) (329)
------
Comprehensive income............... $9,486
======
Stock options exercised............ 305 305
-------- ------- ----- --------
Balance, March 31, 1998............ $245,567 $20,811 $ 145 $266,523
======== ======= ===== ========
</TABLE>
See Independent Accountants' Review Report and notes to financial statements.
F-38
<PAGE> 116
CNA SURETY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
MARCH 31,
1998
------------
<S> <C>
OPERATING ACTIVITIES:
Net income................................................ $ 9,815
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization.......................... 1,942
Accretion of bond discount, net........................ 384
Net realized investment gains.......................... --
Changes in:
Insurance receivables.................................. (647)
Reserve for unearned premiums.......................... 3,684
Reserve for unpaid losses and loss adjustment
expenses.............................................. 1,719
Deferred income taxes, net............................. 1,709
Other assets and liabilities........................... (6,141)
---------
Net cash provided by operating activities................... 12,465
---------
INVESTING ACTIVITIES:
Securities available-for-sale:
Purchases -- fixed income securities................... (135,963)
Maturities -- fixed income securities.................. 8,994
Sales -- fixed income securities....................... --
Change in short-term investments.......................... 118,501
Other, net................................................ (880)
---------
Net cash used in investing activities....................... (9,348)
---------
FINANCING ACTIVITIES:
Stock options exercised................................... 177
---------
Net cash provided by financing activities................... 177
---------
Increase (decrease) in cash................................. 3,294
Cash at beginning of period................................. 130
---------
Cash at end of period....................................... $ 3,424
=========
Supplemental Disclosure of Cash Flow Information:
Cash paid during the period for:
Interest............................................... $ 1,727
Income taxes........................................... $ 1,500
</TABLE>
See Independent Accountants' Review Report and notes to financial statements.
F-39
<PAGE> 117
CNA SURETY CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1998
(UNAUDITED -- SEE INDEPENDENT ACCOUNTANTS' REVIEW REPORT)
1. SIGNIFICANT ACCOUNTING POLICIES
Formation of CNA Surety Corporation and Merger
In December 1996, CNA Financial Corporation ("CNAF") and Capsure Holdings
Corp. ("Capsure") agreed to merge (the "Merger") the surety business of CNAF
with Capsure's insurance subsidiaries, Western Surety Company ("Western Surety")
and Universal Surety of America ("USA"), which are owned by a newly-formed
holding company, 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. Loews Corporation owns approximately 84% 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. The combined
surety operations of CCC and CIC are referred to herein as CCC Surety Operations
("Predecessor").
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. CCC also
agreed to provide certain administrative services at specified rates, subject to
inflationary increases, for three years after the Merger, if CNA Surety chooses
to purchase such services.
Immediately after the Merger, the CNAF operating subsidiaries owned, on a
diluted basis, 61.75% of CNA Surety's common stock and the stockholders and
option holders of Capsure owned 38.25% of CNA Surety's common stock on a diluted
basis. The reorganization agreement provided a mechanism, referred to as the
"Lookback Adjustment", which could adjust the number of shares of CNA Surety
common stock owned by the CNAF operating subsidiaries in the event that either
or both of Capsure's and the CCC Surety Operations' actual net written premiums
for 1997 varied from certain targets. Application and interpretation of the
provisions of the Lookback Adjustment were completed in April 1998 with no
adjustment to the 61.75% ownership percentage of the CNAF operating
subsidiaries.
Principles of Consolidation
The consolidated financial statements include the accounts of CNA Surety
Corporation and all majority-owned subsidiaries. The consolidated financial
statements include the combined consolidated operating results of CCC Surety
Operations and Capsure since the Merger Date.
Predecessor Financial Information
The accompanying Condensed Statement of Certain Revenues and Direct
Operating Expenses of Predecessor for the quarter ended March 31, 1997 reflects
premiums earned, losses incurred, loss adjustment expenses (allocated and
unallocated) and other direct operating expenses of CCC Surety Operations. Such
operating revenues and costs as investment income, realized gains and losses on
investments and certain
F-40
<PAGE> 118
general and administrative expenses, which are indirect or overhead in nature,
are not reflected in operating results since such items were not historically
allocated to CCC Surety Operations by CNAF or its subsidiaries.
Since the accompanying Predecessor financial statement excludes certain
revenues and expenses, as described in the preceding paragraph, this financial
statement is not intended to be a complete presentation of CCC Surety
Operations. The revenues and costs that are reflected in the accompanying
financial statement have been determined in accordance with generally accepted
accounting principles.
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 1997 Annual Report on Form 10-K. Certain financial
information that is normally included in annual financial statements prepared in
accordance with generally accepted accounting principles has been condensed or
omitted as it is not required for interim reporting. 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 1997
Predecessor Financial Statements to conform with the presentation in the 1998
Condensed Consolidated Financial Statements.
Accounting Changes
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income," which establishes accounting standards for reporting and
display of comprehensive income and its components (revenues, expenses, gains,
and losses) in a full set of general-purpose financial statements. This
Statement requires that an enterprise (a) classify items of other comprehensive
income by their nature in a financial statement and (b) display the accumulated
balance of other comprehensive income separately from retained earnings and
additional paid-in capital in the equity section of a statement of financial
position. The Company has adopted this standard in these Condensed Consolidated
Financial Statements for the period ended March 31, 1998.
2. CAPSURE ACQUISITION
The merger of CCC Surety Operations and Capsure has been accounted for by
CNA Surety as an acquisition of Capsure, using purchase accounting. The purchase
price for Capsure has been allocated to Capsure's assets that were acquired and
to Capsure's liabilities that were assumed based on the estimated fair value of
such assets and liabilities at the Merger Date. The purchase price for the
outstanding shares of Capsure common stock was $182.1 million and has been
allocated as follows (dollars in thousands):
<TABLE>
<S> <C>
Capsure net assets at historical cost....................... $100,875
Fair value adjustments:
Purchased intangibles..................................... (73,844)
Intangibles arising from Merger........................... 155,031
--------
Purchase price.............................................. $182,062
========
</TABLE>
Unaudited Pro Forma Results
The following table of unaudited pro forma information has been prepared as
if the acquisition of Capsure had been consummated on January 1, 1996. This
unaudited pro forma financial information gives effect to the following: (i)
adjustment to the Capsure statement of operations, as reported, to reflect the
income effects as if the $10 per share special distribution was made on January
1, 1996; (ii) consummation of the Merger and the related transactions and the
contribution of capital to and the incurrence of additional debt by CNA Surety;
(iii) purchase accounting adjustments to reflect Capsure's assets and
liabilities at fair value; (iv) estimated
F-41
<PAGE> 119
indirect and overhead expenses for the CCC Surety Operations; and (v) estimated
interest expense related to the additional debt (dollars in thousands, except
per share amounts):
<TABLE>
<CAPTION>
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
1997
------------------
<S> <C>
Revenues.................................................... $56,128
Net income.................................................. $29,411
Basic net income per share.................................. $ 0.68
</TABLE>
The foregoing unaudited pro forma operating results include $35.0 million
($22.8 million net of income taxes or $0.53 per share) of favorable loss reserve
development of Predecessor.
This unaudited pro forma financial information is intended for information
purposes only and is not necessarily indicative of the results of operations
which would have been achieved and reported had the Merger and related
transactions been consummated on the dates assumed, nor is it necessarily
indicative of the future consolidated operating results of CNA Surety.
3. INVESTMENTS
The estimated fair value, gross unrealized gains and losses, and amortized
cost of fixed income securities held by CNA Surety at March 31, 1998, by
investment category, were as follows (dollars in thousands):
<TABLE>
<CAPTION>
AMORTIZED GROSS GROSS ESTIMATED
COST UNREALIZED UNREALIZED FAIR
OR COST GAINS LOSSES VALUE
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
Fixed income securities:
U.S. Treasury securities and obligations of
government corporations and agencies........... $189,510 $ 772 $ (221) $190,061
Obligations of states and political
subdivisions................................... 79,784 206 (525) 79,465
Corporate bonds................................... 58,706 331 (362) 58,675
Non-agency collateralized mortgage obligations.... 29,391 40 (120) 29,311
Asset-backed securities........................... 31,659 234 (9) 31,884
-------- ------ ------- --------
Total fixed income securities................ $389,050 $1,583 $(1,237) $389,396
======== ====== ======= ========
</TABLE>
4. REINSURANCE
The effect of reinsurance on the Company's and Predecessor's written and
earned premium was as follows (dollars in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
-------------------------------------
1998 1997
----------------- -----------------
WRITTEN EARNED WRITTEN EARNED
------- ------- ------- -------
(PREDECESSOR)
<S> <C> <C> <C> <C>
Direct.................................................. $27,994 $24,306 $32,611 $36,148
Assumed from affiliates................................. 35,854 36,040 -- --
Assumed from non-affiliates............................. -- -- 431 545
Ceded................................................... (2,012) (1,601) (2,562) (2,864)
------- ------- ------- -------
$61,836 $58,745 $30,480 $33,829
======= ======= ======= =======
</TABLE>
F-42
<PAGE> 120
The effect of reinsurance on the Company's and Predecessor's provision for
loss and loss adjustment expenses was as follows (dollars in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
--------------------------
1998 1997
------- -------------
(PREDECESSOR)
<S> <C> <C>
Gross loss and loss adjustment expense...................... $13,117 $(25,995)
Ceded amounts............................................... (1,899) (1,617)
------- --------
Net loss and loss adjustment expense........................ $11,218 $(27,612)
======= ========
</TABLE>
5. LOOKBACK ADJUSTMENT
The reorganization agreement provided a mechanism, referred to as the
"Lookback Adjustment", which could adjust the number of shares of CNA Surety
common stock owned by CNAF operating companies in the event that either or both
of Capsure's and the CCC Surety Operations' actual net written premiums for 1997
varied from certain targets. Application and interpretation of the provisions of
the Lookback Adjustment were completed in April 1998 with no adjustment to the
61.75% ownership percentage of the CNAF operating companies.
6. LEGAL PROCEEDINGS
The Company and its subsidiaries are parties to numerous 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.
F-43
<PAGE> 121
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
Capsure Holdings Corp.
We have audited the accompanying consolidated financial statements and
financial statement schedules of Capsure Holdings Corp. and Subsidiaries as of
December 31, 1996 and 1995 and for each of the three years in the period ended
December 31, 1996. These consolidated financial statements and financial
statement schedules are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements and financial statement schedules based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
the significant estimates made by management, as well as evaluating the overall
consolidated financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Capsure Holdings Corp. and Subsidiaries as of December 31, 1996 and 1995, and
the consolidated results of their operations and their cash flows for each of
the three years in the period ended December 31, 1996 in conformity with
generally accepted accounting principles. In addition, in our opinion, the
financial statement schedules referred to above, when considered in relation to
the basic consolidated financial statements taken as a whole, present fairly, in
all material respects, the information required to be included therein.
COOPERS & LYBRAND L.L.P.
Chicago, Illinois
February 20, 1997
F-44
<PAGE> 122
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1996 1995
-------- --------
<S> <C> <C>
ASSETS
Invested assets and cash:
Fixed maturities, at fair value (amortized cost: $135,420;
$233,276).............................................. $135,895 $235,718
Equity securities, at fair value (cost: $3,687;
$27,124)............................................... 4,526 27,753
Short-term investments, at cost which approximates fair
value.................................................. 19,416 37,865
Other investments, at fair value.......................... 2,695 3,219
Cash...................................................... 2,736 3,001
-------- --------
165,268 307,556
Deferred policy acquisition costs........................... 28,523 27,057
Reinsurance receivable...................................... 5,642 40,097
Intangible assets, net of amortization...................... 14,024 15,715
Excess cost over net assets acquired, net of amortization... 61,932 68,443
Deferred income taxes, net of valuation allowance........... 16,019 29,293
Other assets................................................ 21,731 26,607
-------- --------
Total assets...................................... $313,139 $514,768
======== ========
LIABILITIES
Reserves:
Unpaid losses and loss adjustment expenses................ $ 38,874 $126,061
Unearned premiums......................................... 69,570 76,781
-------- --------
108,444 202,842
Long-term debt.............................................. 60,000 25,000
Other liabilities........................................... 22,112 29,622
-------- --------
Total liabilities................................. 190,556 257,464
-------- --------
Commitments and contingencies
STOCKHOLDERS' EQUITY
Preferred stock, par value $.01 per share, 5,000,000 shares
authorized;
none issued and outstanding............................... -- --
Common stock, par value $.05 per share, 25,000,000 shares
authorized; 15,804,749 shares issued at December 31, 1996;
15,408,749 shares issued at December 31, 1995............. 790 770
Additional paid-in capital.................................. 118,413 179,276
Retained earnings from August 1, 1986 (date of
reorganization)........................................... 2,297 75,286
Unrealized gain on securities, net of deferred income
taxes..................................................... 1,083 1,972
-------- --------
Total stockholders' equity........................ 122,583 257,304
-------- --------
$313,139 $514,768
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-45
<PAGE> 123
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Revenues:
Net earned premiums...................................... $ 92,491 $ 98,692 $ 92,481
Net investment income.................................... 16,444 20,471 19,129
Net investment gains (losses)............................ 1,715 (1,653) 945
-------- -------- --------
110,650 117,510 112,555
-------- -------- --------
Expenses:
Net loss and loss adjustment expenses.................... 10,054 (7,451) 23,344
Net commissions, brokerage and other underwriting........ 63,204 61,312 53,904
Interest expense......................................... 1,717 4,103 4,726
Write-off of unamortized deferred loan fees.............. 700 -- 1,556
Non-recurring compensation and merger costs.............. 7,865 -- --
Amortization and impairment of goodwill and
intangibles........................................... 2,761 16,853 3,365
Other expenses, net...................................... 2,789 2,442 1,881
-------- -------- --------
89,090 77,259 88,776
-------- -------- --------
Income before income taxes................................. 21,560 40,251 23,779
Income taxes............................................... 8,181 19,721 9,401
-------- -------- --------
Net income................................................. $ 13,379 $ 20,530 $ 14,378
======== ======== ========
Weighted average shares outstanding:
Primary.................................................. 16,395 15,404 15,160
======== ======== ========
Fully diluted............................................ 16,510 15,917 15,455
======== ======== ========
Earnings per share:
Primary.................................................. $ .82 $ 1.33 $ .95
======== ======== ========
Fully diluted............................................ $ .81 $ 1.29 $ .93
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-46
<PAGE> 124
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Common Stock:
Balance, January 1....................................... $ 770 $ 770 $ 753
Common stock issued...................................... -- -- 15
Common stock issued through exercise of warrants and
options............................................... 20 -- 2
-------- -------- --------
Balance, December 31..................................... $ 790 $ 770 $ 770
======== ======== ========
Additional Paid-In Capital:
Balance, January 1....................................... $179,276 $179,250 $165,257
Common stock issued...................................... -- -- 3,985
Common stock issued through exercise of warrants and
options............................................... 2,283 26 8
Return of capital distribution on common stock........... (69,880) -- --
Change in valuation allowance for deferred tax assets.... -- -- 10,000
Stock option repricing................................... 6,734 -- --
-------- -------- --------
Balance, December 31..................................... $118,413 $179,276 $179,250
======== ======== ========
Retained Earnings:
Balance, January 1....................................... $ 75,286 $ 54,756 $ 40,378
Net income............................................... 13,379 20,530 14,378
Dividend on common stock................................. (86,368) -- --
-------- -------- --------
Balance, December 31..................................... $ 2,297 $ 75,286 $ 54,756
======== ======== ========
Unrealized Gain (Loss) on Securities, Net of Deferred
Income Taxes:
Balance, January 1....................................... $ 1,972 $ (9,830) $ 1,318
Impact of adopting SFAS No. 115.......................... -- -- 3,203
Transfer of held-to-maturity securities.................. -- 224 --
Change for the year...................................... (889) 11,578 (14,351)
-------- -------- --------
Balance, December 31..................................... $ 1,083 $ 1,972 $ (9,830)
======== ======== ========
Treasury Stock:
Balance, January 1....................................... $ -- $ (81) $ (81)
Common stock reissued through exercise of options........ -- 81 --
-------- -------- --------
Balance, December 31..................................... $ -- $ -- $ (81)
======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
COMMON STOCK
-------------------------
ISSUED IN TREASURY
---------- -----------
<S> <C> <C>
Shares:
Balance, January 1, 1994.................................. 15,055,231 (13,666)
Common stock issued through exercise of warrants and
options................................................ 45,481 --
Common stock issued in connection with Universal Surety
Holding Corp. acquisition.............................. 307,103 --
---------- -------
Balance, December 31, 1994................................ 15,407,815 (13,666)
Common stock reissued from treasury through exercise of
options................................................ -- 13,666
Common stock issued through exercise of options........... 934 --
---------- -------
Balance, December 31, 1995................................ 15,408,749 --
Common stock issued through exercise of options........... 396,000 --
---------- -------
Balance, December 31, 1996................................ 15,804,749 --
========== =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-47
<PAGE> 125
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------
1996 1995 1994
--------- --------- ---------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income............................................ $ 13,379 $ 20,530 $ 14,378
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization...................... 4,822 18,272 4,617
Accretion of bond discount, net.................... (409) (2,471) (3,933)
Net investment (gains) losses...................... (1,715) 1,653 (945)
Non-recurring compensation and merger costs........ 7,865 -- --
Changes in:
Reserves for unpaid losses and loss adjustment
expenses......................................... (2,364) (22,980) 10,477
Reserve for unearned premiums...................... 5,457 151 (1,160)
Deferred income taxes, net......................... 7,291 18,086 8,820
Other assets and liabilities....................... (3,193) (2,502) (2,970)
--------- --------- ---------
Net cash provided by operating activities............... 31,133 30,739 29,284
--------- --------- ---------
INVESTING ACTIVITIES:
Securities available-for-sale:
Purchases -- fixed maturities...................... (73,862) (108,924) (93,452)
Sales -- fixed maturities.......................... 67,380 71,889 43,762
Maturities -- fixed maturities..................... 46,935 63,315 35,020
Purchases -- equity securities..................... (190) (3,165) (28,350)
Sales -- equity securities......................... 22,451 6,225 8,091
Change in short-term investments...................... 855 (15,786) 47,881
Net proceeds from the sale of UCHC.................... 28,024 -- --
Acquisitions, net of cash acquired.................... -- -- (26,175)
Proceeds from sale of other invested assets........... 508 1,821 1,733
Capital expenditures, net............................. (2,948) (1,351) (1,679)
--------- --------- ---------
Net cash provided by (used in) investing activities..... 89,153 14,024 (13,169)
--------- --------- ---------
FINANCING ACTIVITIES:
Proceeds from long-term debt.......................... 62,000 -- 96,000
Principal payments on long-term debt.................. (27,000) (46,000) (110,214)
Dividends paid........................................ (156,248) -- --
Exercise of warrants and options, net of option
repricing payments................................. 1,186 107 10
Debt issuance costs................................... (489) -- (1,060)
--------- --------- ---------
Net cash used in financing activities................... (120,551) (45,893) (15,264)
--------- --------- ---------
Increase (decrease) in cash............................. (265) (1,130) 851
Cash at beginning of year............................... 3,001 4,131 3,280
--------- --------- ---------
Cash at end of year..................................... $ 2,736 $ 3,001 $ 4,131
========= ========= =========
Supplemental Disclosure of Cash Flow Information:
Cash paid during the year for:
Interest........................................... $ 1,426 $ 3,759 $ 4,121
Income taxes, net of refunds....................... $ 1,195 $ 658 $ 642
Supplemental Disclosure of Non-Cash Investing and
Financing Activities:
Common stock issued in connection with
acquisitions..................................... $ -- $ -- $ 4,000
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-48
<PAGE> 126
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of Capsure
Holdings Corp. and all significant majority-owned subsidiaries ("Capsure" or the
"Company"). Capsure provides surety and fidelity bonds in all 50 states through
a combined network of 120,000 independent agents. Capsure's principal
subsidiaries are Western Surety Company ("Western Surety"), acquired in August
1992, and Universal Surety of America ("Universal Surety"), acquired in
September 1994. Western Surety writes small fidelity and noncontract surety
bonds, referred to as "miscellaneous" bonds, and errors and omissions liability
insurance, as a licensed insurer in all 50 states and the District of Columbia.
Western Surety's sister company, Surety Bonding Company of America, writes
similar business and is licensed in 17 states. Universal Surety specializes in
the underwriting of small contract and miscellaneous surety bonds. Universal
Surety is licensed in 37 states and the District of Columbia with most of its
business generated in Texas.
Basis of Presentation
The accompanying consolidated financial statements have been prepared in
accordance with generally accepted accounting principles. 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 the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates. Certain balances in the prior years' financial statements
have been reclassified to conform to current presentation.
Investments
The Company has the ability to hold all debt securities to maturity.
However, the Company may dispose of securities prior to their scheduled maturity
due to changes in interest rates, prepayments, tax and credit considerations,
liquidity or regulatory capital requirements, or other similar factors. As a
result, the Company considers substantially all of its debt (bonds and
redeemable preferred stocks) and equity securities as available-for-sale.
Certain equity securities at the parent company level that are held principally
for the purpose of selling them in the near term are considered trading
securities.
The accounting policies for each investment category are as follows:
Available-for-Sale Securities -- These securities are reported at fair
value, with unrealized gains and losses, net of deferred income taxes,
reported as a separate component of stockholders' equity until realized.
Cash flows from purchases, sales and maturities are reported gross in the
investing activities section of the cash flow statement.
Trading Securities -- These securities are reported on the balance
sheet at fair value, with any unrealized gains and losses included in
earnings. Cash flows from purchases, sales and maturities are included in
the operating activities section of the cash flow statement.
The amortized cost of debt securities is adjusted for amortization of
premiums and accretion of discounts to maturity. Such amortization is included
in investment income. For mortgage-backed and certain asset-backed securities,
Capsure recognizes income using a constant effective yield based on estimated
cash flows including anticipated prepayments. Significant variances in actual
cash flows from expected cash flows are accounted for prospectively. Any related
adjustment is reflected in investment income. Investment gains or losses are
determined using the specific identification method. Investments with an other
than temporary decline in value are written down to fair value, resulting in
losses that are included in investment gains and losses.
F-49
<PAGE> 127
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Short-term investments are carried at amortized cost which approximates
fair value.
Deferred Policy Acquisition Costs
Policy acquisition costs, consisting of commissions and other underwriting
expenses which vary with, and are directly related to, the production of
business, net of reinsurance commission income, are deferred and amortized to
income as the related premiums are earned. Deferred policy acquisition costs are
subject to a limitation representing the excess of anticipated net earned
premiums over anticipated losses, loss adjustment expenses and maintenance
costs. The ultimate recoverability of policy acquisition costs is determined
without regard to investment income.
Excess Cost Over Net Assets Acquired and Intangible Assets
The excess cost over the fair value of the net assets acquired is amortized
substantially over 40 years. Other intangible assets are amortized over periods
ranging from three to 20 years, a substantial portion of which is amortized over
20 years. Other intangible assets primarily relate to the estimated value of the
acquired insurance in force and the producing agency force as of the acquisition
date. Excess cost over net assets acquired is reported net of accumulated
amortization of $6.3 million and $21.1 million (includes $13.2 million
write-down in 1995) at December 31, 1996 and 1995, respectively. Intangible
assets are reported net of accumulated amortization of $27.3 million and $25.7
million at December 31, 1996 and 1995, respectively.
Management assesses the recoverability of goodwill and intangible assets
based upon estimates of undiscounted future operating cash flows whenever
significant events or changes in circumstances suggest that the carrying amount
of an asset may not be recoverable.
Unpaid Losses and Loss Adjustment Expenses
The liability for unpaid losses and loss adjustment expenses is based on
estimates of (a) the ultimate settlement value of reported claims, (b) incurred
but not reported ("IBNR") claims, (c) future expenses to be incurred in the
settlement of claims and (d) claim recoveries. These estimates are determined
based on the Company's and industry loss experience as well as consideration of
current trends and conditions. The liability for unpaid losses and loss
adjustment expenses is an accounting estimate and, similar to other accounting
estimates, there is the potential that actual future loss payments will differ
significantly from initial estimates. The methods of determining such estimates
and the resulting estimated liability are continually reviewed and updated.
Changes in the estimated liability are reflected in operating income in the year
in which such changes are determined. As described in Note 6, the Company's
incurred losses and loss adjustment expenses in 1995 were reduced by $29.1
million, net of reinsurance, as a result of favorable claim settlements and
certain changes in estimates relating to insured events of prior years.
Insurance Premiums
Insurance premiums are recognized as revenue ratably over the terms of the
related policies. Unearned premiums represent the portion of premiums written
applicable to the unexpired terms of policies in force calculated on a daily pro
rata basis. Premium revenues are reported net of amounts ceded to reinsurers.
Reinsurance
Amounts recoverable from reinsurers are estimated in a manner consistent
with the claim liability associated with the reinsured policy and are reported
as reinsurance receivable rather than netted against the liability for unpaid
losses and loss adjustment expenses. Losses and loss adjustment expenses
incurred are reported net of estimated recoveries under reinsurance contracts.
F-50
<PAGE> 128
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Income Taxes
The Company uses the asset and liability method of accounting for income
taxes required by SFAS No. 109, "Accounting for Income Taxes." Under the asset
and liability method, deferred income taxes are established for the future tax
effects of temporary differences between the tax and financial reporting bases
of assets and liabilities using currently enacted tax rates. Such temporary
differences primarily relate to net operating tax loss carryforwards ("NOLs"),
loss reserve discounting, deferred policy acquisition costs and intangible
assets. Under SFAS No. 109, the effect on deferred taxes of a change in tax
rates is recognized in income in the period of enactment.
In addition, deferred tax assets are valued based upon the expectation of
future realization on a "more likely than not" basis. The initial recognition of
the tax benefits of the NOLs resulted in a credit to additional paid-in capital
for the available NOLs for which future realization was expected. Tax benefits
resulting from the future utilization of such NOLs will reduce the net deferred
tax asset established in accordance with SFAS No. 109.
Reorganization Proceedings
On July 31, 1986, the Company emerged from voluntary bankruptcy proceedings
under Chapter 11 of the United States Bankruptcy Code (the "Bankruptcy Code").
After the requisite acceptances were obtained and the Bankruptcy Court
determined that the Second Amended Joint Plan of Reorganization, as amended (the
"Plan of Reorganization"), satisfied applicable requirements of the Bankruptcy
Code, the Bankruptcy Court confirmed the Plan of Reorganization on December 20,
1985, and the Plan of Reorganization was consummated on July 31, 1986 (the
"Reorganization Date"). The Company emerged from bankruptcy with approximately
$300 million of NOLs resulting from oil and gas operations prior to the
reorganization.
In accordance with accounting principles applicable to reorganizations, the
net assets of the Company were adjusted to fair value, the accumulated deficit
in retained earnings at the date of reorganization was eliminated and the excess
of the fair values of the net assets over the stated value of outstanding
capital stock was assigned to additional paid-in capital.
Earnings Per Share
Earnings per common and common equivalent shares outstanding are computed
using the treasury stock method. Weighted average shares outstanding assuming
full dilution for 1996, 1995 and 1994 were 16.5 million, 15.9 million and 15.5
million, respectively.
Pending Accounting Standards
In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share," which
is effective for both interim and annual periods ending after December 15, 1997.
SFAS No. 128 replaces APB Opinion No. 15, "Earnings Per Share." APB Opinion No.
15 required that entities with simple capital structures present a single
earnings per common share ("EPS") on the face of the income statement, whereas
those with complex capital structures had to present both primary and fully
diluted EPS. SFAS No. 128 simplifies the computation of EPS by replacing the
presentation of primary EPS with a presentation of basic EPS and requires dual
presentation of basic and diluted EPS by entities with complex capital
structures. Basic EPS includes no dilution and is computed by dividing income
available to common stockholders by the weighted average number of common shares
outstanding for the period, whereas primary EPS includes the dilutive effect of
common stock equivalents, such as stock options. Diluted EPS reflects the
potential dilution of securities that could share in the earnings of an entity,
similar to fully diluted EPS. The Company intends to present basic and diluted
EPS in financial statements issued after the effective date.
F-51
<PAGE> 129
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. ACQUISITION AND DISPOSITION OF SUBSIDIARIES
On September 22, 1994, Capsure, through its wholly owned subsidiary,
Capsure Financial Group, Inc. ("CFG"), acquired all of the outstanding common
stock of Universal Surety Holding Corp. ("USHC"). USHC is the holding company of
Universal Surety. Capsure paid $28 million in cash and $4 million in Capsure
common stock for USHC, pursuant to a Stock Purchase Agreement dated as of July
26, 1994. The cash portion of the purchase price was financed with borrowings
under Capsure's revolving credit facility.
The acquisition has been accounted for as a purchase and, accordingly, the
acquired assets and liabilities have been recorded at their estimated fair
values. The operating results of USHC are included in the consolidated
statements of income and cash flows from the September 22, 1994 acquisition
date. The excess of the purchase price over the fair value of net assets
acquired is recorded as excess cost over net assets acquired in the consolidated
balance sheets.
The USHC Stock Purchase Agreement provides for a contingent payment to
certain of the selling shareholders. Such payment shall be in cash or an
equivalent amount of Capsure common stock, at the Company's option, in the year
2000, equal to twenty percent of the excess of the after-tax fair market value
of Universal Surety at December 31, 1999, over an assumed fifteen percent
return, compounded annually, on Capsure's invested capital. The contingent
consideration, if any, shall be reported as compensation expense in the period
the contingency is resolved and the consideration is payable. If the contingent
consideration was determined and payable solely upon results through December
31, 1996, there would be no such payment required.
The following table of unaudited pro forma information has been prepared as
if the acquisition of USHC had been consummated on January 1, 1993, at the same
purchase price, with adjustments to the consolidated results of operations for
the effects of the acquisition in the same manner as subsequent to the
acquisition. Such adjustments include: (i) decreased net investment income and
realized investment gains at USHC; (ii) decreased operating expenses at USHC;
and (iii) increased interest and amortization expense. In management's opinion,
the pro forma financial information is not indicative of consolidated results of
operations that may have occurred had the acquisition taken place on January 1,
1993, or of future results of operations of USHC under the ownership and
operation of Capsure. In the following table, the dollars are in thousands,
except per share amounts:
<TABLE>
<CAPTION>
PRO FORMA (UNAUDITED)
FOR THE YEAR ENDED
DECEMBER 31, 1994
---------------------
<S> <C>
Revenues......................... $122,967
Net income....................... $ 15,086
Net income per common share...... $ .98
</TABLE>
On May 22, 1996, the Company consummated the sale of United Capitol Holding
Company ("UCHC") and its subsidiaries, United Capitol Insurance Company ("United
Capitol"), United Capitol Managers, Inc. and Fischer Underwriting Group,
Incorporated, to a subsidiary of Frontier Insurance Group, Inc. The operating
results of UCHC and its subsidiaries are reflected in Capsure's results through
the closing date. Net proceeds to Capsure of $77 million, which included the
purchase price for the capital stock of UCHC and the release of United Capitol's
excess statutory surplus at closing, approximated Capsure's carrying value. The
goodwill associated with the 1990 acquisition of United Capitol was previously
reduced to estimated net realizable value as of December 31, 1995, resulting in
a $13.2 million impairment of goodwill in 1995.
F-52
<PAGE> 130
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. INVESTMENTS
The cost and estimated fair values of investments in debt and equity
securities as of December 31, 1996 and 1995 were as follows (dollars in
thousands):
<TABLE>
<CAPTION>
AMORTIZED GROSS GROSS ESTIMATED
COST UNREALIZED UNREALIZED FAIR
OR COST GAINS LOSSES VALUE
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
AS OF DECEMBER 31, 1996:
Fixed maturities:
U.S. Treasury securities and obligations of U.S.
Government corporations and agencies:
U.S. Treasury notes........................... $ 5,030 $ 66 $ (13) $ 5,083
Collateralized mortgage obligations........... 35,565 373 (49) 35,889
Mortgage pass-through securities.............. 36,221 244 (84) 36,381
Obligations of states and political
subdivisions.................................. 2,696 8 (36) 2,668
Non-agency collateralized mortgage
obligations................................... 21,877 114 (59) 21,932
Asset-backed securities:
Second mortgages/home equity loans............ 26,961 135 (114) 26,982
Other underlying assets....................... 7,070 22 (132) 6,960
-------- ------ ------- --------
Total fixed maturities................ 135,420 962 (487) 135,895
Equity securities............................... 3,687 839 -- 4,526
-------- ------ ------- --------
Total available-for-sale securities... $139,107 $1,801 $ (487) $140,421
======== ====== ======= ========
AS OF DECEMBER 31, 1995:
Fixed maturities:
U.S. Treasury securities and obligations of U.S.
Government corporations and agencies:
U.S. Treasury notes........................... $ 15,047 $ 488 $ (1) $ 15,534
Collateralized mortgage obligations........... 64,610 430 (349) 64,691
Mortgage pass-through securities.............. 40,313 788 (3) 41,098
Debt securities of foreign governments.......... 5 -- -- 5
Obligations of states and political
subdivisions.................................. 5,748 10 (18) 5,740
Corporate bonds................................. 91 -- (16) 75
Non-agency collateralized mortgage
obligations................................... 34,574 392 (66) 34,900
Asset-backed securities:
Second mortgages/home equity loans............ 49,060 947 (102) 49,905
Automobile loans.............................. 8,229 1 (2) 8,228
Other underlying assets....................... 15,599 97 (154) 15,542
-------- ------ ------- --------
Total fixed maturities................ 233,276 3,153 (711) 235,718
Equity securities............................... 24,758 1,303 (1,245) 24,816
-------- ------ ------- --------
Total available-for-sale securities... $258,034 $4,456 $(1,956) $260,534
======== ====== ======= ========
Equity trading securities....................... $ 2,366 $ 593 $ (22) $ 2,937
======== ====== ======= ========
</TABLE>
As of December 31, 1996, virtually 100% of the Company's debt securities
were considered investment grade by The Standard & Poors Corporation or Moody's
Investor Services, Inc., and 93% were rated at least AA by those agencies. In
addition, the Company's investments in debt securities did not contain any
significant geographic or industry concentration of credit risk.
F-53
<PAGE> 131
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The U.S. Treasury notes and mortgage pass-through securities are backed by
the full faith and credit of the U.S. Government. The U.S. Government
collateralized mortgage obligations consist of securities collateralized by
first mortgages issued by the Federal National Mortgage Association and the
Federal Home Loan Mortgage Corporation, or guaranteed by the Government National
Mortgage Association.
The Company has reduced the prepayment variability commonly associated with
collateralized mortgage obligations by generally investing in planned
amortization class tranches which are structured largely to insulate the
investor from prepayment risk.
The Company's insurance subsidiaries, as required by state law, deposit
certain securities with state insurance regulatory authorities. At December 31,
1996, fixed maturities on deposit had an aggregate carrying value of $4.8
million.
Short-term investments are generally comprised of U.S. Treasury notes,
maturing corporate notes, money market funds, and investment grade commercial
paper equivalents.
The amortized cost and estimated fair value of debt securities at December
31, 1996, by contractual maturity, are shown below. Expected maturities will
differ from contractual maturities as borrowers may have the right to call or
prepay obligations with or without call or prepayment penalties (dollars in
thousands):
<TABLE>
<CAPTION>
ESTIMATED
AMORTIZED FAIR
COST VALUE
--------- ---------
<S> <C> <C>
AVAILABLE-FOR-SALE SECURITIES
Due within one year......................................... $ 110 $ 111
Due after one year but within five years.................... 4,911 4,951
Due after five years but within ten years................... 208 224
Due after ten years......................................... 2,496 2,466
-------- --------
7,725 7,752
Mortgage pass-through securities, collateralized mortgage
obligations and asset-backed securities................... 127,695 128,143
-------- --------
$135,420 $135,895
======== ========
</TABLE>
Major categories of net investment income and net investment gains (losses)
were as follows (dollars in thousands):
<TABLE>
<CAPTION>
1996 1995 1994
------- ------- -------
<S> <C> <C> <C>
Investment income:
Fixed maturities.......................................... $12,009 $16,964 $16,405
Equity securities......................................... 720 1,924 915
Short-term investments.................................... 3,593 1,814 1,722
Other..................................................... 519 260 532
------- ------- -------
Total investment income................................... 16,841 20,962 19,574
Investment expenses......................................... 397 491 445
------- ------- -------
Net investment income....................................... $16,444 $20,471 $19,129
======= ======= =======
Gross investment gains:
Fixed maturities.......................................... $ 1,109 $ 722 $ 88
Equity securities......................................... 4,220 2,505 3,762
Gross investment losses:
Fixed maturities.......................................... (973) (3,757) (625)
Equity securities......................................... (2,718) (2,068) (1,802)
Net unrealized gains (losses) on trading securities......... -- 945 (374)
Other....................................................... 77 -- (104)
------- ------- -------
Net investment gains (losses)............................... $ 1,715 $(1,653) $ 945
======= ======= =======
</TABLE>
F-54
<PAGE> 132
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Net unrealized gain (loss) on securities included in stockholders' equity
was as follows (dollars in thousands):
<TABLE>
<CAPTION>
1996 1995
------------------------ --------------------------
GAINS LOSSES NET GAINS LOSSES NET
------ ------ ------ ------ ------- -------
<S> <C> <C> <C> <C> <C> <C>
Fixed maturities..................... $ 962 $(487) $ 475 $3,153 $ (711) $ 2,442
Equity securities.................... 839 -- 839 1,303 (1,245) 58
Other................................ 352 -- 352 534 -- 534
------ ----- ------ ------ ------- -------
$2,153 $(487) 1,666 $4,990 $(1,956) 3,034
====== ===== ====== =======
Deferred income taxes................ (583) (1,062)
------ -------
Net unrealized gain on securities.... $1,083 $ 1,972
====== =======
</TABLE>
The net investment losses in 1995 reflected the $2.7 million write-down of
the carrying value for two asset-backed securities from the same issuer which
experienced an other than temporary decline in fair value.
A majority of the realized investment gains and losses on equity securities
resulted from sales of securities held at the parent company level. For 1996,
1995 and 1994, investment activity for the equity trading portfolio held at the
parent company level included gross realized investment gains of $3.4 million,
$1.9 million and $1.5 million, respectively, and gross realized investment
losses of $2.6 million, $1.8 million and $1.0 million, respectively.
4. DEFERRED POLICY ACQUISITION COSTS
Policy acquisition costs deferred and the related amortization charged to
income were as follows (dollars in thousands):
<TABLE>
<CAPTION>
1996 1995 1994
------- ------- --------
<S> <C> <C> <C>
Balance at January 1............................... $27,057 $25,150 $ 18,421
Balance at date of acquisition (disposition)....... (478) -- 4,369
Costs deferred during year......................... 39,449 37,666 31,750
Amortization during year........................... (37,505) (35,759) (29,390)
------- ------- --------
Balance at December 31............................. $28,523 $27,057 $ 25,150
======= ======= ========
</TABLE>
5. REINSURANCE
The Company's insurance subsidiaries, in the ordinary course of business,
cede reinsurance to other insurance companies to limit their exposure to loss.
Reinsurance contracts do not relieve the Company of its primary obligations to
claimants. A contingent liability exists with respect to reinsurance ceded to
the extent that any reinsurer is unable to meet the obligations assumed under
the reinsurance agreements. The Company evaluates the financial condition of its
reinsurers, establishes allowances for uncollectible amounts and monitors
concentrations of credit risk. At December 31, 1996, Capsure's largest
reinsurance receivable, including prepaid reinsurance premiums of $0.8 million,
was approximately $2.3 million with Transatlantic Reinsurance Company.
Transatlantic Reinsurance Company is rated A+ (Superior) by A.M. Best Company,
Inc.
F-55
<PAGE> 133
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The effect of reinsurance on premiums written and earned was as follows
(dollars in thousands):
<TABLE>
<CAPTION>
1996 1995 1994
------------------- ------------------- -------------------
WRITTEN EARNED WRITTEN EARNED WRITTEN EARNED
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Direct............................. $107,197 $105,467 $111,305 $113,538 $102,062 $103,871
Assumed............................ 72 45 93 247 294 143
Ceded.............................. (12,160) (13,021) (13,670) (15,093) (11,778) (11,533)
-------- -------- -------- -------- -------- --------
Net premiums....................... $ 95,109 $ 92,491 $ 97,728 $ 98,692 $ 90,578 $ 92,481
======== ======== ======== ======== ======== ========
</TABLE>
The effect of reinsurance on losses and loss adjustment expenses incurred
was as follows (dollars in thousands):
<TABLE>
<CAPTION>
1996 1995 1994
------- ------- -------
<S> <C> <C> <C>
Gross losses and loss adjustment expenses..... $12,769 $ (815) $31,566
Reinsurance recoveries........................ (2,715) (6,636) (8,222)
------- ------- -------
Net losses and loss adjustment expenses....... $10,054 $(7,451) $23,344
======= ======= =======
</TABLE>
6. LIABILITY FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
Activity in the liability for unpaid losses and loss adjustment expenses
was as follows (dollars in thousands):
<TABLE>
<CAPTION>
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Gross balance at January 1................................. $126,061 $149,041 $135,825
Balance at date of acquisition (disposition)............... (84,823) -- 2,738
Incurred related to:
Current year............................................... 23,685 34,073 46,206
Prior years................................................ (10,579) (34,559) (14,522)
-------- -------- --------
Total incurred............................................. 13,106 (486) 31,684
-------- -------- --------
Paid related to:
Current year............................................... 3,390 4,150 3,003
Prior years................................................ 12,080 18,344 18,203
-------- -------- --------
Total paid................................................. 15,470 22,494 21,206
-------- -------- --------
Gross balance at December 31............................... $ 38,874 $126,061 $149,041
======== ======== ========
Balance net of reinsurance at December 31.................. $ 33,378 $ 87,078 $111,164
======== ======== ========
</TABLE>
As a result of favorable claim settlements and changes in estimates of
insured events in prior years, the provision for losses and loss adjustment
expenses decreased by $10.6 million ($6.9 million, net of reinsurance) in 1996,
$34.6 million ($29.1 million, net of reinsurance) in 1995 and $14.5 million
($8.3 million, net of reinsurance) in 1994.
United Capitol's claims development through December 31, 1995, had been
favorable relative to expectations based on industry experience. Due to the
limited prior operating experience of United Capitol and the long-tail nature of
its business, management previously relied principally upon industry development
patterns and expected loss ratios in estimating IBNR. Given the availability of
nine full years of experience and the growing evidence of favorable loss trends
relative to industry indications, management concluded in the fourth quarter of
1995 that it was appropriate to place greater reliance on United Capitol's own
development patterns and emerging loss ratios in estimating IBNR. United Capitol
reduced loss and loss adjustment expenses by $23.2 million in 1995 for net
favorable development related to prior years,
F-56
<PAGE> 134
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
substantially all of which pertains to this change in estimate. This loss
reserve reduction increased Capsure's consolidated income before taxes by $23.2
million, and net income by $15.1 million, or $0.98 per share.
7. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table summarizes disclosure of fair value information of
financial instruments, whether or not recognized in the balance sheet, for which
it is practicable to estimate that value. In cases where quoted market prices
are not available, fair values may be based on estimates using present value or
other valuation techniques. These techniques are significantly affected by the
assumptions used, including the discount rates and estimates of future cash
flows. Accordingly, the estimates presented herein are subjective in nature and
are not necessarily indicative of the amounts that Capsure could realize in a
current market exchange. This information excludes certain financial instruments
and all nonfinancial instruments such as insurance contracts from fair value
disclosure. Thus, the following fair value amounts cannot be aggregated to
determine the underlying economic value of Capsure.
The carrying amounts and estimated fair values of financial instruments
were as follows (dollars in thousands):
<TABLE>
<CAPTION>
1996 1995
---------------------- ----------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
-------- ---------- -------- ----------
<S> <C> <C> <C> <C>
Debt securities......................... $135,895 $135,895 $235,718 $235,718
Equity securities....................... 4,526 4,526 27,753 27,753
Short-term investments.................. 19,416 19,416 37,865 37,865
Other investments....................... 2,695 2,695 3,219 3,219
Cash.................................... 2,736 2,736 3,001 3,001
Long-term debt.......................... 60,000 60,000 25,000 25,000
</TABLE>
The following methods and assumptions were used by Capsure in estimating
fair values of financial instruments:
Investment Securities -- The estimated fair values for debt securities
(including redeemable preferred stock) are based upon quoted market prices,
where available. For debt securities not actively traded, the estimated
fair values are determined using values obtained from independent pricing
services or, in the case of private placements, by discounting expected
future cash flows using a current market rate applicable to the yield,
credit quality and maturity of the investments. The estimated fair values
for equity securities are based on quoted market prices.
Cash, Short-Term Investments and Other Investments -- The carrying
amount for these instruments approximates their estimated fair values.
Long-Term Debt -- The estimated fair value of Capsure's long-term debt
is based on the quoted market prices for the same or similar issues or on
the current rates offered to the Company for debt of the same remaining
maturity.
8. LONG-TERM DEBT
On March 29, 1994, the Company formed a direct, wholly owned subsidiary,
CFG, to which Capsure contributed substantially all its assets and liabilities.
Concurrently, CFG entered into a senior reducing revolving credit agreement with
a syndicate of banks for the principal amount of $135 million (the "Credit
Facility"). The common stock of substantially all of Capsure's subsidiaries and
substantially all assets of Capsure's non-insurance operations have been pledged
under the Credit Facility.
F-57
<PAGE> 135
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Concurrent with the sale of UCHC and its subsidiaries, Capsure and its
lenders entered into an agreement to amend and restate the Credit Facility. The
amendment reduced the commitment to $100 million from $135 million and permitted
an initial draw of up to $70 million for a special dividend to stockholders.
Transaction costs totaled approximately $0.5 million. As of December 31, 1996
and 1995, $60 million and $25 million, respectively, were outstanding under the
Credit Facility. The remaining availability under the Credit Facility may be
used for additional dividends, stock repurchases, acquisitions and for general
corporate purposes.
On September 11, 1996, the Company declared a special cash distribution in
the amount of $10 per share of common stock, payable to all holders of record as
of September 25, 1996. The special distribution was funded from $62 million of
borrowings under the Credit Facility and approximately $94 million from
available cash and marketable securities accumulated at the parent company
level.
The interest rate on borrowings under the Credit Facility may be fixed, at
the Company's option, for a period of one to six months and is based on a margin
over either the London Interbank Offered Rate ("LIBOR") or the greatest of the
agent banks' prime rate, certificate of deposit rate plus 1.0% and the Federal
Funds Effective Rate plus 0.5%. The margin varies based on a leverage ratio and
ranges from 0.75% to 1.50% on LIBOR borrowings and 0.0% to 0.50% on non-LIBOR
borrowings. The Credit Facility provides for a commitment fee on the unused
availability which also varies based on leverage. At December 31, 1996, the
interest rate on outstanding borrowings was 6.56% and the applicable commitment
fee was 0.25%.
The Credit Facility limits the Company with respect to the incurrence of
additional indebtedness and the payment of dividends, imposes certain
restrictions on investments and requires the maintenance of certain financial
ratios and levels of Risk-Based Capital ("RBC"). As of December 31, 1996, the
Company was in compliance with all material restrictions or covenants contained
in the Credit Facility agreement. The use of the Credit Facility for acquisition
purposes is subject to certain conditions with respect to the business and
historical financial results of the target company, the maintenance of certain
financial ratios on a prospective and pro forma basis, and the structure of the
acquisition transaction.
Total borrowings available under the Credit Facility reduce semi-annually
commencing March 31, 1997 by the following amounts (dollars in thousands):
<TABLE>
<S> <C>
March 31, 1997.............................................. $ 6,250
September 30, 1997.......................................... 6,250
March 31, 1998.............................................. 7,000
September 30, 1998.......................................... 7,000
March 31, 1999.............................................. 7,500
September 30, 1999.......................................... 7,500
March 31, 2000.............................................. 8,500
September 30, 2000.......................................... 8,500
March 31, 2001.............................................. 8,500
September 30, 2001.......................................... 8,500
March 31, 2002.............................................. 8,500
September 30, 2002.......................................... 8,500
March 31, 2003.............................................. 7,500
--------
$100,000
========
</TABLE>
Principal and interest payments required under the Credit Facility are
funded principally by dividend and intercompany tax sharing payments received
from Capsure's insurance subsidiaries.
F-58
<PAGE> 136
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. STATUTORY FINANCIAL DATA
Capsure's insurance subsidiaries file annual financial statements prepared
in accordance with statutory accounting practices prescribed or permitted by
applicable insurance regulatory authorities. Prescribed statutory accounting
practices include state laws, regulations and general administrative rules, as
well as guidance provided in a variety of publications of the National
Association of Insurance Commissioners ("NAIC"). Permitted statutory accounting
practices encompass all accounting practices that are not prescribed. Such
practices may differ from state to state, may differ from company to company
within a state, and may change in the future. The permitted statutory accounting
practices of Capsure's insurance subsidiaries did not have a material effect on
reported statutory surplus. The principal differences between statutory
financial statements and financial statements prepared in accordance with
generally accepted accounting principles are that statutory financial statements
do not reflect deferred policy acquisition costs and deferred income taxes and
debt securities are generally carried at amortized cost in statutory financial
statements.
The NAIC has promulgated RBC requirements for property/casualty insurance
companies to evaluate the adequacy of statutory capital and surplus in relation
to investment and insurance risks such as asset quality, asset and liability
matching, loss reserve adequacy, and other business factors. The RBC information
will be used by state insurance regulators as an early warning tool to identify,
for the purpose of initiating regulatory action, insurance companies that
potentially are inadequately capitalized. In addition, the formula defines new
minimum capital standards that will supplement the current system of fixed
minimum capital and surplus requirements on a state-by-state basis. Regulatory
compliance is determined by a ratio (the "Ratio") of the enterprise's regulatory
total adjusted capital, as defined by the NAIC, to its authorized control level
RBC, as defined by the NAIC. Generally, a Ratio in excess of 200% of authorized
control level RBC requires no corrective actions by the company or regulators.
As of December 31, 1996, each of Capsure's insurance subsidiaries had a Ratio
that was substantially in excess of the minimum RBC requirements.
Capsure's insurance subsidiaries are subject to regulation and supervision
by the various state insurance regulatory authorities in which they conduct
business. Such regulation is generally designed to protect policyholders and
includes such matters as maintenance of minimum statutory surplus and
restrictions on the payment of dividends. Generally, statutory surplus of each
insurance subsidiary in excess of a statutorily prescribed minimum is available
for payment of dividends to the parent company. However, such distributions as
dividends may be subject to prior regulatory approval, including a review of the
impact on RBC. Without prior regulatory approval in 1997, Capsure's insurance
subsidiaries may pay stockholder dividends of $18.0 million in the aggregate. In
1996, 1995 and 1994, Capsure received $65.7 million (including $50.2 million of
dividends requiring prior approval), $40.9 million (including $21.6 million of
dividends requiring prior approval), and $21.0 million (including $5.0 million
of dividends requiring prior approval), respectively, in dividends from its
insurance subsidiaries. Capsure received $15.6 million, $21.9 million and $9.5
million in dividends from its surety and fidelity subsidiaries in 1996, 1995 and
1994, respectively.
Combined statutory surplus and net income for insurance operations,
including preacquisition results, as reported to regulatory authorities were as
follows (dollars in thousands):
<TABLE>
<CAPTION>
1996 1995 1994
------- -------- --------
<S> <C> <C> <C>
Statutory surplus........................... $48,913 $113,894 $109,750
Statutory net income........................ $22,045 $ 41,717 $ 23,796
</TABLE>
F-59
<PAGE> 137
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. INCOME TAXES
The components of deferred income taxes were as follows (dollars in
thousands):
<TABLE>
<CAPTION>
1996 1995
------- -------
<S> <C> <C>
Deferred tax assets:
Net operating losses................................... $50,122 $62,000
Loss and loss adjustment expense reserves.............. 793 5,534
Unearned premium reserves.............................. 4,673 4,791
Accrued expenses....................................... 3,738 3,768
Other.................................................. 3,626 839
------- -------
Total gross deferred tax assets................ 62,952 76,932
Valuation allowance.................................... 30,800 30,800
------- -------
Deferred tax asset, net of valuation allowance........... 32,152 46,132
------- -------
Deferred tax liabilities:
Intangible assets...................................... 4,894 5,477
Deferred policy acquisition costs...................... 9,983 9,470
Unrealized gain on securities.......................... 583 1,062
Other.................................................. 673 830
------- -------
Total deferred tax liabilities................. 16,133 16,839
------- -------
Net deferred tax asset................................... $16,019 $29,293
======= =======
</TABLE>
The Internal Revenue Service ("IRS") has not examined the Company's tax
returns for the years in which the Company reported net operating losses. Under
Section 382 of the Internal Revenue Code of 1986, as amended (the "Code"),
certain restrictions on the utilization of NOLs will apply if there is an
ownership change of a corporation entitled to use such carryovers. The Company
believes that there is currently no restriction on the ability of the Company to
utilize its NOLs. If the pending business combination as described in Note 16 is
consummated, an ownership change of the Company under Section 382 of the Code
will occur. This will result in significant restrictions of the Company's
ability to utilize NOLs during all taxable periods after the date of the
business combination.
Capsure and its subsidiaries file a consolidated federal income tax return.
As of December 31, 1996, based upon the Company's consolidated federal income
tax returns, approximately $143 million of consolidated NOLs were available to
offset future taxable income of the Company and its subsidiaries. Such
carryforwards expire by tax year as follows: $42.4 million in 1997, $50.7
million in 1998, $39.2 million in 1999, $7.0 million in 2000, $2.4 million in
2001, $0.9 million in 2002 and $0.4 million in 2003. Although realization is not
assured, management believes that it is more likely than not that Capsure will
generate sufficient taxable income to utilize at least $19.3 million of tax
benefits from its available NOLs at December 31, 1996. Such estimate is based
upon the earnings history of each of its insurance subsidiaries and projections
of future taxable income. The amount of the deferred tax asset considered
realizable, however, could be reduced in the near term if estimates of future
taxable income during the carryforward period are reduced, or if an ownership
change under Section 382 of the Code were to occur.
F-60
<PAGE> 138
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The income tax provisions consisted of the following (dollars in
thousands):
<TABLE>
<CAPTION>
1996 1995 1994
------ ------- ------
<S> <C> <C> <C>
Federal deferred................................ $7,291 $18,086 $8,820
Federal current................................. 560 1,500 305
State........................................... 330 135 276
------ ------- ------
Total income tax expense........................ $8,181 $19,721 $9,401
====== ======= ======
</TABLE>
Reconciliations from the federal statutory tax rate to the effective tax
rate are as follows:
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Federal statutory rate................................. 35.0% 35.0% 35.0%
Excess of cost over net assets acquired and other
purchase accounting adjustments...................... 2.8 13.7 3.0
State income and environmental tax, net of federal
income tax benefit................................... 1.0 .1 .8
Tax exempt interest.................................... (0.1) (.3) (.3)
Other.................................................. (0.8) .5 1.0
---- ---- ----
Effective tax rate........................... 37.9% 49.0% 39.5%
==== ==== ====
</TABLE>
Intercompany tax sharing agreements between Capsure and its subsidiaries
provide that tax sharing payments shall be determined based upon each
subsidiaries' separate return liability, as calculated in accordance with the
Code. Intercompany tax payments are remitted at such times as estimated tax
payments would be required to be made to the IRS. Capsure received tax sharing
payments from its subsidiaries of $17.3 million, $12.8 million and $12.3 million
in 1996, 1995 and 1994, respectively, of which $10.8 million, $8.3 million and
$7.3 million were from its surety and fidelity subsidiaries.
11. COMMITMENTS AND CONTINGENCIES
At December 31, 1996, the future minimum commitment under operating leases
was as follows: 1997 -- $2.5 million; 1998 -- $2.3 million; 1999 -- $1.7
million; 2000 -- $1.3 million; 2001 -- $1.1 million and 2002 and after -- $0.3
million. Total rental expense for 1996, 1995 and 1994 was $2.8 million, $2.3
million and $2.3 million, respectively.
The Company was engaged in oil and gas production, exploration and
development until mid-1993. In connection with the sale of substantially all of
the Company's oil and gas properties, the buyers assumed all material
environmental liabilities.
The Company and its subsidiaries are parties to numerous 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, results of operations and liquidity.
12. EMPLOYEE BENEFITS
The Company sponsors a tax-deferred savings plan (401(k)) covering
substantially all of its employees. The Company matches 50% of the participating
employee's contribution up to 6% of eligible compensation (3% maximum matching).
Western Surety employees may also receive a discretionary profit sharing payment
up to 3% of eligible compensation. Company contributions, including profit
sharing payments, for the years ended December 31, 1996, 1995 and 1994, were
$0.8 million, $0.7 million and $0.7 million, respectively.
The Company sponsors a noncontributory defined contribution retirement plan
covering all eligible employees other than Western Surety personnel. The Company
contributes 4.35% of eligible compensation
F-61
<PAGE> 139
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(8.7% on amounts exceeding the social security wage base). Company contributions
for the years ended December 31, 1996, 1995 and 1994, were $0.2 million, $0.3
million and $0.1 million, respectively.
Western Surety sponsors two postretirement benefit plans covering
substantially all of its employees. One plan provides medical benefits, and the
other plan provides sick leave termination payments. The postretirement health
care plan is contributory; the sick leave plan is noncontributory. The
actuarially determined net periodic postretirement benefit costs for these plans
were $0.4 million, $0.3 million and $0.5 million for the years ended December
31, 1996, 1995 and 1994, respectively. The unfunded accumulated postretirement
benefit obligation (for retirees and fully vested active plan participants) was
$4.4 million and $4.1 million as of December 31, 1996 and 1995, respectively.
13. STOCKHOLDERS' EQUITY
On September 11, 1996, the Company declared a special cash distribution in
the amount of $10 per share of common stock, payable to all holders of record as
of September 25, 1996. Approximately $86.4 million ($5.53 per share) of the
$156.2 million total distribution was paid out of available retained earnings,
with the excess of $69.8 million ($4.47 per share) charged to additional paid-in
capital. The special distribution was paid on October 4, 1996 and was funded
from $62 million of borrowings under Capsure's revolving credit agreement and
approximately $94 million from available cash and marketable securities
accumulated at the parent company level.
On May 24, 1995, the Board of Directors of the Company approved a stock
repurchase plan. The plan authorizes the Company to repurchase up to 500,000
shares of its common stock. These shares may be purchased from time to time in
the public market or through privately negotiated transactions. As of December
31, 1996, no shares have been repurchased under this plan.
The Company has reserved shares of its Common Stock for issuance to
directors, officers, employees and consultants of the Company through incentive
stock options, non-qualified stock options and stock appreciation rights
("SARs") to be granted under the Company's Amended and Restated 1990 Stock
Option Plan (the "Plan"). The most recent Plan amendments approved by
stockholders at the Annual Meeting held on May 23, 1996, among other matters,
increased the aggregate number of shares available for which options and SARs
may be granted under the Plan to 2,250,000 shares.
The Plan is administered by the Compensation Committee (the "Committee"),
consisting of independent members of the Board of Directors. The option prices
are determined by the Committee, but may not be less than the fair market value
of the Common Stock of the Company at the date of grant for incentive stock
options, and may not be less than the par value of the Common Stock of the
Company for non-qualified stock options.
The Plan provides for the granting of incentive stock options as defined
under the Code. All non-qualified stock options and incentive stock options
expire ten years after the date of grant. Since January 1, 1993, all stock
options were granted at an option price equal to fair market value at the date
of grant. In connection with the payment of the special distribution, the Board
of Directors also authorized a corresponding repricing of all outstanding stock
options. This resulted in a new measurement date for the stock options under
applicable accounting pronouncements and required the Company to record in the
third quarter of 1996 a non-recurring compensation charge of $4.1 million, after
applicable income taxes, or 25 cents per share of which $3.6 million, or 22
cents per share, was non-cash. All repriced stock options will be treated as
non-qualified stock options for tax purposes.
F-62
<PAGE> 140
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Stock option activity for the three years ended December 31, 1996 was as
follows:
<TABLE>
<CAPTION>
WEIGHTED
SHARES SUBJECT AVERAGE OPTION
TO OPTION PRICE PER SHARE
-------------- ---------------
<S> <C> <C>
Balance at January 1, 1994...................... 905,775 $ 8.97
Options granted............................... 295,250 $13.38
Options canceled.............................. (1,876) $12.25
Options exercised............................. (1,037) $ 7.74
---------
Balance at December 31, 1994.................... 1,198,112 $10.05
Options granted............................... 190,000 $13.55
Options canceled.............................. (9,063) $13.22
Options exercised............................. (14,600) $ 7.34
---------
Balance at December 31, 1995.................... 1,364,449 $10.55
Options granted............................... 45,000 $18.00
Options canceled.............................. (30,050) $ 9.00
Options exercised............................. (216,000) $10.28
---------
Balance at October 4, 1996 (date of
repricing).................................... 1,163,399 $ 2.04
Options canceled after repricing.............. (1,339) $ 3.26
Options exercised after repricing............. (180,000) $ .46
---------
Balance at December 31, 1996.................... 982,060 $ 2.32
=========
</TABLE>
As of December 31, 1996, 754,662 shares were exercisable under the Plan.
The number of shares available for granting of options under the Plan were
802,528 and 96,189 at December 31, 1996 and 1995, respectively.
The weighted average fair value of options granted in 1996 was $3.22. The
fair value of each option granted during 1996 was estimated on the date of grant
using the Black-Scholes option-pricing model with the following assumptions: (1)
dividend yield of 0%, (2) expected volatility of 25.7%, (3) risk-free interest
rate of 6.47%, and (4) expected life of 6 years.
The following table summarizes information about stock options outstanding
at December 31, 1996:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------- ------------------------
RANGE OF WGTD. AVG. WGTD. AVG. WGTD. AVG.
EXERCISE NUMBER REMAINING EXERCISE NUMBER EXERCISE
PRICES OUTSTANDING CONTR. LIFE PRICE EXERCISABLE PRICE
-------- ----------- ----------- ---------- ----------- ----------
<S> <C> <C> <C> <C> <C>
$0.05 to $8.00...................... 982,060 6.3 years $2.32 754,662 $2.10
======= ========== ===== ======= =====
</TABLE>
In October 1995, the Financial Accounting Standards Board issued SFAS No.
123, "Accounting for Stock-Based Compensation." SFAS No. 123 is effective for
fiscal years beginning after December 15, 1995. SFAS No. 123 introduces a
preferable fair value-based method of accounting for stock-based compensation.
SFAS No. 123 encourages, but does not require, companies to recognize
compensation expense for grants of stock, stock options, and other equity
instruments to employees based on the new fair value-based method of accounting.
As permitted under SFAS No. 123, the Company has continued to apply the existing
accounting rules contained in Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees,"
F-63
<PAGE> 141
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
and related interpretations. Required pro forma disclosures, as if the Company
had adopted the fair value-based recognition requirements under SFAS No. 123 in
1995, are presented below:
<TABLE>
<CAPTION>
1996 1995
----------------------- -----------------------
AS REPORTED PRO FORMA AS REPORTED PRO FORMA
----------- --------- ----------- ---------
<S> <C> <C> <C> <C>
Net income (in thousands)......................... $13,379 $13,256 $20,530 $20,438
======= ======= ======= =======
Net income per common share....................... $ .82 $ .81 $ 1.33 $ 1.32
======= ======= ======= =======
</TABLE>
The effects of applying SFAS No. 123 in this pro forma disclosure are not
indicative of future amounts. SFAS No. 123 does not apply to awards prior to
1995.
14. RELATED PARTY TRANSACTIONS
Equity Group Investments, Inc. ("EGI"), a company affiliated with certain
directors, officers and stockholders of the Company; other affiliated entities;
and individuals affiliated with certain directors and officers of the Company
perform or provide services to the Company and its subsidiaries. These services
relate to acquisition consulting, financial planning, legal and tax advice, and
investor relations, as well as leasing office space and providing certain
computer equipment, operations and maintenance services to the Company. Related
party agreements are generally for a term of one year and are approved by the
independent members of the Board of Directors. The Company's corporate office
space is leased pursuant to a facilities sharing agreement with EGI.
The Company paid rent, administrative services, and office facility
services to EGI or its affiliates of $0.1 million in 1996, 1995 and 1994. The
Company paid $0.2 million in 1996, 1995 and 1994 for financial planning, tax,
accounting, investor relations and computer support and maintenance to EGI or
its affiliates. The Company paid approximately $0.1 million in 1996 and 1995 and
$0.2 million in 1994 in fees for legal services to a law firm affiliated with
EGI. The Company received reimbursement from affiliates of EGI for financial
management services provided by employees of the Company amounting to
approximately $0.1 million in 1995 and 1994, and a negligible amount in 1996.
F-64
<PAGE> 142
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
15. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following is a summary of the unaudited results of operations for the
past two years. The Company sold United Capitol on May 22, 1996 and the
consolidated results of operations shown below include the operating results of
United Capitol through the date of disposition, which affects the comparability
of the financial information (dollars in thousands, except per share data):
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
------- ------- ------- -------
<S> <C> <C> <C> <C>
1996
Revenues.......................................... $28,906 $28,828 $26,878 $26,038
======= ======= ======= =======
Income before income taxes........................ $ 8,917 $ 8,062 $ 899 $ 3,682
Income taxes...................................... 3,397 3,057 342 1,385
------- ------- ------- -------
Net income........................................ $ 5,520 $ 5,005 $ 557 $ 2,297
======= ======= ======= =======
Earnings per common and common equivalent share... $ .35 $ .31 $ .02 $ .14
======= ======= ======= =======
1995
Revenues.......................................... $29,535 $29,485 $29,431 $29,059
======= ======= ======= =======
Income before income taxes........................ $ 6,968 $ 7,287 $ 7,235 $18,761
Income taxes...................................... 2,731 2,851 2,816 11,323
------- ------- ------- -------
Net income........................................ $ 4,237 $ 4,436 $ 4,419 $ 7,438
======= ======= ======= =======
Earnings per common and common equivalent share... $ .28 $ .28 $ .29 $ .48
======= ======= ======= =======
</TABLE>
As described in Note 6, the Company's incurred losses and loss adjustment
expenses were reduced by $29.1 million, net of reinsurance, in the fourth
quarter of 1995 as a result of favorable claim settlements and certain changes
in estimates relating to insured events of prior years. As described in Note 2,
the goodwill associated with the 1990 acquisition of United Capitol was reduced
to estimated net realizable value as of December 31, 1995, resulting in a $13.2
million impairment of goodwill in the fourth quarter of 1995.
16. PENDING BUSINESS COMBINATION
On December 19, 1996, Capsure and certain direct and indirect subsidiaries
of CNA Financial Corporation ("CNAF") entered into a definitive Reorganization
Agreement pursuant to which Capsure will merge with a wholly-owned subsidiary of
CNA Surety Corporation ("CNA Surety"). CNAF, through its subsidiaries, will be
the majority stockholder of CNA Surety, owning 61.75 percent of the shares on a
fully diluted basis. The remaining shares will be issued to the existing Capsure
stockholders (a portion of these shares will be reserved for issuance to the
existing holders of Capsure options who will receive CNA Surety options in the
merger) in a tax-free exchange for their Capsure shares on a one-for-one basis.
The CNA Surety shares are expected to be traded on the New York Stock Exchange.
Equity Capsure Limited Partnership ("Equity Capsure"), Capsure's largest
stockholder with a 25.6 percent ownership interest, and certain other directors
of the Company have agreed to vote their shares in favor of the merger. The
agreement and the transactions contemplated thereby are subject to several
conditions, including ratification by the affirmative vote of Capsure
stockholders and approval by governmental and insurance regulatory authorities.
The completion of the merger pursuant to the Reorganization Agreement will
cause an ownership change under Section 382 of the Code and significantly limit
the future utilization of Capsure's NOLs. If the Reorganization Agreement and
transactions contemplated thereby are approved, Capsure shareholders will be
asked to approve an amendment to its Certificate of Incorporation to delete a
provision designed to facilitate the Company's ability to preserve and utilize
its NOLs.
F-65
<PAGE> 143
SCHEDULE I
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
SUMMARY OF INVESTMENTS
OTHER THAN INVESTMENTS IN RELATED PARTIES
AS OF DECEMBER 31, 1996
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
FAIR CARRYING
COST VALUE VALUE
-------- -------- --------
<S> <C> <C> <C>
FIXED MATURITIES:
Bonds:
U.S. Government and government agencies and
authorities........................................... $ 76,816 $ 77,353 $ 77,353
States, municipalities and political subdivisions........ 2,696 2,668 2,668
All other corporate bonds................................ 55,908 55,874 55,874
-------- -------- --------
Total fixed maturities........................... 135,420 135,895 135,895
-------- -------- --------
EQUITY SECURITIES:
Real estate investment trusts.............................. 3,687 4,526 4,526
-------- -------- --------
Total equity securities.......................... 3,687 4,526 4,526
-------- -------- --------
Short-term investments..................................... 19,416 19,416
Other investments.......................................... 2,343 2,695
-------- --------
Total investments................................ $160,866 $162,532
======== ========
</TABLE>
F-66
<PAGE> 144
SCHEDULE II
CAPSURE HOLDINGS CORP.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY)
BALANCE SHEETS
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1996 1995
-------- --------
<S> <C> <C>
ASSETS
Investment in and advances to Capsure Financial Group,
Inc....................................................... $ 93,695 $221,552
Deferred income taxes, net of valuation allowance........... 31,647 37,275
-------- --------
$125,342 $258,827
======== ========
LIABILITIES
Other liabilities........................................... $ 2,759 $ 1,523
-------- --------
STOCKHOLDERS' EQUITY
Common stock................................................ 790 770
Additional paid-in capital.................................. 118,413 179,276
Retained earnings from August 1, 1986 (date of
reorganization)........................................... 2,297 75,286
Unrealized gain on securities, net of deferred income
taxes..................................................... 1,083 1,972
-------- --------
Total stockholders' equity.................................. 122,583 257,304
-------- --------
$125,342 $258,827
======== ========
</TABLE>
See Notes to Condensed Financial Information and Notes to Consolidated Financial
Statements
F-67
<PAGE> 145
SCHEDULE II
CAPSURE HOLDINGS CORP.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(PARENT COMPANY) -- (CONTINUED)
STATEMENTS OF INCOME
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------
1996 1995 1994
------- ------- -------
<S> <C> <C> <C>
Revenues:
Net investment income..................................... $ -- $ -- $ 17
Net investment gains...................................... -- -- 444
Other income.............................................. -- -- --
------- ------- -------
-- -- 461
Expenses:
Non-recurring compensation and merger costs............... 7,865 -- --
Corporate expense......................................... -- -- 355
------- ------- -------
7,865 -- 355
------- ------- -------
Income (loss) from operations before income taxes and equity
in net income of subsidiaries............................. (7,865) -- 106
Income taxes................................................ (2,632) -- 37
------- ------- -------
Income (loss) before equity in net income of subsidiaries... (5,233) -- 69
Equity in net income of subsidiaries, less cash dividends... 18,612 20,530 14,309
------- ------- -------
Net income.................................................. $13,379 $20,530 $14,378
======= ======= =======
</TABLE>
See Notes to Condensed Financial Information and Notes to Consolidated Financial
Statements
F-68
<PAGE> 146
SCHEDULE II
CAPSURE HOLDINGS CORP.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(PARENT COMPANY) -- (CONTINUED)
STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------
1996 1995 1994
--------- -------- --------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income.............................................. $ 13,379 $ 20,530 $ 14,378
Adjustments to reconcile net income to net cash
provided by operating activities:
Equity in net income of subsidiaries, less cash
dividends....................................... (18,612) (20,530) (14,309)
Net investment gains............................... -- -- (444)
Non-recurring compensation and merger costs........ 7,865 -- --
Changes in:
Deferred income taxes, net......................... 5,628 18,341 1,217
Other assets and liabilities....................... (279) -- 2,406
--------- -------- --------
Net cash provided by operating activities................. 7,981 18,341 3,248
--------- -------- --------
INVESTING ACTIVITIES:
Available-for-sale equity securities purchased.......... -- -- (209)
Change in short-term investments........................ -- -- 5,451
Change in investments in and advances to subsidiaries... 147,081 (18,448) (8,981)
--------- -------- --------
Net cash provided by (used in) investing activities....... 147,081 (18,448) (3,739)
--------- -------- --------
FINANCING ACTIVITIES:
Dividends paid.......................................... (156,248) -- --
Exercise of warrants and options, net of repricing
payments............................................. 1,186 107 10
--------- -------- --------
Net cash (used in) provided by financing activities....... (155,062) 107 10
--------- -------- --------
Increase (decrease) in cash............................... -- -- (481)
Cash at beginning of year................................. -- -- 481
--------- -------- --------
Cash at end of year....................................... $ -- $ -- $ --
========= ======== ========
</TABLE>
See Notes to Condensed Financial Information and Notes to Consolidated Financial
Statements
F-69
<PAGE> 147
SCHEDULE II
CAPSURE HOLDINGS CORP.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(PARENT COMPANY) -- (CONTINUED)
NOTES TO CONDENSED FINANCIAL INFORMATION
1. BASIS OF PRESENTATION
The condensed financial information of the parent company includes the
accounts of Capsure Holdings Corp. ("Capsure"). On March 29, 1994, Capsure
formed Capsure Financial Group, Inc., a direct wholly owned subsidiary, to which
Capsure contributed substantially all its assets and liabilities, including its
investments in SI Acquisition Corp. (parent company of Western Surety), NI
Acquisition Corp. (former parent company of United Capitol) and Pin Oak
Petroleum, Inc.
F-70
<PAGE> 148
SCHEDULE III
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
SUPPLEMENTARY INSURANCE INFORMATION
AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
PROPERTY AND CASUALTY INSURANCE
--------------------------------
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Deferred policy acquisition costs.......................... $ 28,523 $ 27,057 $ 25,150
======== ======== ========
Future policy benefits, losses, claims and loss expenses... $ 38,874 $126,061 $149,041
======== ======== ========
Unearned premiums.......................................... $ 69,570 $ 76,781 $ 76,630
======== ======== ========
Other policy claims and benefits payable................... $ -- $ -- $ --
======== ======== ========
Net premium revenue........................................ $ 92,491 $ 98,692 $ 92,481
======== ======== ========
Net investment income...................................... $ 14,195 $ 19,773 $ 18,597
======== ======== ========
Benefits, claims, losses and settlement expenses........... $ 10,054 $ (7,451) $ 23,344
======== ======== ========
Amortization of deferred policy acquisition costs.......... $ 37,505 $ 35,759 $ 29,390
======== ======== ========
Other operating expenses................................... $ 25,699 $ 25,553 $ 24,514
======== ======== ========
Net premiums written....................................... $ 95,109 $ 97,728 $ 90,578
======== ======== ========
</TABLE>
F-71
<PAGE> 149
SCHEDULE IV
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
REINSURANCE
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
PERCENTAGE
CEDED TO ASSUMED OF AMOUNT
GROSS OTHER FROM OTHER NET ASSUMED
AMOUNT COMPANIES COMPANIES AMOUNT TO NET
-------- --------- ---------- ------- ----------
<S> <C> <C> <C> <C> <C>
1996
Premiums:
Property and casualty insurance.... $105,467 $13,021 $ 45 $92,491 --
-------- ------- ---- ------- ---
Total premiums.................. $105,467 $13,021 $ 45 $92,491 --
======== ======= ==== ======= ===
1995
Premiums:
Property and casualty insurance.... $113,538 $15,093 $247 $98,692 0.3%
-------- ------- ---- ------- ---
Total premiums.................. $113,538 $15,093 $247 $98,692 0.3%
======== ======= ==== ======= ===
1994
Premiums:
Property and casualty insurance.... $103,871 $11,533 $143 $92,481 0.2%
-------- ------- ---- ------- ---
Total premiums.................. $103,871 $11,533 $143 $92,481 0.2%
======== ======= ==== ======= ===
</TABLE>
F-72
<PAGE> 150
SCHEDULE V
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
ADDITIONS
------------------------
BALANCE AT CHARGED TO CHARGED TO BALANCE AT
BEGINNING OF COSTS AND OTHER END OF
PERIOD EXPENSES ACCOUNTS DEDUCTIONS(1) PERIOD
------------ ---------- ---------- ------------- ----------
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1996
Allowance for possible losses on
premiums receivable........... $ 768 $423 $ -- $329 $862
====== ==== ==== ==== ====
Allowance for possible losses on
reinsurance receivable........ $ 70 $ -- $ -- $ 70 $ --
====== ==== ==== ==== ====
Year ended December 31, 1995
Allowance for possible losses on
premiums receivable........... $ 898 $245 $ -- $375 $768
====== ==== ==== ==== ====
Allowance for possible losses on
reinsurance receivable........ $ 5 $ 65 $ -- $ -- $ 70
====== ==== ==== ==== ====
Year ended December 31, 1994
Allowance for possible losses on
premiums receivable........... $1,276 $190 $ -- $568 $898
====== ==== ==== ==== ====
Allowance for possible losses on
reinsurance receivable........ $ 2 $ 3 $ -- $ -- $ 5
====== ==== ==== ==== ====
</TABLE>
- - ---------------
(1) Accounts charged against allowance.
F-73
<PAGE> 151
SCHEDULE VI
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
SUPPLEMENTAL INFORMATION CONCERNING PROPERTY-CASUALTY
INSURANCE OPERATIONS
AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Deferred policy acquisition costs.......................... $ 28,523 $ 27,057 $ 25,150
======== ======== ========
Reserves for unpaid claims and claim adjustment expenses... $ 38,874 $126,061 $149,041
======== ======== ========
Discount (if any) deducted................................. $ -- $ -- $ --
======== ======== ========
Unearned premiums.......................................... $ 69,570 $ 76,781 $ 76,630
======== ======== ========
Net earned premiums........................................ $ 92,491 $ 98,692 $ 92,481
======== ======== ========
Net investment income...................................... $ 14,195 $ 19,773 $ 18,597
======== ======== ========
Net claims and claim adjustment expenses incurred related
to:
Current year............................................. $ 16,909 $ 21,631 $ 31,688
======== ======== ========
Prior years.............................................. $ (6,855) $(29,082) $ (8,344)
======== ======== ========
Amortization of deferred policy acquisition costs.......... $ 37,505 $ 35,759 $ 29,390
======== ======== ========
Net paid claims and claim adjustment expenses.............. $ 11,039 $ 16,636 $ 16,719
======== ======== ========
Net premiums written....................................... $ 95,109 $ 97,728 $ 90,578
======== ======== ========
</TABLE>
F-74
<PAGE> 152
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
-------- ------------
<S> <C> <C>
ASSETS
Invested assets and cash:
Fixed maturities, at fair value (amortized cost: $133,794;
$135,420).............................................. $133,968 $135,895
Equity securities, at fair value (cost: $3,687)........... -- 4,526
Short-term investments, at cost which approximates fair
value.................................................. 28,219 19,416
Other investments, at fair value.......................... 2,442 2,695
Cash...................................................... 2,951 2,736
-------- --------
167,580 165,268
Deferred policy acquisition costs........................... 31,201 28,523
Reinsurance receivable...................................... 8,073 5,642
Intangible assets, net of amortization...................... 13,469 14,024
Excess cost over net assets acquired, net of amortization... 61,080 61,932
Deferred income taxes, net of valuation allowance........... 11,832 16,019
Other assets................................................ 24,408 21,731
-------- --------
Total assets...................................... $317,643 $313,139
======== ========
LIABILITIES
Reserves:
Unpaid losses and loss adjustment expenses................ $ 39,301 $ 38,874
Unearned premiums......................................... 74,931 69,570
-------- --------
114,232 108,444
Long-term debt.............................................. 54,000 60,000
Other liabilities........................................... 19,904 22,112
-------- --------
Total liabilities................................. 188,136 190,556
======== ========
Commitments and contingencies
STOCKHOLDERS' EQUITY
Preferred stock, par value $.01 per share, 5,000,000 shares
authorized; none issued and outstanding................... -- --
Common stock, par value $.05 per share, 25,000,000 shares
authorized; 15,850,245 shares issued at June 30, 1997;
15,804,749 shares issued at December 31, 1996............. 793 790
Additional paid-in capital.................................. 118,580 118,413
Retained earnings........................................... 9,847 2,297
Unrealized gain on securities, net of deferred income
taxes..................................................... 287 1,083
-------- --------
Total stockholders' equity........................ 129,507 122,583
-------- --------
$317,643 $313,139
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-75
<PAGE> 153
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------ ------------------
1997 1996 1997 1996
------- ------- ------- -------
<S> <C> <C> <C> <C>
Revenues:
Net earned premiums............................... $22,962 $23,184 $45,258 $46,533
Net investment income............................. 2,798 4,512 5,924 9,546
Net investment gains.............................. 549 1,132 636 1,655
------- ------- ------- -------
26,309 28,828 51,818 57,734
------- ------- ------- -------
Expenses:
Net losses and loss adjustment expenses........... 1,931 2,801 3,159 6,197
Net commissions, brokerage and other
underwriting................................... 15,909 15,699 31,286 30,455
Interest expense.................................. 995 127 1,998 633
Write-off of unamortized deferred loan fees....... -- 700 -- 700
Amortization of goodwill and intangibles.......... 698 705 1,396 1,418
Other expenses, net............................... 632 734 1,300 1,352
------- ------- ------- -------
20,165 20,766 39,139 40,755
------- ------- ------- -------
Income before income taxes.......................... 6,144 8,062 12,679 16,979
Income taxes........................................ 2,407 3,057 5,129 6,454
------- ------- ------- -------
Net income.......................................... $ 3,737 $ 5,005 $ 7,550 $10,525
======= ======= ======= =======
Weighted average shares outstanding:
Primary........................................... 16,600 15,955 16,594 15,931
======= ======= ======= =======
Fully diluted..................................... 16,613 15,968 16,613 15,968
======= ======= ======= =======
Earnings per share:
Primary........................................... $ .22 $ .31 $ .45 $ .66
======= ======= ======= =======
Fully diluted..................................... $ .22 $ .31 $ .45 $ .66
======= ======= ======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-76
<PAGE> 154
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
--------------------
1997 1996
-------- --------
<S> <C> <C>
OPERATING ACTIVITIES:
Net income................................................ $ 7,550 $ 10,525
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization.......................... 2,207 2,341
Accretion of bond discount, net........................ (75) (317)
Net investment gains................................... (636) (1,655)
Changes in:
Reserve for unpaid losses and loss adjustment
expenses.............................................. 427 707
Reserve for unearned premiums.......................... 5,361 7,091
Deferred income taxes, net............................. 4,519 5,896
Other assets and liabilities........................... (9,126) (8,198)
-------- --------
Net cash provided by operating activities................... 10,227 16,390
-------- --------
INVESTING ACTIVITIES:
Securities available-for-sale:
Purchases -- fixed maturities.......................... (13,317) (51,725)
Sales -- fixed maturities.............................. -- 59,463
Maturities -- fixed maturities......................... 15,029 27,507
Purchases -- equity securities......................... -- (190)
Sales -- equity securities............................. 4,314 19,813
Change in short-term investments.......................... (8,803) (74,702)
Net proceeds from the sale of UCHC........................ -- 28,024
Change in other investments............................... 253 475
Capital expenditures, net................................. (1,606) (1,280)
-------- --------
Net cash (used in) provided by investing activities......... (4,130) 7,385
-------- --------
FINANCING ACTIVITIES:
Principal payments on long-term debt...................... (6,000) (25,000)
Exercise of stock options................................. 118 5
-------- --------
Net cash used in financing activities....................... (5,882) (24,995)
-------- --------
Increase (decrease) in cash................................. 215 (1,220)
Cash at beginning of period................................. 2,736 3,001
-------- --------
Cash at end of period....................................... $ 2,951 $ 1,781
======== ========
Supplemental Disclosure of Cash Flow Information:
Cash paid during the period for:
Interest............................................... $ 2,017 $ 646
Income taxes, net of refunds........................... $ 378 $ 765
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-77
<PAGE> 155
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1997
(UNAUDITED)
1. SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
These unaudited Consolidated Financial Statements should be read in
conjunction with the Consolidated Financial Statements and Notes thereto
included in Capsure Holdings Corp.'s ("Capsure" or the "Company") 1996 Annual
Report on Form 10-K. The following Notes to the Consolidated Financial
Statements highlight significant changes to the Notes included in the 1996
Annual Report on Form 10-K and such interim disclosures as required by the
Securities and Exchange Commission. Certain financial information that is
normally included in annual financial statements prepared in accordance with
generally accepted accounting principles but is not required for interim
reporting purposes has been condensed or omitted. The accompanying unaudited
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 1996
Consolidated Financial Statements to conform with the presentation in the 1997
Consolidated Financial Statements.
2. INVESTMENTS
The cost and estimated fair value of investments at June 30, 1997 were as
follows (dollars in thousands):
<TABLE>
<CAPTION>
AMORTIZED GROSS GROSS ESTIMATED
COST UNREALIZED UNREALIZED FAIR
OR COST GAINS LOSSES VALUE
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
Available-For-Sale Securities
Fixed maturities:
U.S. Treasury securities and obligations of U.S.
Government corporations and agencies:
U.S. Treasury notes........................... $ 7,014 $ 45 $ (17) $ 7,042
Collateralized mortgage obligations........... 34,546 206 (241) 34,511
Mortgage pass-through securities.............. 37,379 383 (66) 37,696
Obligations of states and political
subdivisions.................................. 2,276 4 (17) 2,263
Non-agency collateralized mortgage
obligations................................... 19,733 75 (55) 19,753
Asset-backed securities:
Second mortgages/home equity loans............ 26,136 121 (123) 26,134
Other underlying assets....................... 6,710 23 (164) 6,569
-------- ---- ----- --------
Total available-for-sale securities... $133,794 $857 $(683) $133,968
======== ==== ===== ========
</TABLE>
F-78
<PAGE> 156
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1997
(UNAUDITED)
3. REINSURANCE
The effect of reinsurance on premiums written and earned for the six months
ended June 30, 1997 and 1996 was as follows (dollars in thousands):
<TABLE>
<CAPTION>
1997 1996
------------------ ------------------
WRITTEN EARNED WRITTEN EARNED
------- ------- ------- -------
<S> <C> <C> <C> <C>
Direct.............................. $52,502 $49,203 $60,776 $55,422
Assumed............................. -- -- 82 31
Ceded............................... (2,136) (3,945) (9,863) (8,920)
------- ------- ------- -------
Net premiums........................ $50,366 $45,258 $50,995 $46,533
======= ======= ======= =======
</TABLE>
The effect of reinsurance on losses and loss adjustment expenses incurred
for the six months ended June 30, 1997 and 1996 was as follows (dollars in
thousands):
<TABLE>
<CAPTION>
1997 1996
------- -------
<S> <C> <C>
Gross losses and loss adjustment expenses................ $ 6,128 $ 9,184
Reinsurance recoveries................................... (2,969) (2,987)
------- -------
Net losses and loss adjustment expenses.................. $ 3,159 $ 6,197
======= =======
</TABLE>
F-79
<PAGE> 157
======================================================
NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS IN CONNECTION WITH THIS OFFERING
OTHER THAN THOSE CONTAINED IN THE PROSPECTUS, AND, IF GIVEN OR MADE, SUCH
INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE COMPANY OR ANY OF THE UNDERWRITERS. THIS PROSPECTUS DOES NOT CONSTITUTE
AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY OF THE SECURITIES
OFFERED HEREBY BY ANYONE IN ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION
IS NOT AUTHORIZED OR IN WHICH THE PERSON MAKING SUCH OFFER OR SOLICITATION IS
NOT QUALIFIED TO DO SO OR TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH
OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE
HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THE
INFORMATION HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE HEREOF OR
THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE SUCH DATE.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
<S> <C>
Available Information.................. 2
Cautionary Statement Regarding Forward-
Looking Information.................. 2
Prospectus Summary..................... 3
Risk Factors........................... 12
The Company............................ 18
Use of Proceeds........................ 19
Dividend Policy........................ 19
Price Range of Common Stock............ 20
Selected Consolidated Financial Data... 21
Pro Forma Condensed Statement of
Consolidated Operations.............. 26
Management's Discussion and Analysis of
Financial Condition and Results of
Operations of CNA Surety and of the
Statement of Certain Assets and
Liabilities and the Statements of
Certain Revenues and Direct Operating
Expenses of the Predecessor
Operations........................... 30
Business of the Company................ 46
Management of the Company.............. 61
Executive Compensation................. 64
Certain Relationships and Related
Transactions......................... 67
Principal and Selling Stockholders..... 70
Description of Capital Stock........... 72
Underwriting........................... 73
Experts................................ 74
Legal Matters.......................... 74
Glossary of Selected Insurance Terms... 75
Index To Financial Statement
Schedules............................ F-1
</TABLE>
======================================================
======================================================
4,388,129 SHARES
CNA SURETY CORPORATION
COMMON STOCK
[CNA SURETY LOGO]
-------------------------
PROSPECTUS
-------------------------
DONALDSON, LUFKIN & JENRETTE
SECURITIES CORPORATION
SALOMON SMITH BARNEY
, 1998
======================================================
<PAGE> 158
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
Expenses in connection with the Offering, other than underwriting discounts
and commissions, to be paid by the Company are as follows:
<TABLE>
<S> <C>
Securities and Exchange Commission Registration Fee......... $23,633
NASD Filing Fees............................................ $ 8,500
NYSE Filing Fees............................................ $ 2,304
Federal Taxes............................................... $ *
State Taxes................................................. $ *
Registrar and Transfer Agent................................ $ *
Printing Registration Statement and Prospectus.............. $ *
Printing Stock certificates................................. $ *
Legal Fees.................................................. $ *
Blue Sky Fees............................................... $ 7,500
Accounting Fees............................................. $ *
Miscellaneous............................................... $ *
-------
Total..................................................... $ *
</TABLE>
- - ---------------
* To be filed by amendment.
The Company will bear all of the foregoing expenses. In addition, the
Company intends to pay all expenses of registration, issuance of and
distribution, excluding underwriters' discounts and commissions, with respect to
the shares being sold by the Selling Stockholders.
ITEM 14. INDEMNIFICATION OF OFFICERS AND DIRECTORS.
Delaware law permits a corporation to adopt a provision in its certificate
of incorporation eliminating or limiting the personal liability of a director to
the corporation or its stockholders for monetary damages for breach of fiduciary
duty as a director, except that such provision shall not limit the liability of
a director for: (i) any breach of the director's duty of loyalty to the
corporation or its stockholders; (ii) acts or omissions not in good faith or
which involve intentional misconduct or a knowing violation of the law; (iii)
liability under section 174 of the Delaware General Corporation Law; or (iv) any
transaction from which the directors derived an improper personal benefit. The
CNA Surety certificate of incorporation limits the personal liability of CNA
Surety's directors for monetary damages to the fullest extent permissible under
applicable law.
Under Delaware law, a corporation may indemnify any person made a party or
threatened to be made a party to any type of proceeding (other than an action by
or in the right of the corporation) because he or she is or was an officer,
director, employee or agent of the corporation, or was serving at the request of
the corporation as an officer, director, employee or agent of the corporation,
against expenses, judgements, fines, and amounts paid in settlement actually and
reasonably incurred in connection with such proceeding if: (i) he or she acted
in good faith and in a manner such director reasonably believed to be in or not
opposed to the best interests of the corporation; or (ii) in the case of a
criminal proceeding, he or she had no reasonable cause to believe that his or
her conduct was unlawful. A corporation may indemnify any person made party or
threatened to be made a party to any threatened, pending or completed action or
suit brought by or in the right of the corporation because he or she was an
officer, director, employee or agent of the corporation, or was serving at the
request of the corporation as an officer, director, employee or agent of the
corporation, against expenses actually and reasonably incurred in connection
with such action or suit if he or she acted in good faith and in a manner such
director reasonably believed to be in or not opposed to the best interests of
the corporation, except that there may be no such indemnification if the person
is found liable to the corporation unless, in such case, the court determines
the person is entitled thereto. A corporation must indemnify a
II-1
<PAGE> 159
director, officer, employee or agent against expenses actually and reasonably
incurred by him or her who successfully defends himself or herself in a
proceeding to which they were a party because he or she was a director, officer,
employee or agent of the corporation. Expenses incurred by any officer or
director (or other employees or agents as deemed appropriate by the board of
directors) in defending a civil or criminal proceeding may be paid by the
corporation in advance of the final disposition of such proceeding upon receipt
of an undertaking by or on behalf of such director or officer to repay such
amount if it shall ultimately be determined that he or she is not entitled to be
indemnified by the corporation. The Delaware law indemnification and expense
advancement provisions are not exclusive of any other rights which may be
granted by the bylaws, a vote of stockholders or disinterested directors,
agreement or otherwise.
The CNA Surety bylaws provide for the indemnification, in a non-derivative
suit, of any person who is a party or is threatened to be made a party to any
suit or proceeding, because such person, or a person for whom such person was or
is a representative, was or is an officer, director, employee or agent of the
CNA Surety, or was serving at the request of CNA Surety as an officer, director,
employee or agent of the corporation, against expenses in connection with such
suit, action or proceeding if such person acted in good faith and in a manner
such director reasonably believed to be in or not opposed to the best interests
of CNA Surety, and with respect to any criminal action or proceeding, had no
reasonable cause to believe such conduct was unlawful. The CNA Surety bylaws
provide further for the indemnification in derivative suits if such person acted
in good faith and in a manner such person believed to be in or not opposed to
the best interests of CNA Surety; provided, however, that no indemnification
will be made for any claim, issue or matter as to which such person has been
adjudged liable to CNA Surety, unless the court in which such action was brought
determined, despite the adjudication of liability, that such person is fairly
and reasonably entitled to indemnity for such expenses that such court deems
proper. The bylaws of CNA Surety also permit the advancement of expenses
incurred by a director, officer, employee or agent of CNA Surety in defending a
suit or action, provided that such person executes an undertaking to repay the
advanced expenses if it is ultimately determined that such person is not
entitled to be indemnified by CNA Surety.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
None.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
<TABLE>
<CAPTION>
EXHIBIT NUMBER DESCRIPTION
- - -------------- -----------
<S> <C>
1(1)* Form of Underwriting Agreement.
2(1) Reorganization Agreement dated as of December 19, 1996 among
Capsure Holdings Corp., Continental Casualty Company, CNA
Surety Corporation, Surety Acquisition Company and certain
affiliates of Continental Casualty Company (filed on
December 27, 1996 as Exhibit 2 to Capsure Holdings Corp.'s
Form 8-K, and incorporated herein by reference).
2(2) First Amendment to the Reorganization Agreement dated as of
July 14, 1997 among Capsure Holdings Corp., Continental
Casualty Company, CNA Surety Corporation, Surety Acquisition
Company and certain affiliates of Continental Casualty
Company (filed on July 16, 1997 as Exhibit 2 to Capsure
Holdings Corp.'s Form 8-K, and incorporated herein by
reference).
3(1) Certificate of Incorporation of CNA Surety Corporation dated
December 10, 1996 (filed on August 15, 1997 as Exhibit
3(1)to CNA Surety Corporation's Registration Statement on
Form S-4 (Registration No. 333-33753), and incorporated
herein by reference).
3(2) Amendment to Certificate of Incorporation of CNA Surety
Corporation dated May 27, 1997 (filed on August 15, 1997 as
Exhibit 3(2) to CNA Surety Corporation's Registration
Statement on Form S-4 (Registration No. 333-33753), and
incorporated herein by reference).
3(3) Bylaws of CNA Surety Corporation (filed on August 15, 1997
as Exhibit 3(3)to CNA Surety Corporation's Registration
Statement on Form S-4 (Registration No. 333-33753), and
incorporated herein by reference).
</TABLE>
II-2
<PAGE> 160
<TABLE>
<CAPTION>
EXHIBIT NUMBER DESCRIPTION
- - -------------- -----------
<S> <C>
3(4) Amendment to Bylaws of CNA Surety Corporation (filed on
March 20, 1998 as Exhibit 3(4) to CNA Surety Corporation's
Annual Report on Form 10-K, and incorporated herein by
reference).
4(1) Specimen certificate of CNA Surety Corporation (filed on
August 15, 1997 as Exhibit 4(1) to CNA Surety Corporation's
Registration Statement on Form S-4 (Registration No.
333-33753), and incorporated herein by reference).
4(2) Registration Rights Agreement, dated as of September 30,
1996 between CNA Surety Corporation and Equity Capsure
Limited Partnership (filed on August 15, 1997 as Exhibit
4(2) to CNA Surety Corporation's Registration Statement on
Form S-4 (Registration No. 333-33753), and incorporated
herein by reference).
5* Opinion of Seyfarth, Shaw, Fairweather & Geraldson.
10(1) Agreement dated as of June 30, 1997 by and among John Knox,
Jr., Capsure Holdings Corp. and CNA Surety Corporation
(filed on August 15, 1997 as Exhibit 10(6) to CNA Surety
Corporation's Registration Statement on Form S-4
(Registration No. 333-33753), and incorporated herein by
reference).
10(2) Stock Purchase Agreement among John T. Knox, Jr., Universal
Surety Holding Corp., Capsure Financial Group, Inc. and
Capsure Holdings Corp. dated July 26, 1994 (filed on October
6, 1994 as Exhibit 2 to Capsure Holdings Corp.'s Current
Report on Form 8-K, and incorporated herein by reference).
10(3) Non-Competition and Non-Solicitation Agreement between
Capsure Holdings Corp. and Frontier Insurance Company, dated
as of May 22, 1996 (filed on August 15, 1997 as Exhibit
10(9) to CNA Surety's Registration Statement on Form S-4
(Registration No. 333-33753), and incorporated herein by
reference).
10(4) Contract Surety Bond Reinsurance Agreement dated as of
September 22, 1994 between Western Surety Company, a South
Dakota corporation, and Universal Surety of America, a Texas
corporation (filed on March 30, 1995 as Exhibit 10(23) to
Capsure Holdings Corp.'s Annual Report on Form 10-K, and
incorporated herein by reference).
10(5) Co-Employee Agreement dated as of September 22, 1994 between
Western Surety Company and Universal Surety of America
(filed on March 30, 1995 as Exhibit 10(24) to Capsure
Holdings Corp.'s Annual Report on Form 10-K, and
incorporated herein by reference).
10(6) Form of CNA Surety Corporation Replacement Stock Option Plan
(filed on August 15, 1997 as Exhibit 10(12) to CNA Surety
Corporation's Registration Statement on Form S-4
(Registration No. 333-33753), and incorporated herein by
reference).
10(7) Form of CNA Surety Corporation 1997 Long-Term Equity
Compensation Plan (filed on August 15, 1997 as Exhibit
10(12) to CNA Surety Corporation's Registration Statement on
Form S-4 (Registration No. 333-33753), and incorporated
herein by reference).
10(8) Form of Aggregate Stop Loss Reinsurance Contract by and
between Western Surety Company, Universal Surety of America,
Surety Bonding Company of America and Continental Casualty
Company (filed on December 27, 1996 as Exhibit 2 to Capsure
Holdings Corp.'s Form 8-K, and incorporated herein by
reference).
10(9) Form of Surety Excess of Loss Reinsurance Contract by and
between Western Surety Company, Universal Surety of America,
Surety Bonding Company of America and Continental Casualty
Company (filed on December 27, 1996 as Exhibit 2 to Capsure
Holdings Corp.'s Form 8-K, and incorporated herein by
reference).
10(10) Form of Surety Quota Share Treaty by and between Western
Surety Company and Continental Casualty Company (filed on
December 27, 1996 as Exhibit 2 to Capsure Holdings Corp.'s
Form 8-K, and incorporated herein by reference).
10(11) Employment Agreement dated as of October 1, 1997 by and
between CNA Surety Corporation and Dan L. Kirby (filed on
March 20, 1998 as Exhibit 10(13) to CNA Surety's Annual
Report on Form 10-K, and incorporated herein by reference).
10(12) Employment Agreement dated as of October 3, 1997 by and
between CNA Surety Corporation and Mark C. Vonnahme (filed
on March 20, 1998 as Exhibit 10(14) to CNA Surety's Annual
Report on Form 10-K, and incorporated herein by reference).
10(13) Credit Agreement, dated as of September 30, 1997, among CNA
Surety Corporation, the lenders party thereto, and Chase
Manhattan Bank, as Administrative Agent.
</TABLE>
II-3
<PAGE> 161
<TABLE>
<CAPTION>
EXHIBIT NUMBER DESCRIPTION
- - -------------- -----------
<S> <C>
10(14) Surety Second Excess of Loss Reinsurance Contract by and
between Western Surety Company, Universal Surety of America,
Surety Bonding Company of America and Continental Casualty
Company.
10(15) Form of CNA Surety Corporation Non-Employee Directors
Deferred Compensation Plan.
15 Awareness Letter from Deloitte & Touche, dated June 3, 1998.
21 Subsidiaries of the Registrant.
23(1) Consent of Deloitte & Touche LLP dated June 3, 1998.
23(2)* Consent of Seyfarth, Shaw, Fairweather & Geraldson dated
, 1998 included in opinion filed as Exhibit
5.
23(3) Consent of Coopers & Lybrand L.L.P., dated June 4, 1998
24 Powers of Attorney
27 Financial Data Schedule.
99(1) Consent of William Pate, dated June 3, 1998
</TABLE>
- - ---------------
* To be filed by amendment.
All other schedules are omitted because they are not applicable, not
required under the instructions or the information required is set forth in the
financial statements or the notes to the financial statements.
ITEM 17. UNDERTAKINGS
(a) Insofar as indemnification for liabilities arising under the Act may be
permitted to directors, officers and controlling persons of the registrant
pursuant to the foregoing provisions, or otherwise, the registrant has been
advised that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Act and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by the registrant of expenses incurred
or paid by a director, officer or controlling person of the registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Act and will be governed by the final adjudication of
such issue.
(b) The undersigned registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act
of 1933, the information omitted from the form of prospectus filed as part
of this registration statement in reliance upon Rule 430A and contained in
a form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or
(4) or 497(h) under the Securities Act shall be deemed to be part of this
registration statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities
Act of 1933, each post-effective amendment that contains a form of
prospectus shall be deemed to be a new registration statement relating to
the securities offered therein, and the offering of such securities at that
time shall be deemed to be the initial bona fide offering thereof.
II-4
<PAGE> 162
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Company has
duly caused this Amendment No. 1 to the Registration Statement to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of
Chicago, State of Illinois, on this 17th day of June, 1998.
CNA SURETY CORPORATION
/s/ MARK C. VONNAHME
By:
--------------------------------------
Mark C. Vonnahme
President and Chief Executive
Officer
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities and dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <C> <S>
* /s/ GIORGIO BALZER Director June 17, 1998
- - ---------------------------------------------
*Giorgio Balzer
* /s/ PHILIP H. BRITT Director June 17, 1998
- - ---------------------------------------------
*Philip H. Britt
Director
- - ---------------------------------------------
David T. Cumming
* /s/ ROD F. DAMMEYER Director June 17, 1998
- - ---------------------------------------------
*Rod F. Dammeyer
* /s/ MELVIN GRAY Director June 17, 1998
- - ---------------------------------------------
*Melvin Gray
* /s/ JOE KIRBY Director June 17, 1998
- - ---------------------------------------------
*Joe Kirby
* /s/ ROY E. POSNER Director June 17, 1998
- - ---------------------------------------------
*Roy E. Posner
* /s/ ADRIAN M. TOCKLIN Director June 17, 1998
- - ---------------------------------------------
*Adrian M. Tocklin
* /s/ ROBERT T. VAN GIESON Chairman of the Board of Directors June 17, 1998
- - ---------------------------------------------
*Robert T. Van Gieson
/s/ MARK C. VONNAHME President, Chief Executive Officer and June 17, 1998
- - --------------------------------------------- Director (Principal Executive Officer)
Mark C. Vonnahme
</TABLE>
II-5
<PAGE> 163
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <C> <S>
/s/ JOHN S. HENEGHAN Vice President and Chief Financial June 17, 1998
- - --------------------------------------------- Officer (Principal Financial Officer)
John S. Heneghan
/s/ THOMAS A. POTTLE Vice President, Chief Operations Officer June 17, 1998
- - --------------------------------------------- and Assistant Secretary
Thomas A. Pottle (Principal Accounting Officer)
* /s/ SANDRA D. WAGMAN June 17, 1998
- - ---------------------------------------------
Sandra D. Wagman
Attorney-In-Fact
</TABLE>
II-6
<PAGE> 1
EXHIBIT 10(13)
[EXECUTION COUNTERPART]
$130,000,000
CREDIT AGREEMENT
Dated as of September 30, 1997
among
CNA SURETY CORPORATION,
THE LENDERS PARTY HERETO,
and
THE CHASE MANHATTAN BANK,
as Administrative Agent
<PAGE> 2
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C> <C>
ARTICLE I
DEFINITIONS...............................................................................1
ARTICLE II
THE FACILITY............................................................................ 20
2.1 The Facility......................................................................................20
2.1.1 Description of Facility...........................................................................20
2.1.2 Facility Amount...................................................................................21
2.1.3 Availability of Facility..........................................................................21
2.2 Ratable Advances..................................................................................21
2.2.1 Ratable Advances..................................................................................21
2.2.2 Ratable Advance Rate Options......................................................................21
2.2.3 Method of Selecting Types and Interest Periods for Ratable Advances...............................21
2.2.4 Conversion and Continuation of Outstanding Ratable Advances.......................................22
2.3 Competitive Bid Advances..........................................................................22
2.3.1 Competitive Bid Option............................................................................22
2.3.2 Competitive Bid Quote Request.....................................................................23
2.3.3 Invitation for Competitive Bid Quotes.............................................................23
2.3.4 Submission and Contents of Competitive Bid Quotes.................................................24
2.3.5 Notice to Borrower................................................................................25
2.3.6 Acceptance and Notice by Borrower.................................................................26
2.3.7 Allocation by Administrative Agent................................................................26
2.4 Availability of Funds.............................................................................27
2.5 Facility Fee; Reductions in Aggregate Commitment..................................................27
2.6 Minimum Amount of Each Advance; Limit on Interest Periods.........................................27
2.7 Optional Principal Payments.......................................................................27
2.8 Mandatory Prepayments.............................................................................28
2.9 Interest Rate, etc................................................................................28
2.10 Rates Applicable After Default....................................................................28
2.11 Method of Payment.................................................................................28
2.12 Telephonic Notices................................................................................29
2.13 Interest Payment Dates; Interest and Fee Basis....................................................29
2.14 Notification of Advances, Interest Rates, Prepayments and Commitment Reductions...................30
2.15 Lending Installations.............................................................................30
2.16 Non-Receipt of Funds by the Administrative Agent..................................................30
2.17 Taxes.............................................................................................31
2.18 Evidence of Debt..................................................................................32
</TABLE>
<PAGE> 3
-ii-
<TABLE>
<S> <C> <C>
ARTICLE III
CHANGE IN CIRCUMSTANCES..................................................................33
3.1 Yield Protection..................................................................................33
3.2 Changes in Capital Adequacy Regulations...........................................................34
3.3 Availability of Types of Advances.................................................................34
3.4 Funding Indemnification...........................................................................35
3.5 Lender Statements; Survival of Indemnity..........................................................35
3.6 Right to Substitute Lender........................................................................35
ARTICLE IV
CONDITIONS PRECEDENT.....................................................................36
4.1 Initial Advance...................................................................................36
4.2 Each Advance......................................................................................39
ARTICLE V
REPRESENTATIONS AND WARRANTIES...........................................................39
5.1 Corporate Existence and Standing..................................................................39
5.2 Authorization and Validity........................................................................39
5.3 Compliance with Laws and Contracts................................................................40
5.4 Governmental Consents.............................................................................40
5.5 Financial Statements..............................................................................41
5.6 Material Adverse Change...........................................................................41
5.7 Taxes.............................................................................................42
5.8 Litigation and Contingent Obligations.............................................................42
5.9 Capitalization....................................................................................42
5.10 ERISA.............................................................................................42
5.11 Default...........................................................................................43
5.12 Federal Reserve Regulations.......................................................................43
5.13 Investment Company................................................................................43
5.14 Reorganization Documents..........................................................................43
5.15 Disclosure........................................................................................44
5.16 Properties........................................................................................44
5.17 Liens.............................................................................................44
5.18 Restrictive Agreements............................................................................45
ARTICLE VI
COVENANTS................................................................................45
6.1 Financial Reporting...............................................................................45
6.2 Use of Proceeds...................................................................................47
6.3 Certain Notices...................................................................................47
</TABLE>
<PAGE> 4
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<TABLE>
<S> <C> <C>
6.4 Conduct of Business...............................................................................48
6.5 Taxes.............................................................................................48
6.6 Insurance.........................................................................................49
6.7 Compliance with Laws..............................................................................49
6.8 Maintenance of Properties.........................................................................49
6.9 Inspection........................................................................................49
6.10 Merger............................................................................................49
6.11 Sale of Assets....................................................................................50
6.12 Liens.............................................................................................50
6.13 Indebtedness......................................................................................51
6.14 Consolidated Capitalization.......................................................................51
6.15 Insurance Company Surplus.........................................................................51
6.16 Maximum Statutory Net Written Premiums............................................................51
6.17 Investments, Loans, Advances, Guarantees and Acquisitions.........................................51
6.18 Transactions with Affiliates......................................................................52
6.19 Restrictive Agreements............................................................................53
6.20 Leases............................................................................................53
6.21 Sale and Leaseback................................................................................53
6.22 Fiscal Year.......................................................................................53
ARTICLE VII
DEFAULTS.................................................................................54
ARTICLE VIII
ACCELERATION, WAIVERS, AMENDMENTS AND REMEDIES...........................................56
8.1 Acceleration......................................................................................56
8.2 Amendments........................................................................................56
8.3 Preservation of Rights............................................................................57
ARTICLE IX
GENERAL PROVISIONS.......................................................................57
9.1 Survival of Representations.......................................................................57
9.2 Headings..........................................................................................57
9.3 Entire Agreement..................................................................................57
9.4 Several Obligations; Benefits of this Agreement...................................................58
9.5 Expenses; Indemnification; Damage Waiver..........................................................58
9.6 Numbers of Documents..............................................................................59
9.7 Accounting........................................................................................59
9.8 Severability of Provisions........................................................................59
9.9 Nonliability of Lenders...........................................................................59
9.10 Governing Law.....................................................................................60
9.11 Jurisdiction; Consent to Service of Process.......................................................60
</TABLE>
<PAGE> 5
-iv-
<TABLE>
<S> <C> <C>
9.12 Confidentiality...................................................................................60
9.13 Waiver of Jury Trial..............................................................................61
9.14 Disclosure........................................................................................61
9.15 Counterparts......................................................................................61
ARTICLE X
THE ADMINISTRATIVE AGENT.................................................................61
10.1 Appointment.......................................................................................61
10.2 Powers............................................................................................62
10.3 General Immunity..................................................................................62
10.4 No Responsibility for Loans, Recitals, etc........................................................62
10.5 Action on Instructions of Lenders.................................................................62
10.6 Employment of Administrative Agents and Counsel...................................................63
10.7 Reliance on Documents; Counsel....................................................................63
10.8 Administrative Agent's Reimbursement and Indemnification..........................................63
10.9 Notice of Default.................................................................................64
10.10 Rights as a Lender................................................................................64
10.11 Lender Credit Decision............................................................................64
10.12 Successor Administrative Agent....................................................................64
ARTICLE XI
SETOFF; RATABLE PAYMENTS.................................................................65
11.1 Setoff............................................................................................65
11.2 Ratable Payments..................................................................................66
ARTICLE XII
BENEFIT OF AGREEMENT; ASSIGNMENTS; PARTICIPATIONS........................................66
12.1 Successors and Assigns............................................................................66
12.2 Participations....................................................................................67
12.2.1 Permitted Participants; Effect....................................................................67
12.2.2 Voting Rights.....................................................................................67
12.2.3 Benefit of Setoff.................................................................................67
12.3.1 Permitted Assignments.............................................................................67
12.3.2 Register..........................................................................................68
12.3.3 Effect; Effective Date............................................................................68
12.4 Dissemination of Information......................................................................69
12.5 Tax Treatment.....................................................................................69
</TABLE>
<PAGE> 6
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<TABLE>
<S> <C> <C>
ARTICLE XIII
NOTICES..................................................................................69
13.1 Giving Notice.....................................................................................69
13.2 Change of Address.................................................................................70
</TABLE>
Exhibit "A" - Competitive Bid Quote Request
Exhibit "B" - Invitation for Competitive Bid Quotes
Exhibit "C" - Competitive Bid Quote
Exhibit "D" - Opinion of the Counsel to the Borrower
Exhibit "E" - Compliance Certificate
Exhibit "F" - Assignment and Acceptance
Schedule 1 - Commitments
Schedule 5.3 - Approvals and Consents
Schedule 5.7 - Tax Matters
Schedule 5.8 - Litigation
Schedule 5.9 - Capitalization and Subsidiaries
Schedule 5.17 - Liens
Schedule 5.18 - Restrictive Agreements
Schedule 6.13 - Existing Indebtedness
<PAGE> 7
CREDIT AGREEMENT dated as of September 30, 1997 between CNA Surety
Corporation, the Lenders and The Chase Manhattan Bank, as administrative agent.
R E C I T A L S:
A. The Borrower has requested the Lenders to make loans to it from time
to time in an aggregate principal amount up to but not exceeding $130,000,000,
the proceeds of which the Borrower will use (a) to refinance, contemporaneously
with (and after giving effect to) the Merger, existing indebtedness of Capsure
Holdings, (b) to make certain capital contributions to Western and USA, each a
Subsidiary of the Borrower (after giving effect to the Merger), and (c) for the
general corporate purposes of the Borrower and its Subsidiaries.
B. The Lenders are willing to make such loans on the terms and
conditions set forth herein.
NOW, THEREFORE, in consideration of the mutual covenants and
undertakings herein contained, and for other good and valuable consideration,
the receipt and sufficiency of which are hereby acknowledged, the Borrower, the
Lenders, and the Agent hereby agree as follows:
ARTICLE I
DEFINITIONS
As used in this Agreement:
"Absolute Rate" means, with respect to an Absolute Rate Loan made by a
given Lender for the relevant Absolute Rate Interest Period, the rate of
interest per annum (rounded to the nearest 1/100 of 1%) offered by such Lender
and accepted by the Borrower.
"Absolute Rate Advance" means a borrowing hereunder consisting of the
aggregate amount of the several Absolute Rate Loans made by some or all of the
Lenders to the Borrower at the same time and for the same Interest Period.
"Absolute Rate Auction" means a solicitation of Competitive Bid Quotes
setting forth Absolute Rates pursuant to Section 2.3.
"Absolute Rate Interest Period" means, with respect to an Absolute Rate
Advance, a period of not less than seven and not more than 360 days commencing
on a Business Day selected by the
<PAGE> 8
-2-
Borrower pursuant to this Agreement. If such Absolute Rate Interest Period would
end on a day which is not a Business Day, such Absolute Rate Interest Period
shall end on the next succeeding Business Day.
"Absolute Rate Loan" means a Loan which bears interest at the Absolute
Rate.
"Administrative Agent" means The Chase Manhattan Bank in its capacity
as administrative agent for the Lenders pursuant to Article X, and not in its
individual capacity as a Lender, and any successor Administrative Agent
appointed pursuant to Article X.
"Administrative Questionnaire" means an Administrative Questionnaire in
a form supplied by the Administrative Agent.
"Advance" means a borrowing hereunder consisting of the aggregate
amount of the several Loans made by some or all of the Lenders to the Borrower
on the same Borrowing Date, of the same Type (or on the same interest basis in
the case of Competitive Bid Advances) and, when applicable, for the same
Interest Period and includes a Competitive Bid Advance.
"Affiliate" of any Person means any other Person directly or indirectly
controlling, controlled by or under common control with such Person. A Person
shall be deemed to control another Person if the controlling Person owns 10% or
more of any class of voting securities (or other ownership interests) of the
controlled Person or possesses, directly or indirectly, the power to direct or
cause the direction of the management or policies of the controlled Person,
whether through ownership of stock, by contract or otherwise.
"Aggregate Commitment" means the aggregate of the Commitments of all
the Lenders, as reduced from time to time pursuant to the terms hereof.
"Agreement Accounting Principles" means generally accepted accounting
principles as in effect from time to time, applied in a manner consistent with
those used in preparing the financial statements referred to in Section 5.5(a);
provided, however, that for purposes of all computations required to be made
with respect to compliance by the Borrower with Section 6.14, such term shall
mean generally accepted accounting principles as in effect on the date hereof,
applied in a manner consistent with those used in preparing the financial
statements referred to in Section 5.5.
"Alternate Base Rate" means, for any day, a rate of interest per annum
equal to the higher of (a) the Prime Rate for
<PAGE> 9
-3-
such day and (b) the sum of the Federal Funds Effective Rate for such day plus
1/2% per annum.
"Annual Statement" means the annual statutory financial statement of
any Insurance Subsidiary required to be filed with the insurance commissioner
(or similar authority) of its jurisdiction of incorporation, which statement
shall be in the form required by such Insurance Subsidiary's jurisdiction of
incorporation or, if no specific form is so required, in the form of financial
statements recommended by the NAIC to be used for filing annual statutory
financial statements and shall contain the type of information recommended by
the NAIC to be disclosed therein, together with all exhibits or schedules filed
therewith.
"Applicable Eurodollar Margin" and "Applicable Facility Fee Percentage"
mean, respectively, the applicable rates per annum set forth in the table below
under the captions "Applicable Eurodollar Margin" and "Applicable Facility Fee
Percentage", as the case may be, set forth opposite the applicable Consolidated
Capitalization Ratio as at the last day of the most recently ended fiscal
quarter of the Borrower for which financial statements have been delivered
pursuant to Section 6.1(a) or 6.1(b), as the case may be, together with the
related compliance certificate for such fiscal quarter or fiscal year, as the
case may be, required by Section 6.1(c), provided that if, on any day, either
Western or USA has a claims paying ability rating from A.M. Best & Company,
Inc., of less than "A-" (or if such rating is no longer published by A.M. Best &
Company, Inc., from another rating agency acceptable to the Administrative
Agent), or either Western or USA does not have such a rating, the applicable
rates set forth in the table below under the caption (i) "Applicable Eurodollar
Margin" shall be increased by 0.10% per annum and (ii) "Applicable Facility Fee
Percentage" shall be increased by 0.025% per annum.
<PAGE> 10
-4-
<TABLE>
<CAPTION>
<S> <C> <C>
- - ------------------------------------------------------------------------------------------------------------------
Applicable Applicable
Range of Consolidated Eurodollar Facility Fee
Capitalization Ratio Margin Percentage
- - ------------------------------------------------------------------------------------------------------------------
Less than 0.15 to 1.0 0.16% 0.09%
- - ------------------------------------------------------------------------------------------------------------------
Greater than or equal to 0.15 to 0.20% 0.10%
1.0 and less than or equal to 0.35
to 1.0
- - ------------------------------------------------------------------------------------------------------------------
Greater than 0.35 to 1.0 0.275% 0.125%
- - -------------------------------------------------------------------------------------------------------------------
</TABLE>
From and including the initial Borrowing Date to but excluding the fifth
Business Day following the date of receipt of the first financial statements
delivered pursuant to Section 6.1(a) or 6.1(b), as the case may be, together
with the related compliance certificate for such fiscal quarter or fiscal year,
as the case may be, required by Section 6.1(c), the "Applicable Eurodollar
Margin" and the "Applicable Facility Fee Percentage" shall be determined in
accordance with the certificate delivered pursuant to Section 4.1(e). The
"Applicable Eurodollar Margin" and the "Applicable Facility Fee Percentage"
shall be adjusted on the fifth Business Day following the date of receipt of the
relevant financial statements pursuant to Section 6.1(a) or 6.1(b), as the case
may be, and the related compliance certificate for such fiscal quarter or fiscal
year, as the case may be, required by Section 6.01(c). In the event the
financial statements for any fiscal quarter or fiscal year or the certificate
required by Section 6.1(c) are not delivered when due and such financial
statements and/or certificate are not delivered prior to the date upon which
such becomes a Default, then, effective upon such Default, during the period
from the date upon which such financial statements were required to be delivered
until one Business Day following the date upon which they actually are
delivered, the Applicable Eurodollar Margin and the Applicable Facility Fee
Percentage shall be the highest rates provided for in the above table; provided
that, notwithstanding the foregoing, the Applicable Eurodollar Margin and the
Applicable Facility Fee Percentage shall be the highest rate set forth in the
above table for any period during which a Default or Unmatured Default shall
have occurred and be continuing.
"Article" means an article of this Agreement unless another document is
specifically referenced.
<PAGE> 11
-5-
"Assignment and Acceptance" is defined in Section 12.3.1.
"Authorized Officer" means any of the Chief Executive Officer, the
President, the Chief Financial Officer, the Chief Operations Officer, any Vice
President or the Secretary of the Borrower, acting singly.
"Borrower" means CNA Surety Corporation, a Delaware corporation, and
its successors and assigns.
"Borrowing Date" means a date on which an Advance is made hereunder.
"Business Day" means (a) with respect to any borrowing, payment or rate
selection of Eurodollar Advances, a day (other than a Saturday or Sunday) on
which banks generally are open in New York for the conduct of substantially all
of their commercial lending activities and on which dealings in United States
dollars are carried on in the London interbank market and (b) for all other
purposes, a day (other than a Saturday or Sunday) on which banks generally are
open in New York for the conduct of substantially all of their commercial
lending activities.
"Capitalized Lease" of a Person means any lease of Property by such
Person as lessee which would be capitalized on a balance sheet of such Person
prepared in accordance with Agreement Accounting Principles.
"Capitalized Lease Obligations" of a Person means the amount of the
obligations of such Person under Capitalized Leases which would be shown as a
liability on a balance sheet of such Person prepared in accordance with
Agreement Accounting Principles.
"Capsure Credit Agreement" means the Amended and Restated Credit
Agreement dated as of May 22, 1996 between Capsure Financial Group, Inc.,
Capsure Holdings, the lenders party thereto and Chase (formerly known as
Chemical Bank), as administrative agent, as amended.
"Capsure Holdings" means Capsure Holdings Corp., a Delaware
corporation.
"CCC Surety Operations" means the combined surety businesses of (a)
Continental Casualty and its Affiliates and (b) Continental Insurance and its
Affiliates.
"Change" means (a) any change after the date of this Agreement in the
Risk-Based Capital Guidelines for banks or (b) any adoption of or change in any
other law, governmental or
<PAGE> 12
-6-
quasi-governmental rule, regulation, policy, guideline, interpretation, or
directive (whether or not having the force of law) after the date of this
Agreement which affects the amount of capital required or expected to be
maintained by any Lender or any Lending Installation or any corporation
controlling any Lender.
"Change in Control" means (a) the Continental Casualty Pool and the
Continental Insurance Pool shall cease to own, in the aggregate (directly or
indirectly), beneficially and of record free and clear of all Liens, other
encumbrances, or voting agreements, restrictions or trusts of any kind, at least
51% of the outstanding shares of capital stock of the Borrower on a fully
diluted basis and shares representing the right to elect a majority of the
directors of the Borrower, (b) the Continental Casualty Pool shall cease to own
(directly or indirectly) beneficially and of record, free and clear of all
Liens, other encumbrances, or voting agreements, restrictions or trusts of any
kind, at least 46% of the outstanding shares of capital stock of the Borrower on
a fully diluted basis and shares representing the right to elect a majority of
the directors of the Borrower or (c) after giving effect to the Merger, the
Borrower shall cease to own, directly or indirectly, beneficially and of record,
free and clear of all Liens, other encumbrances, or voting agreements,
restrictions or trusts of any kind, 100% of the outstanding shares of capital
stock (on a fully diluted basis) of each Significant Subsidiary.
"Chase" means The Chase Manhattan Bank in its individual capacity, and
its successors.
"Closing Date" means September 30, 1997.
"Closing Transactions" is defined in Section 4.1(e).
"CNA Financial" means CNA Financial Corporation, a Delaware
corporation.
"Code" means the Internal Revenue Code of 1986, as amended, reformed or
otherwise modified from time to time.
"Commitment" means, for each Lender, the obligation of such Lender to
make Loans not exceeding the amount set forth opposite its name on Schedule 1
hereto or in the Assignment and Acceptance relating to any assignment that has
become effective pursuant to Section 12.3.2, as such amount may be modified from
time to time pursuant to the terms hereof.
"Competitive Bid Advance" means a borrowing hereunder consisting of the
aggregate amount of the several Competitive Bid
<PAGE> 13
-7-
Loans made by some or all of the Lenders to the Borrower at the same time and
for the same Interest Period.
"Competitive Bid Borrowing Notice" is defined in Section 2.3.6.
"Competitive Bid Loan" means a Eurodollar Bid Rate Loan or an Absolute
Rate Loan, or both, as the case may be.
"Competitive Bid Margin" means the margin above or below the applicable
Eurodollar Base Rate offered for a Eurodollar Bid Rate Loan, expressed as a
percentage (rounded to the nearest 1/100 of 1%) to be added or subtracted from
such Eurodollar Base Rate.
"Competitive Bid Quote" means a Competitive Bid Quote substantially in
the form of Exhibit "C" hereto completed and delivered by a Lender to the
Administrative Agent in accordance with Section 2.3.4.
"Competitive Bid Quote Request" means a Competitive Bid Quote Request
substantially in the form of Exhibit "A" hereto completed and delivered by the
Borrower to the Administrative Agent in accordance with Section 2.3.2.
"Consolidated" or "consolidated", when used in connection with any
calculation, means a calculation to be determined on a consolidated basis for
the Borrower and its Subsidiaries in accordance with Agreement Accounting
Principles, or SAP, as applicable.
"Consolidated Capitalization Ratio" means, as at any date of
determination, the ratio of (a) consolidated Indebtedness of the Borrower and
its Subsidiaries as at such date to (b) the sum of (i) consolidated Indebtedness
of the Borrower and its Subsidiaries as at such date plus (ii) Consolidated Net
Worth as at such date.
"Consolidated Net Worth" means, at any date of determination, the
amount of consolidated common and preferred shareholders' equity of the Borrower
and its Subsidiaries, determined as at such date in accordance with Agreement
Accounting Principles; provided, however, that unrealized appreciation and
depreciation of securities which are classified as available for sale and are
subject to FASB 115 shall be excluded when computing Consolidated Net Worth.
"Continental Casualty" means Continental Casualty Company, an Illinois
insurance company.
<PAGE> 14
-8-
"Continental Casualty Pool" means Continental Casualty, American
Casualty Company of Reading, Pennsylvania, CNA Casualty of California, CNA
Lloyd's of Texas, Columbia Casualty Company, National Fire Insurance Company of
Hartford, Transcontinental Insurance Company, Transportation Insurance Company
and Valley Forge Insurance Company.
"Continental Insurance" means The Continental Insurance Company, a New
Hampshire insurance company.
"Continental Insurance Pool" means Continental Insurance, Boston Old
Colony Insurance Company, The Buckeye Union Insurance Company, Commercial
Insurance Company of Newark, New Jersey, Continental Lloyd's Insurance Company,
The Continental Insurance Company of New Jersey, The Continental Insurance
Company of Puerto Rico, Continental Reinsurance Corporation, The Fidelity and
Casualty Company of New York, Firemen's Insurance Company of Newark, New Jersey,
First Insurance Company of Hawaii Ltd., The Glens Falls Insurance Company,
Kansas City Fire and Marine Insurance Company, The Mayflower Insurance Company,
Ltd., National-Ben Franklin Insurance Company of Illinois, Niagara Fire
Insurance Company and Pacific Insurance Company.
"Contingent Obligation" of a Person means any agreement, undertaking or
arrangement by which such Person assumes, guarantees, endorses, contingently
agrees to purchase or provide funds for the payment of, or otherwise becomes or
is contingently liable upon, the financial obligation or liability of any other
Person, or agrees to maintain the net worth or working capital or other
financial condition of any other Person, or otherwise assures any creditor of
such other Person against loss, including, without limitation, any comfort
letter, operating agreement, take-or-pay contract or application for a Letter of
Credit, but excluding (a) the endorsement of instruments for deposit or
collection in the ordinary course of business and (b) obligations incurred by
any Insurance Subsidiary in the ordinary course of its financial guaranty or
other business.
"Controlled Group" means all members of a controlled group of
corporations and all trades or businesses (whether or not incorporated) under
common control which, together with the Borrower or any of its Subsidiaries, are
treated as a single employer under Section 414 of the Code.
"Conversion/Continuation Notice" is defined in Section 2.2.4.
"Default" means an event described in Article VII.
<PAGE> 15
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"Environmental Laws" means federal, state or local environmental,
health and safety statutes, regulations, ordinances, codes, rules, orders,
decrees, directives and standards relating to the protection of the environment
or to emissions, releases or discharges of any toxic or hazardous waste,
substance or chemical or any pollutant, contaminant, chemical or other substance
or the clean-up or remediation thereof.
"ERISA" means the Employee Retirement Income Security Act of 1974, as
amended from time to time, and any rule or regulation issued thereunder.
"Eurodollar Advance" means a Eurodollar Bid Rate Advance or a
Eurodollar Ratable Advance, or both, as the case may be.
"Eurodollar Base Rate" means, with respect to a Eurodollar Advance for
the relevant Eurodollar Interest Period, the rate appearing on Page 3750 of the
Dow Jones Markets Service (or on any successor or substitute page of such
Service, or any successor to or substitute for such Service, providing rate
quotations comparable to those currently provided on such page of such Service,
as determined by the Administrative Agent from time to time for purposes of
providing quotations of interest rates applicable to dollar deposits in the
London interbank market) at approximately 11:00 a.m., London time, two Business
Days prior to the commencement of such Eurodollar Interest Period, as the rate
for dollar deposits with a maturity comparable to such Eurodollar Interest
Period. In the event that such rate is not available at such time for any
reason, then the "Eurodollar Base Rate" with respect to such Eurodollar Advance
for such Eurodollar Interest Period shall be the rate at which dollar deposits
of $5,000,000 and for a maturity comparable to such Eurodollar Interest Period
are offered by the principal London office of Chase in immediately available
funds in the London interbank market at approximately 11:00 a.m., London time,
two Business Days prior to the commencement of such Eurodollar Interest Period.
"Eurodollar Bid Rate" means, with respect to a Eurodollar Bid Rate Loan
made by a given Lender for the relevant Eurodollar Interest Period, the sum of
(a) the Eurodollar Base Rate and (b) the Competitive Bid Margin offered by such
Lender and accepted by the Borrower.
"Eurodollar Bid Rate Advance" means a Competitive Bid Advance which
bears interest at a Eurodollar Bid Rate.
"Eurodollar Bid Rate Loan" means a Loan which bears interest at the
Eurodollar Bid Rate.
<PAGE> 16
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"Eurodollar Interest Period" means, with respect to a Eurodollar
Ratable Advance or a Eurodollar Bid Rate Advance, a period of one, two, three or
six months commencing on a Business Day selected by the Borrower pursuant to
this Agreement. Such Eurodollar Interest Period shall end on (but exclude) the
day which corresponds numerically to such date one, two, three or six months
thereafter, provided, however, that if there is no such numerically
corresponding day in such next, second, third or sixth succeeding month, such
Eurodollar Interest Period shall end on the last Business Day of such next,
second, third or sixth succeeding month. If a Eurodollar Interest Period would
otherwise end on a day which is not a Business Day, such Eurodollar Interest
Period shall end on the next succeeding Business Day, provided, however, that if
said next succeeding Business Day falls in a new month, such Eurodollar Interest
Period shall end on the immediately preceding Business Day.
"Eurodollar Loan" means a Eurodollar Ratable Loan or Eurodollar Bid
Rate Loan, or both, as the case may be.
"Eurodollar Ratable Advance" means an Advance which bears interest at a
Eurodollar Rate requested by the Borrower pursuant to Section 2.2.3.
"Eurodollar Ratable Loan" means a Loan requested by the Borrower
pursuant to Section 2.2.3 which bears interest at a Eurodollar Rate.
"Eurodollar Rate" means, with respect to a Eurodollar Ratable Advance
for the relevant Eurodollar Interest Period, the sum of (a) the quotient of (i)
the Eurodollar Base Rate applicable to such Eurodollar Interest Period, divided
by (ii) one minus the Reserve Requirement (expressed as a decimal) applicable to
such Eurodollar Interest Period (such quotient being rounded, if necessary, to
the next higher multiple of 1/16 of 1%), plus (b) the Applicable Eurodollar
Margin.
"Federal Funds Effective Rate" means, for any day, an interest rate per
annum equal to the weighted average of the rates on overnight Federal funds
transactions with members of the Federal Reserve System arranged by Federal
funds brokers on such day, as published for such day (or, if such day is not a
Business Day, for the immediately preceding Business Day) by the Federal Reserve
Bank of New York, or, if such rate is not so published for any day which is a
Business Day, the average of the quotations at approximately 11 a.m. (New York
time) on such day on such transactions received by the Administrative Agent from
three Federal funds brokers of recognized standing selected by the
Administrative Agent in its sole discretion.
"Financial Statements" is defined in Section 5.5.
<PAGE> 17
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"Floating Rate Advance" means an Advance which bears interest at the
Alternate Base Rate.
"Floating Rate Loan" means a Ratable Loan which bears interest at the
Alternate Base Rate.
"Governmental Authority" means the federal government, any state or
other political subdivision thereof and any entity exercising executive,
legislative, judicial, regulatory or administrative functions of or pertaining
to government including, without limitation, any board of insurance, insurance
department or insurance commissioner.
"Indebtedness" of a Person means, without duplication, such Person's
(a) obligations for borrowed money, (b) obligations representing the deferred
purchase price of Property or services (excluding accounts payable arising in
the ordinary course of such Person's business payable on terms customary in the
trade), (c) obligations, whether or not assumed, secured by Liens or payable out
of the proceeds or production from Property now or hereafter owned or acquired
by such Person, (d) obligations which are evidenced by notes, acceptances, or
similar instruments, (e) Capitalized Lease Obligations, (f) net Rate Hedging
Obligations (other than Rate Hedging Obligations, if any, entered into in
respect of the Loans or any portion thereof) and (g) Contingent Obligations, (h)
obligations for which such Person is obligated pursuant to or in respect of a
Letter of Credit and (i) repurchase obligations or liabilities of such Person
with respect to accounts, notes receivable or securities sold by such Person
(but excluding the obligations of any Insurance Subsidiary in respect of the
repurchase of securities pursuant to repurchase agreements or the lending of
securities pursuant to securities lending arrangements, in each case, entered
into in the ordinary course of business).
"Information Memorandum" means the Confidential Information Memorandum
dated April 1997 with respect to the credit facilities provided herein.
"Insurance Subsidiary" means any Subsidiary of the Borrower which is
engaged in any insurance business.
"Interest Period" means a Eurodollar Interest Period or an Absolute
Rate Interest Period.
"Invitation for Competitive Bid Quotes" means an Invitation for
Competitive Bid Quotes substantially in the form of Exhibit "B" hereto,
completed and delivered by the Administrative Agent to the Lenders in accordance
with Section 2.3.3.
<PAGE> 18
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"Lenders" means the lending institutions listed on the signature pages
of this Agreement and their respective successors and assigns.
"Lending Installation" means, with respect to a Lender or the
Administrative Agent, any office, branch, subsidiary or affiliate of such Lender
or the Administrative Agent.
"Letter of Credit" of a Person means a letter of credit or similar
instrument which is issued upon the application of such Person or upon which
such Person is an account party or for which such Person is in any way liable.
"License" means any license, certificate of authority, permit or other
authorization which is required to be obtained from the Governmental Authority
in connection with the operation, ownership or transaction of insurance
business.
"Lien" means any security interest, lien (statutory or other),
mortgage, pledge, hypothecation, assignment, deposit arrangement, encumbrance or
preference, priority or other security agreement or preferential arrangement of
any kind or nature whatsoever (including, without limitation, the interest of a
vendor or lessor under any conditional sale, Capitalized Lease or other title
retention agreement). The term "Lien" shall not include the rights of purchasers
of any securities in such securities arising under repurchase agreements or
similar rights in respect of securities lending arrangements, in each case
entered into by the Borrower or any Subsidiary in the ordinary course of
business.
"Loan" means, with respect to a Lender, such Lender's portion of any
Advance and "Loans" means, with respect to the Lenders, the aggregate of all
Advances.
"Loan Documents" means this Agreement and the other documents and
agreements contemplated hereby and executed by the Borrower in favor of the
Administrative Agent or any Lender.
"Margin Stock" has the meaning assigned to that term under Regulation
U.
"Material Adverse Effect" means a material adverse effect on (a) the
business, Property, condition (financial or otherwise) or prospects of the
Borrower and its Subsidiaries taken as a whole, (b) the ability of the Borrower
to perform its obligations under the Loan Documents, or (c) the validity or
enforceability of any of the Loan Documents or the rights or remedies of the
Administrative Agent or the Lenders thereunder.
<PAGE> 19
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"Merger" means the merger of Surety Acquisition with and into Capsure
Holdings.
"Moody's" means Moody's Investors Service, Inc.
"Multiemployer Plan" means a Plan maintained pursuant to a collective
bargaining agreement or any other arrangement to which the Borrower or any
member of the Controlled Group is a party to which more than one employer is
obligated to make contributions.
"NAIC" means the National Association of Insurance Commissioners or any
successor thereto, or in lieu thereof, any other association, agency or other
organization performing advisory, coordination or other like functions among
insurance departments, insurance commissions and similar Governmental
Authorities of the various states of the United States of America toward the
promotion of uniformity in the practices of such Governmental Authorities.
"Obligations" means all unpaid principal of and accrued and unpaid
interest on the Loans, all accrued and unpaid fees and all expenses,
reimbursements, indemnities and other obligations of the Borrower to the Lenders
or to any Lender, the Administrative Agent or any indemnified party hereunder
arising under any of the Loan Documents.
"Participants" is defined in Section 12.2.1.
"Payment Date" means the last day of each March, June, September and
December.
"PBGC" means the Pension Benefit Guaranty Corporation, or any successor
thereto.
"Permitted Investments" means:
(a) direct obligations of, or obligations the principal of and interest
on which are unconditionally guaranteed by, the United States of America,
any agency thereof, the Federal National Mortgage Association, the Federal
Home Loan Mortgage Corporation, the Governmental National Mortgage
Association, the Student Loan Market Association, the Federal Home Loan Bank
or the Federal Farm Credit Bank, in each case maturing within three years
from the date of acquisition thereof;
(b) investments in commercial paper maturing within 270 days from the
date of acquisition thereof and having, at such date of acquisition, the
highest credit rating obtainable from S&P or from Moody's;
<PAGE> 20
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(c) investments in certificates of deposit, banker's acceptances and
time deposits maturing within 180 days from the date of acquisition thereof
issued or guaranteed by or placed with, and money market deposit accounts
issued or offered by, any domestic office of any commercial bank organized
under the laws of the United States of America or any State thereof which
has a combined capital and surplus and undivided profits of not less than
$500,000,000;
(d) fully collateralized repurchase agreements and securities lending
arrangements with a term of not more than 30 days for securities described
in clause (a) above and entered into with (i) a financial institution
satisfying the criteria described in clause (c) above or (ii) a "registered
broker or dealer" within the meaning of Section 7 of the Securities Exchange
Act of 1934 which has total stockholders' equity in excess of $750,000,000;
and
(e) bonds, debentures, notes and other similar securities of any Person
organized under the laws of the United States of America or any state
thereof having, at the date of acquisition, a rating of BBB- or higher from
S&P or Baa3 or higher by Moody's, in each case maturing within three years
from the date of acquisition thereof.
"Person" means any natural person, corporation, firm, joint venture,
partnership, association, enterprise, trust or other entity or organization, or
any government or political subdivision or any agency, department or
instrumentality thereof.
"Plan" means an employee pension benefit plan, as defined in Section
3(2) of ERISA, maintained, sponsored or contributed to by the Borrower or any of
its Subsidiaries or, with respect to such a plan that is subject to Title IV of
ERISA, by any member of the Controlled Group.
"Prepayment Percentage" is defined in Section 2.8.
"Prime Rate" means the rate of interest per annum publicly announced
from time to time by Chase as its prime rate in effect at its principal office
in New York City; each change in the Prime Rate shall be effective from and
including the date such change is publicly announced as being effective.
"Property" of a Person means any and all property, whether real,
personal, tangible, intangible, or mixed, of such Person, or other assets owned,
leased or operated by such Person.
"pro-rata" means, when used with respect to a Lender, and any described
aggregate or total amount, an amount equal to such Lender's pro-rata share or
portion based on its percentage
<PAGE> 21
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of the Aggregate Commitment or if the Aggregate Commitment has been terminated,
its percentage of the aggregate principal amount of outstanding Advances.
"Purchasers" is defined in Section 12.3.1.
"Quarterly Statement" means the quarterly statutory financial statement
of any Insurance Subsidiary required to be filed with the insurance commissioner
(or similar authority) of its jurisdiction of incorporation, which statement
shall be in the form required by such Insurance Subsidiary's jurisdiction of
incorporation or, if no specific form is so required, in the form of financial
statements recommended by the NAIC to be used for filing quarterly statutory
financial statements and shall contain the type of information recommended by
the NAIC to be disclosed therein, together with all exhibits or schedules filed
therewith.
"Ratable Advance" means a borrowing hereunder consisting of the
aggregate amount of the several Ratable Loans made by the Lenders to the
Borrower at the same time, of the same Type and for the same Interest Period.
"Ratable Borrowing Notice" is defined in Section 2.2.3.
"Ratable Loan" means a Loan made by a Lender pursuant to Section 2.2
hereof.
"Rate Hedging Obligations" of a Person means any and all obligations of
such Person, whether absolute or contingent and howsoever and whensoever
created, arising, evidenced or acquired (including all renewals, extensions and
modifications thereof and substitutions therefor), under (a) any and all
agreements, devices or arrangements designed to protect at least one of the
parties thereto from the fluctuations of interest rates, exchange rates or
forward rates applicable to such party's assets, liabilities or exchange
transactions, including, but not limited to, dollar-denominated or
cross-currency interest rate exchange agreements, forward currency exchange
agreements, interest rate cap or collar protection agreements, forward rate
currency or interest rate options, puts and warrants, and (b) any and all
cancellations, buybacks, reversals, terminations or assignments of any of the
foregoing.
"Register" is defined in Section 12.3.2.
"Regulation D" means Regulation D of the Board of Governors of the
Federal Reserve System as from time to time in effect and any successor thereto
or other regulation or official interpretation of said Board of Governors
relating to reserve requirements applicable to depositary institutions.
<PAGE> 22
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"Regulation G" means Regulation G of the Board of Governors of the
Federal Reserve System as from time to time in effect shall include and any
successor or other regulation or official interpretation of said Board of
Governors relating to the extension of credit by Persons other than banks,
brokers and dealers for the purpose of purchasing or carrying margin stocks
applicable to such Persons.
"Regulation U" means Regulation U of the Board of Governors of the
Federal Reserve System as from time to time in effect and any successor or other
regulation or official interpretation of said Board of Governors relating to the
extension of credit by banks for the purpose of purchasing or carrying margin
stocks applicable to such Persons.
"Regulation X" means Regulation X of the Board of Governors of the
Federal Reserve System as from time to time in effect and shall include any
successor or other regulation or official interpretation of said Board of
Governors relating to the extension of credit by the specified lenders for the
purpose of purchasing or carrying margin stocks applicable to such Persons.
"Related Parties" means, with respect to any specified Person, such
Person's Affiliates and the respective directors, officers, employees, agents
and advisors of such Person and such Person's Affiliates.
"Reorganization Agreement" means that certain Reorganization Agreement
dated as of December 19, 1996 among Capsure Holdings, Continental Casualty, the
Borrower, Surety Acquisition and certain Affiliates of Continental Casualty.
"Reorganization Documents" means the Reorganization Agreement, the
certificate of merger executed pursuant thereto and the other documents,
certificates and agreements delivered in connection with the Merger.
"Reportable Event" means a reportable event as defined in Section 4043
of ERISA and the regulations issued under such section, with respect to a Plan,
excluding, however, such events as to which the PBGC has by regulation waived
the requirement of Section 4043(a) of ERISA that it be notified within 30 days
of the occurrence of such event, provided, however, that a failure to meet the
minimum funding standard of Section 412 of the Code and of Section 302 of ERISA
shall be a Reportable Event regardless of the issuance of any such waiver of the
notice requirement in accordance with either Section 4043(a) of ERISA or Section
412(d) of the Code.
<PAGE> 23
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"Required Lenders" means Lenders in the aggregate having at least
66-2/3% of the Aggregate Commitment or, if the Aggregate Commitment has been
terminated, Lenders in the aggregate holding at least 66-2/3% of the aggregate
unpaid principal amount of the outstanding Advances.
"Reserve Requirement" means, with respect to a Eurodollar Interest
Period, the maximum aggregate reserve requirement (including all basic,
supplemental, marginal and other reserves) which is imposed under Regulation D
on Eurocurrency liabilities.
"Risk-Based Capital Guidelines" means (a) the risk-based capital
guidelines in effect in the United States on the date of this Agreement and (b)
the corresponding capital regulations promulgated by regulatory authorities
outside the United States implementing the July 1988 report of the Basle
Committee on Banking Regulation and Supervisory Practices Entitled
"International Convergence of Capital Measurements and Capital Standards" and
any amendments to such regulations adopted prior to the date of this Agreement.
"S&P" means Standard & Poor's Ratings Services, a division of The
McGraw-Hill Companies.
"SAP" means, with respect to any Insurance Subsidiary, the statutory
accounting practices prescribed or permitted by the insurance commissioner (or
other similar authority) from time to time in the jurisdiction of incorporation
of such Insurance Subsidiary for the preparation of annual statements and other
financial reports by insurance companies of the same type as such Insurance
Subsidiary; provided, however, that for purposes of all computations required to
be made with respect to compliance by the Borrower with Section 6.15, such term
shall mean SAP (as defined above) as in effect on the date hereof, applied in a
manner consistent with those used in preparing the financial statements referred
to in Section 5.5.
"Section" means a numbered section of this Agreement, unless another
document is specifically referenced.
"Significant Insurance Subsidiary" means any Significant Subsidiary
which is an Insurance Subsidiary.
"Significant Subsidiary" means Western, USA and any other Subsidiary
(i) the value of the total assets of which exceeds 5% of the value of the total
assets of the Borrower and its Subsidiaries on a consolidated basis as of the
end of the most recently completed fiscal year or (ii) the consolidated income
(before income taxes, extraordinary items and the cumulative effect of any
change in Agreement Accounting
<PAGE> 24
-18-
Principles) of which exceeds 5% of such income of the Borrower and its
Subsidiaries on a consolidated basis for the most recently completed fiscal
year.
"Single Employer Plan" means a Plan subject to Title IV of ERISA
maintained by the Borrower or any member of the Controlled Group for employees
of the Borrower or any member of the Controlled Group, other than a
Multiemployer Plan.
"Statutory Net Written Premiums" means, for any period, the net
premiums written of the Insurance Subsidiaries (on a combined basis) during such
period, determined in accordance with SAP.
"Subsidiary" of a Person means (a) any corporation more than 50% of the
outstanding securities having ordinary voting power of which shall at the time
be owned or controlled, directly or indirectly, by such Person or by one or more
of its Subsidiaries or by such Person and one or more of its Subsidiaries, or
(b) any partnership, association, joint venture or similar business organization
more than 50% of the ownership interests having ordinary voting power of which
shall at the time be so owned or controlled. Unless otherwise expressly
provided, all references herein to a "Subsidiary" shall mean a Subsidiary of the
Borrower.
"Substantial Portion" means, with respect to the Property of the
Borrower and its Subsidiaries, Property which represents more than 10% of the
consolidated assets of the Borrower and its Subsidiaries as would be shown in
the consolidated financial statements of the Borrower and its Subsidiaries as at
the beginning of the twelve-month period ending with the month in which such
determination is made.
"Surety Acquisition" means Surety Acquisition Company, a Delaware
corporation and a Wholly-Owned Subsidiary of the Borrower.
"Surplus as Regards Policyholders" means, with respect to any Insurance
Subsidiary at any time, the surplus as regards policyholders of such Insurance
Subsidiary at such time, as determined in accordance with SAP.
"Termination Date" means (a) September 30, 2002, or (b) such earlier
date on which the obligations of the Lenders to make Loans hereunder are
terminated pursuant to the terms of this Agreement.
"Termination Event" means, with respect to a Plan which is subject to
Title IV of ERISA, (a) a Reportable Event, (b) the withdrawal of the Borrower or
any other member of the Controlled
<PAGE> 25
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Group from such Plan during a plan year in which the Borrower or any other
member of the Controlled Group was a "substantial employer" as defined in
Section 4001(a)(2) of ERISA or was deemed such under Section 4068(f) of ERISA,
(c) the termination of such Plan, the filing of a notice of intent to terminate
such Plan or the treatment of an amendment of such Plan as a termination under
Section 4041 of ERISA or (d) the institution by the PBGC of proceedings to
terminate such Plan, in each case which could reasonably be expected to have a
Material Adverse Effect.
"Transferee" is defined in Section 12.4.
"Type" means, with respect to any Advance, its nature as a Floating
Rate Advance, Eurodollar Advance or Absolute Rate Advance.
"Unfunded Liabilities" means the amount (if any) by which the present
value of all vested and unvested accrued benefits under a Single Employer Plan
exceeds the fair market value of assets allocable to such benefits, all
determined as of the then most recent valuation date for such Plans using the
PBGC actuarial assumptions utilized for purposes of determining the current
liability for purposes of such valuation.
"Unmatured Default" means an event which but for the lapse of time or
the giving of notice, or both, would constitute a Default.
"USA" means Universal Surety of America, a Texas insurance company.
"Western" means Western Surety Company, a South Dakota insurance
company.
"Wholly-Owned Subsidiary" of a Person means (a) any Subsidiary all of
the outstanding voting securities of which shall at the time be owned or
controlled, directly or indirectly, by such Person or one or more Wholly-Owned
Subsidiaries of such Person, or by such Person and one or more Wholly-Owned
Subsidiaries of such Person, or (b) any partnership, association, joint venture
or similar business organization 100% of the ownership interests having ordinary
voting power of which shall at the time be so owned or controlled. Unless
otherwise expressly provided, all references herein to a "Wholly-Owned
Subsidiary" shall mean a Wholly-Owned Subsidiary of the Borrower.
The foregoing definitions shall be equally applicable to both the
singular and plural forms of the defined terms. The words "herein", "hereof" and
words of similar import as used in this Agreement shall refer to this Agreement
as a whole and not to any particular provision in this Agreement. References to
<PAGE> 26
-20-
"Articles", "Sections", "subsections", "paragraphs", "Exhibits" and "Schedules"
in this Agreement shall refer to Sections, subsections, paragraphs, Exhibits and
Schedules of this Agreement unless otherwise expressly provided. References to
Persons include their respective permitted successors and assigns or, in the
case of governmental Persons, Persons succeeding to the relevant functions of
such persons. All references to statutes and related regulations shall include
any amendments of same and any successor statutes and regulations.
ARTICLE II
THE FACILITY
2.1. The Facility.
2.1.1. Description of Facility. The Lenders hereby establish in favor
of the Borrower a revolving credit facility pursuant to which, and upon the
terms and subject to the conditions herein set out:
(a) each Lender severally agrees to make Ratable Loans to the
Borrower in accordance with Section 2.2 in amounts not to exceed in the
aggregate at any one time outstanding the amount of its Commitment less the
amount of such Lender's pro-rata share of the outstanding principal amount
of all Competitive Bid Advances (regardless of which Lender or Lenders made
such Competitive Bid Advances) exclusive of Competitive Bid Advances being
repaid substantially contemporaneously with the making of any such Ratable
Loans; and
(b) each Lender may, in its sole discretion, make bids to make
Competitive Bid Loans to the Borrower, and make such Loans, in accordance
with Section 2.3.
2.1.2. Facility Amount. In no event may the aggregate principal amount
of all outstanding Advances (including both the Ratable Advances and the
Competitive Bid Advances) at any time exceed the Aggregate Commitment.
2.1.3. Availability of Facility. Subject to the terms of this
Agreement, from and including the date hereof to, but not including the
Termination Date the Borrower may borrow, repay and reborrow Advances hereunder.
All outstanding Advances and all other unpaid Obligations shall be due and
payable in full by the Borrower on the Termination Date.
<PAGE> 27
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2.2. Ratable Advances.
2.2.1. Ratable Advances. Each Ratable Advance hereunder shall consist
of borrowings made from the several Lenders ratably in proportion to the amounts
of their respective Commitments.
2.2.2. Ratable Advance Rate Options. The Ratable Advances may be
Floating Rate Advances or Eurodollar Ratable Advances, or a combination thereof,
selected by the Borrower in accordance with Section 2.2.3 or 2.2.4. No Ratable
Advance may mature after, or have an Interest Period which extends beyond, the
Termination Date.
2.2.3. Method of Selecting Types and Interest Periods for Ratable
Advances. The Borrower shall select the Type of each Ratable Advance and, in the
case of each Eurodollar Ratable Advance, the Eurodollar Interest Period
applicable to such Ratable Advance from time to time. The Borrower shall give
the Administrative Agent irrevocable notice (a "Ratable Borrowing Notice") not
later than 11:00 a.m. (New York time) on the Borrowing Date of each Floating
Rate Advance and three Business Days before the Borrowing Date for each
Eurodollar Ratable Advance. A Ratable Borrowing Notice shall specify:
(a) the Borrowing Date, which shall be a Business Day, of such
Ratable Advance;
(b) the aggregate amount of such Ratable Advance, which, when
added to all outstanding Ratable Advances and Competitive Bid Advances and
after giving effect to the repayment of any such outstanding Advances out of
the proceeds of the requested Ratable Advance, shall not exceed the
Aggregate Commitment;
(c) the Type of Advance selected; and
(d) in the case of each Eurodollar Ratable Advance, the Eurodollar
Interest Period applicable thereto (which may not end after the Termination
Date).
2.2.4. Conversion and Continuation of Outstanding Ratable Advances.
Floating Rate Advances shall continue as Floating Rate Advances unless and until
such Floating Rate Advances are converted into Eurodollar Ratable Advances. Each
Eurodollar Ratable Advance shall continue as a Eurodollar Ratable Advance until
the end of the then applicable Eurodollar Interest Period therefor, at which
time such Eurodollar Ratable Advance shall be automatically converted into a
Floating Rate Advance unless the Borrower shall have given the Administrative
Agent a
<PAGE> 28
-22-
Conversion/Continuation Notice requesting that, at the end of such Eurodollar
Interest Period, such Eurodollar Ratable Advance continue as a Eurodollar
Ratable Advance for the same or another Eurodollar Interest Period. Subject to
the terms of Section 2.6, the Borrower may elect from time to time to convert
all or any part of a Ratable Advance of any Type into any other Type or Types of
Ratable Advances; provided that any conversion of any Eurodollar Ratable Advance
shall be made on, and only on, the last day of the Eurodollar Interest Period
applicable thereto. The Borrower shall give the Administrative Agent irrevocable
notice (a "Conversion/Continuation Notice") of each conversion of a Ratable
Advance or continuation of a Eurodollar Ratable Advance not later than 11:00
a.m. (New York time) at least three Business Days, in the case of a conversion
into or continuation of a Eurodollar Ratable Advance, prior to the date of the
requested conversion or continuation, specifying:
(a) the requested date, which shall be a Business Day, of such
conversion or continuation;
(b) the aggregate amount and Type of Ratable Advance which is to
be converted or continued; and
(c) the amount and Type(s) of Ratable Advance(s) into which such
Ratable Advance is to be converted or continued and, in the case of a
conversion into or continuation of an Eurodollar Ratable Advance, the
duration of the Eurodollar Interest Period applicable thereto.
2.3. Competitive Bid Advances.
2.3.1. Competitive Bid Option. In addition to Ratable Advances
pursuant to Section 2.2, but subject to the terms and conditions of this
Agreement (including, without limitation, the limitation set forth in
Section 2.1.2 as to the maximum aggregate principal amount of all outstanding
Advances hereunder), prior to the Termination Date the Borrower may, as set
forth in this Section 2.3, request the Lenders to make offers to make
Competitive Bid Advances to the Borrower. Each Lender may, but shall have no
obligation to, make such offers and the Borrower may, but shall have no
obligation to, accept any such offers in the manner set forth in this Section
2.3.
2.3.2. Competitive Bid Quote Request. When the Borrower wishes to
request offers to make Competitive Bid Loans under this Section 2.3, it shall
transmit to the Administrative Agent by telecopy a Competitive Bid Quote Request
substantially in the form of Exhibit "A" hereto so as to be received no later
than (a) 11:00 a.m. (New York time) at least four Business Days prior to the
Borrowing Date proposed therein, in the case of a Eurodollar Auction or (b)
10:00 a.m. (New York time) at least one
<PAGE> 29
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Business Day prior to the Borrowing Date proposed therein, in the case of an
Absolute Rate Auction specifying:
(a) the proposed Borrowing Date, which shall be a Business Day,
for the proposed Competitive Bid Advance;
(b) the aggregate principal amount of such Competitive Bid
Advance;
(c) whether the Competitive Bid Quotes requested are to set forth
a Eurodollar Bid Rate, an Absolute Rate, or both; and
(d) the Interest Period applicable thereto (which may not end
after the Termination Date).
The Borrower may request offers to make Competitive Bid Loans for more than one
Interest Period in a single Competitive Bid Quote Request. No Competitive Bid
Quote Request shall be given within 5 Business Days (or such other number of
days as the Borrower and the Administrative Agent may agree) of any other
Competitive Bid Quote Request. A Competitive Bid Quote Request that does not
conform substantially to the format of Exhibit "A" hereto shall be rejected, and
the Administrative Agent shall promptly notify the Borrower of such rejection by
telecopy.
2.3.3. Invitation for Competitive Bid Quotes. Promptly and in any
event before the close of business on the same Business Day of receipt of a
Competitive Bid Quote Request that is not rejected pursuant to Section 2.3.2,
the Administrative Agent shall send to each of the Lenders by telex or telecopy
an Invitation for Competitive Bid Quotes substantially in the form of Exhibit
"B" hereto, which shall constitute an invitation by the Borrower to each Lender
to submit Competitive Bid Quotes offering to make the Competitive Bid Loans to
which such Competitive Bid Quote Request relates in accordance with this
Section 2.3.
2.3.4. Submission and Contents of Competitive Bid Quotes.
(a) Each Lender may, in its sole discretion, submit a Competitive
Bid Quote containing an offer or offers to make Competitive Bid Loans in
response to any Invitation for Competitive Bid Quotes. Each Competitive Bid
Quote must comply with the requirements of this Section 2.3.4 and must be
submitted to the Administrative Agent by telex or telecopy at its offices
specified in or pursuant to Article XIII not later than (i) 10:00 a.m. (New
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York time) at least three Business Days prior to the proposed Borrowing
Date, in the case of a Eurodollar Auction or (ii) 10:00 a.m. (New York time)
on the proposed Borrowing Date, in the case of an Absolute Rate Auction (or,
in either case upon reasonable prior notice to the Lenders, such other time
and date as the Borrower and the Administrative Agent may agree); provided
that Competitive Bid Quotes submitted by Chase may only be submitted if the
Administrative Agent or Chase notifies the Borrower of the terms of the
offer or offers contained therein not later than 15 minutes prior to the
latest time at which the relevant Competitive Bid Quotes must be submitted
by the other Lenders. Subject to Articles IV and VIII, any Competitive Bid
Quote so made shall be irrevocable except with the written consent of the
Administrative Agent given on the instructions of the Borrower.
(b) Each Competitive Bid Quote shall be in substantially the form
of Exhibit "C" hereto and shall in any case specify:
(i) the proposed Borrowing Date, which shall be the same as
that set forth in the applicable Invitation for Competitive Bid Quotes;
(ii) the principal amount of the Competitive Bid Loan for
which each such offer is being made, which principal amount (A) may be
greater than, less than or equal to the Commitment of the quoting
Lender, (B) must be at least $10,000,000 and an integral multiple of
$1,000,000, and (C) may not exceed the principal amount of Competitive
Bid Loans for which offers were requested;
(iii) in the case of a Eurodollar Auction, the Competitive
Bid Margin offered for each such Competitive Bid Loan;
(iv) the minimum amount, if any, of the Competitive Bid Loan
which may be accepted by the Borrower;
(v) in the case of an Absolute Rate Auction, the Absolute
Rate offered for each such Competitive Bid Loan; and
(vi) the identity of the quoting Lender.
(c) The Administrative Agent shall reject any Competitive Bid
Quote that:
(i) is not substantially in the form of Exhibit "C" hereto
or does not specify all of the information required by Section
2.3.4(b);
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(ii) contains qualifying, conditional or similar language,
other than any such language contained in Exhibit "C" hereto;
(iii) proposes terms other than or in addition to those set
forth in the applicable Invitation for Competitive Bid Quotes; or
(iv) arrives after the time set forth in Section 2.3.4(a).
If any Competitive Bid Quote shall be rejected pursuant to this Section
2.3.4(c), then the Administrative Agent shall promptly notify the relevant
Lender of such rejection.
2.3.5. Notice to Borrower. The Administrative Agent shall promptly
notify the Borrower of the terms (a) of any Competitive Bid Quote submitted by a
Lender that is in accordance with Section 2.3.4 and (b) of any Competitive Bid
Quote that amends, modifies or is otherwise inconsistent with a previous
Competitive Bid Quote submitted by such Lender with respect to the same
Competitive Bid Quote Request. Any such subsequent Competitive Bid Quote shall
be disregarded by the Administrative Agent unless such subsequent Competitive
Bid Quote specifically states that it is submitted solely to correct a manifest
error in such former Competitive Bid Quote. The Administrative Agent's notice to
the Borrower shall specify the aggregate principal amount of Competitive Bid
Loans for which offers have been received for each Interest Period specified in
the related Competitive Bid Quote Request and the respective principal amounts
and Eurodollar Bid Rates or Absolute Rates, as the case may be, so offered.
2.3.6. Acceptance and Notice by Borrower. Not later than (a) 11:00
a.m. (New York time) at least three Business Days prior to the proposed
Borrowing Date, in the case of a Eurodollar Auction or (b) 11:00 a.m. (New York
time) on the proposed Borrowing Date, in the case of an Absolute Rate Auction
(or, in either case upon reasonable prior notice to the Lenders, such other
time and date as the Borrower and the Administrative Agent may agree), the
Borrower shall notify the Administrative Agent of its acceptance or rejection
of the offers so notified to it pursuant to Section 2.3.5; provided, however,
that the failure by the Borrower to give such notice to the Administrative
Agent shall be deemed to be a rejection of all such offers. In the case of
acceptance, such notice (a "Competitive Bid Borrowing Notice") shall specify
the aggregate principal amount of offers for each Interest Period that are
accepted. The Borrower may accept any Competitive Bid Quote in whole or in part
(subject to the terms of Section 2.3.4(b)(iv)); provided that:
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(a) the aggregate principal amount of each Competitive Bid
Advance may not exceed the applicable amount set forth in the related
Competitive Bid Quote Request,
(b) acceptance of offers may only be made on the basis of
ascending Eurodollar Bid Rates or Absolute Rates, as the case may be,
and
(c) the Borrower may not accept any offer that is described
in Section 2.3.4(c) or that otherwise fails to comply with the
requirements of this Agreement.
2.3.7. Allocation by Administrative Agent. If offers are made by two
or more Lenders with the same Eurodollar Bid Rates or Absolute Rates, as the
case may be, for a greater aggregate principal amount than the amount in
respect of which offers are accepted for the related Interest Period, the
principal amount of Competitive Bid Loans in respect of which such offers are
accepted shall be allocated by the Administrative Agent among such Lenders as
nearly as possible (in such multiples, not greater than $1,000,000, as the
Administrative Agent may deem appropriate) in proportion to the aggregate
principal amount of such offers; provided, however, that no Lender shall be
allocated a portion of any Competitive Bid Advance which is less than the
minimum amount which such Lender has indicated that it is willing to accept.
Allocations by the Administrative Agent of the amounts of Competitive Bid Loans
shall be conclusive in the absence of manifest error. The Administrative Agent
shall promptly, but in any event on the same Business Day, notify each Lender
of its receipt of a Competitive Bid Borrowing Notice and the aggregate
principal amount of such Competitive Bid Advance allocated to each
participating Lender.
2.4. Availability of Funds. Not later than noon (New York time) on
each Borrowing Date, each Lender (or in the case of a Competitive Bid Advance,
each Lender making a portion of such Advance) shall make available its Loan or
Loans, in funds immediately available in New York City to the Administrative
Agent at its address specified pursuant to Article XIII. The Administrative
Agent will make the funds so received from the Lenders available to the Borrower
at the Administrative Agent's aforesaid address.
2.5. Facility Fee; Reductions in Aggregate Commitment. The Borrower
agrees to pay to the Administrative Agent for the ratable account of each Lender
a facility fee equal to the Applicable Facility Fee Percentage times such
Lender's Commitment from the date hereof to and including the Termination Date
applicable to such Lender, payable in arrears on each Payment Date hereafter and
on the Termination Date. The Borrower may permanently reduce the Aggregate
Commitment in whole, or in
<PAGE> 33
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part ratably among the Lenders, in integral multiples of $10,000,000, upon at
least three Business Days' written notice to the Administrative Agent, which
notice shall specify the amount of any such reduction; provided, however, that
the amount of the Aggregate Commitment may not be reduced below the aggregate
principal amount of the outstanding Advances. All accrued facility fees shall be
payable on the effective date of any termination of the obligations of the
Lenders to make Loans hereunder.
2.6. Minimum Amount of Each Advance; Limit on Interest Periods. Each
Eurodollar Ratable Advance shall be in the minimum amount of $10,000,000 (and in
multiples of $1,000,000 if in excess thereof). Each Floating Rate Advance shall
be in the minimum amount of $5,000,000 (and in multiples of $1,000,000 if in
excess thereof); provided, however, that any Floating Rate Advance may be in the
amount of the unused Aggregate Commitment. No more than twelve Eurodollar
Interest Periods for Eurodollar Ratable Advances may be outstanding at any one
time.
2.7. Optional Principal Payments. The Borrower may from time to time
pay, without penalty or premium, all outstanding Advances (other than
Competitive Bid Advances, which may not be voluntarily prepaid), or, in a
minimum aggregate amount of $10,000,000 or any integral multiple of $5,000,000
in excess thereof, any portion of the outstanding Advances (other than
Competitive Bid Advances) upon three Business Days' prior notice to the
Administrative Agent. Any prepayment of a Eurodollar Advance prior to the last
day of the applicable Eurodollar Interest Period shall be subject to the
indemnity provisions of Section 3.4.
2.8. Mandatory Prepayments. If at any time the aggregate principal
balance of the Loans exceeds the Aggregate Commitment, the Borrower shall repay
immediately its then outstanding Loans in such amount as may be necessary to
eliminate such excess.
2.9. Interest Rate, etc. Each Floating Rate Advance shall bear
interest at the Floating Rate on the outstanding principal amount thereof for
each day from and including the date such Advance is made or is converted from a
Ratable Eurodollar Advance into a Floating Rate Advance pursuant to Section
2.2.4 to but excluding the date it becomes due or is converted into a Eurodollar
Ratable Advance pursuant to Section 2.2.4 hereof, at a rate per annum equal to
the Floating Rate for such day. Each Eurodollar Advance and Absolute Rate
Advance shall bear interest from and including the first day of the Interest
Period applicable thereto to (but not including) the last day of such Eurodollar
Interest Period at the interest rate
<PAGE> 34
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determined as applicable to such Eurodollar Advance or Absolute Rate Advance.
2.10. Rates Applicable After Default. Notwithstanding anything to the
contrary contained in Section 2.2.3 or 2.2.4, no Advance may be made as,
converted into or continued as a Eurodollar Ratable Advance (except with the
consent of the Required Lenders) when any Default or Unmatured Default has
occurred and is continuing. During the continuance of a Default, the Required
Lenders may, at their option, by notice to the Borrower (which notice may be
revoked at the option of the Required Lenders notwithstanding any provision of
Section 8.2 requiring unanimous consent of the Lenders to changes in interest
rates), declare that (a) each Eurodollar Advance and Absolute Rate Advance shall
bear interest for the remainder of the applicable Interest Period at a rate per
annum equal to the Alternate Base Rate plus 2% per annum and (b) each Floating
Rate Advance shall bear interest at a rate per annum equal to the Alternate Base
Rate plus 2% per annum.
2.11. Method of Payment. All payments of the Obligations hereunder
shall be made, without setoff, deduction, or counterclaim, in immediately
available funds to the Administrative Agent at the Administrative Agent's
address specified pursuant to Article XIII, or at any other Lending Installation
of the Administrative Agent specified in writing by the Administrative Agent to
the Borrower, by 1:00 p.m. (New York time) on the date when due. Each payment by
the Borrower on account of principal or interest on the Loans shall be applied
ratably among the Lenders by the Administrative Agent according to the
respective outstanding principal amounts of the Loans then due and owing to the
Lenders. Each payment delivered to the Administrative Agent for the account of
any Lender shall be delivered promptly by the Administrative Agent to such
Lender in the same type of funds that the Administrative Agent received at its
address specified pursuant to Article XIII or at any Lending Installation
specified in a notice received by the Administrative Agent from such Lender. The
Administrative Agent is hereby authorized to charge the account of the Borrower
maintained with Chase for each payment of principal, interest and fees as it
becomes due hereunder.
2.12. Telephonic Notices. The Borrower hereby authorizes the Lenders
and the Administrative Agent to extend, convert or continue Advances, effect
selections of Types of Advances, submit Competitive Bid Quotes and to transfer
funds based on telephonic notices made by any person or persons the
Administrative Agent or any Lender in good faith believes to be acting on
behalf of the Borrower. The Borrower agrees to deliver promptly to the
Administrative Agent a written confirmation, if such confirmation is
requested by the Administrative Agent or any
<PAGE> 35
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Lender, of each telephonic notice signed by an Authorized Officer. If the
written confirmation differs in any material respect from the action taken by
the Administrative Agent and the Lenders, the records of the Administrative
Agent and the Lenders shall govern absent manifest error.
2.13. Interest Payment Dates; Interest and Fee Basis. Interest
accrued on each Floating Rate Advance shall be payable on each Payment Date,
commencing with the first such date to occur after the date hereof, on any date
on which a Floating Rate Advance is prepaid, whether due to acceleration or
otherwise, and at maturity. Interest accrued on that portion of the outstanding
principal amount of any Floating Rate Advance converted into a Eurodollar
Ratable Advance on a day other than a Payment Date shall be payable on the date
of conversion. Interest accrued on each Eurodollar Advance or Absolute Rate
Advance shall be payable on the last day of its applicable Interest Period, on
any date on which the Eurodollar Advance or Absolute Rate Advance is prepaid,
whether by acceleration or otherwise, and at maturity. Interest accrued on each
Eurodollar Advance or Absolute Rate Advance having an Interest Period longer
than three months shall also be payable on the last day of each three-month
interval during such Interest Period. Facility fees shall be calculated for
actual days elapsed on the basis of a 360-day year. All interest shall be
calculated for actual days elapsed on the basis of a 360-day year, except that
interest computed by reference to the Alternate Base Rate at times when the
Alternate Base Rate is based on the Prime Rate shall be calculated on a 365 or
366-day year basis, as applicable. Interest shall be payable for the day an
Advance is made but not for the day of any payment on the amount paid if payment
is received prior to 1:00 p.m. (New York time) at the place of payment. If any
payment of principal of or interest on an Advance shall become due on a day
which is not a Business Day, such payment shall be made on the next succeeding
Business Day and, in the case of a principal payment, such extension of time
shall be included in computing interest in connection with such payment.
2.14. Notification of Advances, Interest Rates, Prepayments and
Commitment Reductions. Promptly after receipt thereof, the Administrative Agent
will notify each Lender of the contents of each Aggregate Commitment reduction
notice, Ratable Borrowing Notice, Conversion/Continuation Notice, Invitation for
Competitive Quotes and repayment notice received by it hereunder. The
Administrative Agent will notify each Lender of the interest rate applicable to
each Eurodollar Advance promptly upon determination of such interest rate and
will give each Lender prompt notice of each change in the Alternate Base Rate.
<PAGE> 36
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2.15. Lending Installations. Each Lender may book its Loans at any
Lending Installation selected by such Lender and may change its Lending
Installation from time to time. All terms of this Agreement shall apply to any
such Lending Installation and any promissory notes issued to a Lender hereunder
shall be deemed held by such Lender for the benefit of such Lending
Installation. Each Lender may, by written or telecopy notice to the
Administrative Agent and the Borrower, designate a Lending Installation through
which Loans will be made by it and for whose account Loan payments are to be
made.
2.16. Non-Receipt of Funds by the Administrative Agent. Unless the
Borrower or a Lender, as the case may be, notifies the Administrative Agent
prior to the date on which it is scheduled to make payment to the Administrative
Agent of (a) in the case of a Lender, the proceeds of a Loan or (b) in the case
of the Borrower, a payment of principal, interest or fees to the Administrative
Agent for the account of the Lenders, that it does not intend to make such
payment, the Administrative Agent may assume that such payment has been made.
The Administrative Agent may, but shall not be obligated to, make the amount of
such payment available to the intended recipient in reliance upon such
assumption. If such Lender or the Borrower, as the case may be, has not in fact
made such payment to the Administrative Agent, the recipient of such payment
shall, on demand by the Administrative Agent, repay to the Administrative Agent
the amount so made available together with interest thereon in respect of each
day during the period commencing on the date such amount was so made available
by the Administrative Agent until the date the Administrative Agent recovers
such amount at a rate per annum equal to (a) in the case of payment by a Lender,
the Federal Funds Effective Rate for such day or (b) in the case of payment by
the Borrower, the interest rate applicable to the relevant Loan.
2.17. Taxes. (a) Any payments made by the Borrower under this
Agreement shall be made free and clear of, and without deduction or withholding
for or on account of, any present or future income, stamp or other taxes,
levies, imposts, duties, charges, fees, deductions or withholdings, now or
hereafter imposed, levied, collected, withheld or assessed by any Governmental
Authority, excluding taxes upon the overall net income of any Lender or
applicable Lending Installation imposed by the jurisdiction in which such Lender
or Lending Installation is incorporated or has its principal place of business.
If any such non-excluded taxes, levies, imposts, duties, charges, fees
deductions or withholdings ("Non-Excluded Taxes") are required to be withheld
from any amounts payable to the Administrative Agent or any Lender hereunder,
the amounts so payable to the Administrative Agent or such Lender shall be
increased to the extent necessary to yield to the Administrative Agent or such
<PAGE> 37
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Lender (after payment of all Non-Excluded Taxes) interest or any such other
amounts payable hereunder at the rates or in the amounts specified in or
pursuant to this Agreement; provided, however, that the Borrower shall not be
required to increase any such amounts payable to any Lender that is not
organized under the laws of the U.S. or a state thereof if such Lender fails to
comply with the requirements of paragraph (b) of this subsection 2.17. Whenever
any Non-Excluded Taxes are payable by the Borrower, as promptly as practicable
thereafter the Borrower shall send to the Administrative Agent for its own
account or for the account of such Lender, as the case may be, a certified copy
of an original official receipt received by the Borrower showing payment
thereof. If the Borrower fails to pay any Non-Excluded Taxes when due to the
appropriate taxing authority or fails to remit to the Administrative Agent the
required receipts or other required documentary evidence, the Borrower shall
indemnify the Administrative Agent and the Lenders for any incremental taxes,
interest or penalties that may become payable by any Administrative Agent or
any Lender as a result of any such failure. The agreements in this subsection
2.17 shall survive the termination of this Agreement and the payment of all
other amounts payable hereunder.
(b) At least five Business Days prior to the first date on which
interest or fees are payable hereunder for the account of any Lender, each
Lender that is not organized under the laws of the United States of America or a
state thereof agrees that it will deliver to each of the Borrower and the
Administrative Agent two duly completed copies of United States Internal Revenue
Service Form 1001 or 4224, certifying in either case that such Lender is
entitled to receive payments under this Agreement without deduction or
withholding of any United States federal income taxes. Each Lender which so
delivers a Form 1001 or 4224 further undertakes to deliver to each of the
Borrower and the Administrative Agent two additional copies of such form (or a
successor form) on or before the date that such form expires (currently, three
successive calendar years for Form 1001 and one calendar year for Form 4224) or
becomes obsolete or after the occurrence of any event requiring a change in the
most recent forms so delivered by it, and such amendments thereto or extensions
or renewals thereof as may be reasonably requested by the Borrower or the
Administrative Agent, in each case certifying that such Lender is entitled to
receive payments under this Agreement without deduction or withholding of any
United States federal income taxes, unless any change in treaty, law or
regulation (and not a change in the Lender's business, operations or place of
business or incorporation) has occurred prior to the date on which any such
delivery would otherwise be required which renders all such forms inapplicable
or which would prevent such Lender from duly completing and delivering any such
form with respect to it and such Lender advises the Borrower and the
<PAGE> 38
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Administrative Agent that it is not capable of receiving payments without any
deduction or withholding of United States federal income tax.
(c) Any stamp, documentary or similar taxes or charges payable or ruled
payable by any Governmental Authority in respect of the Loan Documents shall be
paid by the Borrower, together with interest and penalties, if any.
2.18. Evidence of Debt. (a) Each Lender shall maintain in accordance
with its usual practice an account or accounts evidencing the indebtedness of
the Borrower to such Lender resulting from each Advance made by such Lender,
including the amounts of principal and interest payable and paid to such Lender
from time to time hereunder.
(b) The Administrative Agent shall maintain accounts in which it shall
record (i) the amount of each Advance made hereunder, the Type thereof and the
Interest Period applicable thereto, (ii) the amount of any principal or interest
due and payable or to become due and payable from the Borrower to each Lender
hereunder and (iii) the amount of any sum received by the Administrative Agent
hereunder for the account of the Lenders and each Lender's share thereof.
(c) The entries made in the accounts maintained pursuant to paragraph
(a) or (b) of this Section shall be prima facie evidence of the existence and
amounts of the obligations recorded therein; provided that the failure of any
Lender or the Administrative Agent to maintain such accounts or any error
therein shall not in any manner affect the obligation of the Borrower to repay
the Advances in accordance with the terms of this Agreement.
(d) Any Lender may request that Advances made by it be evidenced by a
promissory note. In such event, the Borrower shall prepare, execute and deliver
to such Lender a promissory note payable to the order of such Lender (or, if
requested by such Lender, to such Lender and its registered assigns) and in a
form approved by the Administrative Agent. Thereafter, the Advances evidenced by
such promissory note and interest thereon shall at all times (including after
assignment pursuant to Section 12.3) be represented by one or more promissory
notes (payable to the order of each Lender holding a portion of such Advances
or, if such promissory note is a registered note, to such Lender and its
registered assigns).
<PAGE> 39
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ARTICLE III
CHANGE IN CIRCUMSTANCES
3.1. Yield Protection. If, after the date hereof, the adoption of or
any change in any law or any governmental or quasi-governmental rule,
regulation, policy, guideline or directive (whether or not having the force of
law), or any change in the interpretation or administration thereof, or the
compliance of any Lender therewith,
(a) subjects any Lender or any applicable Lending Installation to
any tax, duty, charge or withholding on or from payments due from the
Borrower (excluding taxation of the overall net income of any Lender or
applicable Lending Installation imposed by the jurisdiction in which such
Lender or Lending Installation is incorporated or has its principal place of
business), or changes the basis of taxation of principal, interest or any
other payments to any Lender or Lending Installation in respect of its
Eurodollar Loans or other amounts due it hereunder with respect to its
Eurodollar Loans, or
(b) with respect to Eurodollar Loans, imposes or increases or
deems applicable any reserve, assessment, insurance charge, special deposit
or similar requirement against assets of, deposits with or for the account
of, or credit extended by, any Lender or any applicable Lending Installation
(other than reserves and assessments taken into account in determining the
interest rate applicable to Eurodollar Advances), or
(c) imposes any other condition the result of which is to increase
the cost to any Lender or any applicable Lending Installation of making,
funding or maintaining Eurodollar Loans or reduces any amount receivable by
any Lender or any applicable Lending Installation in connection with
Eurodollar Loans, or requires any Lender or any applicable Lending
Installation to make any payment calculated by reference to the amount of
Eurodollar Loans held or interest received by it in respect thereof,
and, in the case of any of Section 3.1(a), (b) or (c), the Lender shall in good
faith determine the amount of such increased expense incurred or reduction in
amount received to be material, then, within 15 days of demand by such Lender,
the Borrower shall pay such Lender that portion of such increased expense
incurred or reduction in an amount received (other than any such expense or
reduction for which the Lenders are also entitled to compensation pursuant to
Section 2.17(a)) which such Lender
<PAGE> 40
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determines is attributable to making, funding and maintaining its Loans and its
Commitment.
3.2. Changes in Capital Adequacy Regulations. If a Lender determines
in good faith that the amount of capital required or expected to be maintained
by such Lender, any Lending Installation of such Lender or any corporation
controlling such Lender is increased by an amount deemed material by such Lender
as a result of a Change, then, within 15 days of demand by such Lender, the
Borrower shall pay such Lender the amount necessary to compensate for any
shortfall in the rate of return on the portion of such increased capital which
such Lender determines is attributable to this Agreement, its Loans or its
obligation to make Loans hereunder (after taking into account such Lender's
policies as to capital adequacy).
3.3. Availability of Types of Advances. If any Lender determines in
good faith that maintenance of any of its Eurodollar Loans at a suitable Lending
Installation would violate any applicable law, rule, regulation or directive,
whether or not having the force of law, the Administrative Agent shall suspend
the availability of the affected Type of Advance and require any Eurodollar
Advances to be repaid or converted into a Floating Rate Advance within five days
after Borrower's receipt of notice by such Lender; or if the Required Lenders
determine that (a) deposits of a type or maturity appropriate to match fund
Eurodollar Advances are not available, or (b) the interest rate applicable to a
Type of Advance does not accurately or fairly reflect the cost of making or
maintaining such Advance, then the Administrative Agent shall suspend the
availability of the affected Type of Advance and require any Eurodollar Advances
of the affected Type to be repaid.
3.4. Funding Indemnification. If any payment of a Eurodollar Advance
occurs on a date which is not the last day of the applicable Eurodollar Interest
Period, whether because of acceleration, prepayment or otherwise, or a
Eurodollar Advance is not made, continued or converted on the date specified by
the Borrower for any reason other than default by the Lenders, the Borrower will
indemnify each Lender for any loss or cost incurred by it resulting therefrom,
including, without limitation, any loss or cost in liquidating or employing
deposits acquired to fund or maintain the Eurodollar Advance.
3.5. Lender Statements; Survival of Indemnity. To the extent
reasonably possible, each Lender shall designate an alternate Lending
Installation with respect to its Eurodollar Loans to reduce any liability of the
Borrower to such Lender under Sections 3.1 and 3.2 or to avoid the
unavailability of a Type of Advance under Section 3.3, so long as such
designation is not disadvantageous to such Lender. Each Lender shall deliver a
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written statement of such Lender to the Borrower (with a copy to the
Administrative Agent) as to the amount due, if any, under Section 3.1, 3.2 or
3.4. Such written statement shall set forth in reasonable detail the
calculations upon which such Lender determined such amount and shall be final,
conclusive and binding on the Borrower in the absence of manifest error.
Determination of amounts payable under such Sections in connection with a
Eurodollar Loan shall be calculated as though each Lender funded its Eurodollar
Loan through the purchase of a deposit of the type and maturity corresponding to
the deposit used as a reference in determining the Eurodollar Rate applicable to
such Loan, whether in fact that is the case or not. Unless otherwise provided
herein, the amount specified in the written statement of any Lender shall be
payable on demand after receipt by the Borrower of the written statement. The
obligations of the Borrower under Sections 3.1, 3.2 and 3.4 shall survive
payment of the Obligations and termination of this Agreement.
3.6. Right to Substitute Lender. Any Lender claiming any additional
amounts payable pursuant to Section 3.1 or 3.2 or unable to make a Type of
Advance available in accordance with Section 3.3, shall, so long as no Default
or Unmatured Default has occurred and is continuing, upon the written request of
the Borrower delivered to such Lender and the Administrative Agent, assign,
pursuant to and in accordance with the provisions of Section 12.3, all of its
rights and obligations under this Agreement and under the Loan Documents to
another Lender or to a commercial bank, other financial institution, commercial
finance company or other institutional lender selected by the Borrower and
reasonably acceptable to the Administrative Agent that has agreed not to claim
any additional amounts under Section 3.1 or 3.2 with respect to some or all of
the taxes or regulatory changes that gave rise to such assigning Lender's claim
for such compensation, or that has agreed to make the Type of Advance available
that was not made available from such assigning Lender, in consideration for (a)
the payment by such assignee to such assigning Lender of the principal of, and
interest accrued and unpaid to the date of such assignment on, the Loans held by
such assigning Lender, (b) the payment by the Borrower to such assigning Lender
of any and all other amounts owing to such assigning Lender under any provision
of this Agreement accrued and unpaid to the date of such assignment and (c) the
Borrower's release of such assigning Lender from any further obligation or
liability under this Agreement and the Loan Documents. Notwithstanding anything
to the contrary contained in this Section 3.6, in no event shall the replacement
of any Lender result in a decrease or reallocation of the Aggregate Commitments
without the prior written consent of each of the remaining Lenders.
<PAGE> 42
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ARTICLE IV
CONDITIONS PRECEDENT
4.1. Initial Advance. The Lenders shall not be required to
make the initial Advance hereunder unless the Borrower has furnished to the
Administrative Agent with sufficient copies for the Lenders the following and
the other conditions set forth below have been satisfied, in each case on or
before October 15, 1997:
(a) Executed originals of this Agreement and each of the
other Loan Documents, which shall be in full force and effect,
together with all schedules, exhibits, documents and financial
statements required to be delivered pursuant hereto.
(b) Copies of the articles of incorporation of the Borrower,
together with all amendments thereto, and a certificate of good
standing, both certified by the appropriate governmental officer in
its jurisdiction of incorporation.
(c) Copies, certified by the Secretary or an Assistant
Secretary of the Borrower, of its by-laws and Board of Directors'
resolutions authorizing the execution, delivery and performance of
the Loan Documents by the Borrower.
(d) An incumbency certificate, executed by the Secretary or
an Assistant Secretary of the Borrower, which shall
identify by name and title and bear the signature of the officers of
the Borrower authorized to sign the Loan Documents and to make
borrowings hereunder, upon which certificate the Administrative Agent
and the Lenders shall be entitled to rely until informed of any change
in writing by the Borrower.
(e) A certificate dated the initial Borrowing Date and
signed by an Authorized Officer of the Borrower, in form and substance
satisfactory to the Administrative Agent, to the effect that: (i) on
the initial Borrowing Date (both before and after giving effect
to the consummation of the Merger and the making of the Loans
hereunder), each of the representations and warranties set forth in
Article V of this Agreement is true and correct and no Default or
Unmatured Default has occurred and is continuing; (ii) no injunction or
temporary restraining order which would prohibit the making of the
Loans, the consummation of the
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Merger, or the consummation of any of the transactions contemplated
hereby or by the Reorganization Documents (collectively the "Closing
Transactions"), or other litigation which could reasonably be expected
to have a Material Adverse Effect is pending or, to the best of such
Person's knowledge, threatened; (iii) contemporaneously with the
initial Advance, all outstanding indebtedness for money borrowed of
Capsure Holdings and its Subsidiaries under the Capsure Credit
Agreement is being repaid in full; and (iv) there has occurred no
material adverse change in Capsure Holdings' consolidated financial
condition and operations as reflected in Capsure Holdings' consolidated
financial statements as of December 31, 1996. Such certificate shall
also set forth the Consolidated Capitalization Ratio as of the initial
Borrowing Date (after giving effect to the consummation of the Merger
and the making of the Loans hereunder); provided that, in calculating
the Consolidated Capitalization Ratio for purposes of this Section
4.1(e), the Consolidated Net Worth of the Borrower and its Subsidiaries
may be based on the pro forma balance sheet referred to in Section 5.5,
so long as such Authorized Officer certifies that no event or change
has occurred that could reasonably be expected to have a material
effect on the stockholders' equity set forth on such balance sheet.
(f) A certificate dated the initial Borrowing Date
and signed by a senior officer of CNA Financial, in form and substance
satisfactory to the Administrative Agent, to the effect that there has
occurred no material adverse change in the consolidated financial
condition and operations of the CCC Surety Operations as reflected in
the consolidated financial statements of the CCC Surety Operations as
of December 31, 1996.
(g) A written opinion of the Borrower's counsel,
addressed to the Lenders, in substantially the form of Exhibit "D"
hereto.
(h) A copy of the Reorganization Documents and any
amendments, supplements and modifications thereto certified as true and
complete by an Authorized Officer of the Borrower together with
evidence satisfactory to the Administrative Agent that the Merger is
being consummated substantially contemporaneously with the making of
the initial Advance.
(i) Either evidence of termination of the Capsure
Credit Agreement and repayment of all Indebtedness outstanding
thereunder or a bank payoff letter in form and substance acceptable to
the Administrative Agent from the
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agent for the lenders under the Capsure Credit Agreement together with
releases of any Liens securing such agreement.
(j) A copy of each reinsurance agreement to which any
of the Borrower's Insurance Subsidiaries is a party, certified as true
and complete by an Authorized Officer of the Borrower.
(k) The Administrative Agent shall have received all
fees and other amounts due and payable on or prior to the Closing Date,
including, to the extent invoiced, reimbursement or payment of all
out-of-pocket expenses required to be reimbursed or paid by the
Borrower hereunder.
(l) Such other documents as any Lender or the
Administrative Agent may have reasonably requested.
4.2. Each Advance. The Lenders shall not be required to make
any Advance unless on the applicable Borrowing Date:
(a) There exists no Default or Unmatured Default and
none would result from such Advance; and
(b) The representations and warranties contained in
Article V are true and correct as of such Borrowing Date.
Each Ratable Borrowing Notice and Competitive Bid Quote Request with
respect to each such Advance shall constitute a representation and warranty by
the Borrower that the conditions contained in Sections 4.2(a) and (b) have been
satisfied. Any Lender may require a duly completed compliance certificate in
substantially the form of Exhibit "E" hereto as a condition to making an
Advance.
ARTICLE V
REPRESENTATIONS AND WARRANTIES
The Borrower represents and warrants to the Lenders that:
5.1. Corporate Existence and Standing. Each of the Borrower
and each Significant Subsidiary is a corporation duly incorporated, validly
existing and in good standing (if applicable) under the laws of its respective
jurisdiction of incorporation and is duly qualified and in good standing (if
applicable) as a foreign corporation and is duly authorized to conduct its
business in each jurisdiction in which its business is conducted and in which
the failure to be so qualified or
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authorized may reasonably be expected to have a Material Adverse Effect.
5.2. Authorization and Validity. The Borrower has all
requisite power and authority (corporate and otherwise) and legal right to
execute and deliver each of the Loan Documents and the Reorganization Documents
and to perform its obligations thereunder. The execution and delivery by the
Borrower of the Loan Documents and the Reorganization Documents and the
performance of its obligations thereunder have been duly authorized by proper
corporate proceedings and the Loan Documents and the Reorganization Documents
constitute legal, valid and binding obligations of the Borrower enforceable
against the Borrower in accordance with their terms, except as enforceability
may be limited by bankruptcy, insolvency or similar laws affecting the
enforcement of creditors' rights generally.
5.3. Compliance with Laws and Contracts. The Borrower and its
Subsidiaries have complied with all applicable statutes, rules, regulations,
orders, judgments, decrees and restrictions, including without limitation all
Environmental Laws, of any Governmental Authority having jurisdiction over the
conduct of their respective businesses or the ownership of their respective
Properties, except where the failure to so comply could not reasonably be
expected to have a Material Adverse Effect. Neither the execution and delivery
by the Borrower of the Loan Documents or the Reorganization Documents, the
application of the proceeds of the Loans, the consummation of the Closing
Transactions or any other transaction contemplated in the Loan Documents or the
Reorganization Documents, nor compliance with the provisions of the Loan
Documents or the Reorganization Documents will, or at the relevant time did, (a)
violate any law, rule, regulation (including Regulations G, U or X), order,
writ, judgment, injunction, decree or award binding on the Borrower or any
Subsidiary or the Borrower's or any Subsidiary's charter, articles or
certificate of incorporation or by-laws, (b) violate the provisions of or
require the approval or consent of any party to any indenture, instrument or
agreement to which the Borrower or any Subsidiary is a party or is subject, or
by which it or its Property is bound, or conflict with or constitute a default
thereunder, or result in the creation or imposition of any Lien (other than
Liens permitted by, the Loan Documents) in, of or on the Property of the
Borrower or any Subsidiary pursuant to the terms of any such indenture,
instrument or agreement, or (c) require any consent of the stockholders of any
Person, except for approvals or consents which have been obtained at or before
the time of the initial Advance and are disclosed on Schedule 5.3 and except for
any violation of, or failure to obtain an approval or consent required under,
any such indenture, instrument or agreement which could not reasonably be
expected to have a Material Adverse Effect.
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5.4. Governmental Consents. Except for any of the following
which have been (or will have been prior to the "Effective Time" as defined in
the Reorganization Agreement) entered, taken, obtained, filed or made and which
remain in full force and effect or which if not entered, taken, obtained or
filed could not reasonably be expected to have a Material Adverse Effect, no
order, consent, approval, qualification, license, authorization, or validation
of, or filing, recording or registration with, or exemption by, or other action
in respect of, any court, Governmental Authority, any securities exchange or
other Person is or at the relevant time was required to authorize, or is or at
the relevant time was required in connection with the execution, delivery,
consummation or performance of, or the legality, validity, binding effect or
enforceability of, any of the Loan Documents or the Reorganization Documents,
the application of the proceeds of the Loans or the consummation of the Merger
or any other transaction contemplated in the Loan Documents or the
Reorganization Documents. The applicable waiting period under the
Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, with respect
to the Merger has expired or terminated.
5.5. Financial Statements. The Borrower has heretofore
furnished to each of the Lenders (a) the December 31, 1996 and December 31, 1995
audited statements of certain assets and liabilities and the December 31, 1996,
December 31, 1995 and December 31, 1994 audited statements of certain revenues
and direct operating expenses of the CCC Surety Operations, (b) the December 31,
1996, December 31, 1995 and December 31, 1994 audited consolidated financial
statements of Capsure Holdings and its Subsidiaries, (c) the June 30, 1997
unaudited quarterly statement of certain assets and liabilities and the related
statement of certain revenues and direct operating expenses of the CCC Surety
Operations and (d) the June 30, 1997 unaudited quarterly financial statement of
Capsure Holdings and its Subsidiaries (collectively, the "Financial
Statements"). As of the date of this Agreement after giving effect to the
Closing Transactions, to the best of the Borrower's knowledge the unaudited pro
forma consolidated balance sheet of the Borrower and its Subsidiaries and the
related pro forma statement of consolidated operations included in the proxy
statement relating to the Merger filed with the Securities and Exchange
Commission pursuant to Section 14(a) of the Securities Exchange Act of 1934 and
heretofore furnished to each of the Lenders fairly represents the Borrower's and
the Subsidiaries' pro forma financial condition and results of operations on a
consolidated basis in accordance with Agreement Accounting Principles and/or SAP
(as labeled), consistently applied, in each case as if the Merger had been
consummated on the date set forth in the notes to such pro forma financial
statements. Each of the Financial Statements was prepared in accordance with
Agreement Accounting Principles or
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SAP, as applicable, and fairly presents the consolidated (statutory, if
applicable) financial condition and operations of the respective entities at
such dates and the consolidated results of their operations for the respective
periods then ended (except, in the case of such unaudited statements, for normal
year-end audit adjustments).
5.6. Material Adverse Change. No material adverse change in
the business, condition (financial or otherwise), operations, performance or
Properties of the Borrower and its Subsidiaries taken as a whole has occurred
since December 31, 1996.
5.7. Taxes. The Borrower and its Subsidiaries have filed or
caused to be filed or properly filed for extensions on a timely basis and in
correct form all United States federal and applicable material foreign, state
and local tax returns and all other material tax returns which are required to
be filed and have paid all material taxes due pursuant to said returns or
pursuant to any assessment received by the Borrower or any Subsidiary, except
such taxes, if any, as are being contested in good faith and as to which
adequate reserves have been provided in accordance with Agreement Accounting
Principles, except as set forth in Schedule 5.7, and as to which no Lien exists.
There are no pending audits or, to the best of the Borrower's knowledge,
investigations regarding the Borrower's or its Subsidiaries' federal, foreign,
state or local tax returns which may reasonably be expected to have Material
Adverse Effect. No claims are being asserted with respect to any such taxes
which could reasonably be expected to have a Material Adverse Effect. The
charges, accruals and reserves on the books of the Borrower and its Subsidiaries
in respect of any taxes or other governmental charges are in accordance with
Agreement Accounting Principles.
5.8. Litigation and Contingent Obligations. Except as
disclosed on Schedule 5.8, there is no litigation, arbitration, proceeding,
inquiry or governmental investigation (including, without limitation, by any
insurance regulatory authority) pending or, to the knowledge of any of their
officers, threatened against or affecting the Borrower or any Subsidiary or any
of their respective properties which could reasonably be expected to have a
Material Adverse Effect or which seeks to prevent, enjoin or unduly delay the
making of the Loans or Advances under this Agreement.
5.9. Capitalization. Schedule 5.9 hereto contains (a) an
accurate description of the Borrower's capitalization and (b) an accurate list
of all of the Subsidiaries as of the date of this Agreement but giving effect to
the Closing Transactions, setting forth their respective jurisdictions of
incorporation and
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the percentage of their capital stock owned by the Borrower or other
Subsidiaries.
5.10. ERISA. Neither the Borrower nor any other member of the
Controlled Group maintains, or is obligated to contribute to, any Multiemployer
Plan or has incurred, or is reasonably expected to incur, any withdrawal
liability to any Multiemployer Plan. Each Plan complies in all material respects
with all applicable requirements of law and regulations, except where
noncompliance would not have a Material Adverse Effect. Neither the Borrower nor
any member of the Controlled Group has, with respect to any Plan, failed to make
any material contribution or pay any material amount required under Section 412
of the Code or Section 302 of ERISA or the terms of such Plan. The Borrower has
not engaged in any prohibited transaction (as defined in Section 4975 of the
Code or Section 406 of ERISA) in connection with any Plan which may reasonably
be expected to have a Material Adverse Effect. Within the last five years
neither the Borrower nor any member of the Controlled Group has engaged in a
transaction which resulted in a Single Employer Plan with an Unfunded Liability
being transferred out of the Controlled Group. No Termination Event has occurred
or is reasonably expected to occur with respect to any Plan which is subject to
Title IV of ERISA.
5.11. Default. No Default or Unmatured Default has occurred
and is continuing.
5.12. Federal Reserve Regulations. Neither the Borrower nor
any Subsidiary is engaged, directly or indirectly, principally, or as one of its
important activities, in the business of extending, or arranging for the
extension of, credit for the purpose of purchasing or carrying Margin Stock.
Neither the making of any Loan hereunder, the use of the proceeds thereof, nor
any other aspect of the financing of the Acquisition, will violate or be
inconsistent with the provisions of Regulation G, Regulation U or Regulation X.
5.13. Investment Company. Neither the Borrower nor any
Subsidiary is, or after giving effect to any Advance will be, an "investment
company" or a company "controlled" by an "investment company" within the meaning
of the Investment Company Act of 1940, as amended, or a "holding company", a
"subsidiary company" of a "holding company" or an "affiliate" of a "holding
company" or of a "subsidiary company" of a "holding company" within the meaning
of the Public Utility Holding Company Act of 1935, as amended.
5.14. Reorganization Documents.
The Borrower has delivered to each of the Lenders true, complete and correct
copies of the Reorganization Documents (including all schedules,
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exhibits, annexes, amendments, supplements, modifications, and all other
material documents delivered pursuant thereto or in connection therewith). The
Reorganization Documents as originally executed and delivered by the parties
thereto are in full force and effect and have not been amended, waived,
supplemented or modified without the consent of the Required Lenders. Each of
the representations and warranties of the Borrower (and, to the Borrower's
knowledge, of Capsure Holdings) therein is true and correct in all material
aspects as of the date hereof. Neither the Borrower nor, to the Borrower's
knowledge, any other party thereto is in material default in the performance of
or compliance with any provisions thereof. The Merger has become effective in
accordance with the terms of the Reorganization Documents and in accordance with
applicable laws and regulations.
5.15. Disclosure. None of the (a) information, exhibits or
reports (including, without limitation, the Information Memorandum) furnished or
to be furnished by the Borrower or any Subsidiary to the Administrative Agent or
to any Lender in connection with the negotiation of the Loan Documents, or (b)
representations or warranties of the Borrower contained in this Agreement, the
other Loan Documents, the Reorganization Documents or any other document,
certificate or written statement furnished to the Administrative Agent or the
Lenders by or on behalf of the Borrower or any Subsidiary for use in connection
with the transactions contemplated by this Agreement or the Reorganization
Documents, as the case may be, contained, contains or will contain any untrue
statement of a material fact or omitted, omits or will omit to state a material
fact necessary in order to make the statements contained herein or therein not
misleading in light of the circumstances in which the same were made. The pro
forma financial information contained in such materials is based upon good faith
estimates and assumptions believed by the Borrower to be reasonable at the time
made. There is no fact known to the Borrower (other than matters of a general
economic nature) that has had or could reasonably be expected to have a Material
Adverse Effect and that has not been disclosed herein or in such other
documents, certificates and statements furnished to the Lenders for use in
connection with the transactions contemplated by this Agreement.
5.16. Properties. (a) Each of the Borrower and its
Subsidiaries has good title to, or valid leasehold interests in, all its real
and personal property material to its business, except for minor defects in
title that do not interfere with its ability to conduct its business as
currently conducted or to utilize such properties for their intended purposes.
(b) Each of the Borrower and its Subsidiaries owns, or is
licensed to use, all trademarks, tradenames, copyrights,
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patents and other intellectual property material to its business, and the use
thereof by the Borrower and its Subsidiaries does not infringe upon the rights
of any other Person, except for any such infringements that, individually or in
the aggregate, could not reasonably be expected to result in a Material Adverse
Effect.
5.17. Liens. Schedule 5.17 attached hereto is a complete and
correct list, as of the date of this Agreement, of each Lien securing
Indebtedness of any Person and covering any Property of the Borrower or any of
its Subsidiaries, and the aggregate Indebtedness secured (or that may be
secured) by each such Lien and the Property covered by each such Lien is
correctly described in said Schedule 5.17.
5.18. Restrictive Agreements. Except as set forth on Schedule
5.18 hereto, neither the Borrower nor any of its Subsidiaries is party to any
agreement that prohibits, restricts or imposes any condition upon (a) the
ability of the Borrower or any Subsidiary to create, incur or permit to exist
any Lien upon any of its property or assets, or (b) the ability of any
Subsidiary to pay dividends or other distributions with respect to any shares of
its capital stock or to make or repay loans or advances to the Borrower or any
other Subsidiary or to undertake or assume Contingent Obligations of the
Borrower or any other Subsidiary.
ARTICLE VI
COVENANTS
During the term of this Agreement, unless the Required Lenders
shall otherwise consent in writing:
6.1. Financial Reporting. The Borrower will furnish to the
Lenders:
(a) As soon as practicable and in any event within
120 days after the close of each of its fiscal years, an audit report
which is not qualified as to going concern or access or in any other
material respect and which is certified by independent certified public
accountants, acceptable to the Lenders, prepared in accordance with
Agreement Accounting Principles on a consolidated basis for itself and
its Subsidiaries, including balance sheets as of the end of such period
and related income and cash flow statements accompanied by a
certificate of said accountants that, in the course of the examination
necessary for their certification of the foregoing, they have obtained
no knowledge of any Default or Unmatured Default, or if, in the
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opinion of such accountants, any Default or Unmatured Default shall
exist, stating the nature and status thereof.
(b) As soon as practicable and in any event within 75
days after the close of each quarterly period (other than the fourth
quarterly period) of each of its fiscal years, for itself and its
Subsidiaries, a consolidated unaudited balance sheet as at the close of
each such period and consolidated income and cash flow statements for
the period from the beginning of such fiscal year to the end of such
quarter, all certified by its chief financial officer.
(c) Together with the financial statements required
by clauses (a) and (b), a compliance certificate in substantially the
form of Exhibit "E" hereto signed by the chief financial officer of the
Borrower showing the calculations necessary to determine compliance
with the financial covenants contained in this Agreement and stating
that no Default or Unmatured Default exists, or if any Default or
Unmatured Default exists, stating the nature and status thereof.
(d) Upon the earlier of (i) ten days after the
regulatory filing date or (ii) 75 days after the close of each of the
first three fiscal quarters of each fiscal year of each Significant
Insurance Subsidiary, copies of the Quarterly Statement of such
Insurance Subsidiary, certified by such officers as shall be required
by SAP of such Significant Insurance Subsidiary, all such statements to
be prepared in accordance with SAP consistently applied through the
period reflected herein.
(e) Upon the earlier of (i) fifteen days after the
regulatory filing date or (ii) 90 days after the close of each fiscal
year of each Significant Insurance Subsidiary, copies of the Annual
Statement of such Significant Insurance Subsidiary and the related
management discussion and analysis for such fiscal year, as certified
by such officers as shall be required by SAP for such Significant
Insurance Subsidiary and prepared on the NAIC annual statement blanks
(or such other form as shall be required by the jurisdiction of
incorporation of each such Significant Insurance Subsidiary), all such
statements to be prepared in accordance with SAP consistently applied
throughout the periods reflected therein.
(f) As soon as available and only to the extent such
an audited statement is required to be prepared by any Governmental
Authority, a copy of the audited Annual Statement of each Significant
Insurance Subsidiary for the
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preceding year, as certified by such officers as shall be required by
SAP for such Significant Insurance Subsidiary and prepared on the NAIC
annual statement blanks (or such other form as shall be required by the
jurisdiction of incorporation of each such Significant Insurance
Subsidiary), all such statements to be prepared in accordance with SAP
consistently applied throughout the periods reflected therein and to be
certified by independent certified public accountants of recognized
national standing reasonably acceptable to the Administrative Agent.
(g) Within 150 days after the close of each of its
fiscal years, annual statutory statements for the Borrower's Insurance
Subsidiaries on a consolidated or combined basis, certified by such
officers as shall be required by SAP, such statements to be prepared in
accordance with SAP consistently applied throughout the periods
reflected therein.
(h) As soon as possible and in any event within 20
days after the Borrower knows that any Termination Event has occurred
with respect to any Plan, a statement, signed by the chief financial
officer of the Borrower, describing said Termination Event and the
action which the Borrower proposes to take with respect thereto.
(i) Promptly upon the filing thereof, copies of all
registration statements and annual, quarterly, monthly or other regular
reports which the Borrower or any of its Significant Insurance
Subsidiaries files with the Securities and Exchange Commission or any
securities exchange.
(j) Such other information (including, without
limitation, non-financial information) as the Administrative Agent or
any Lender may from time to time reasonably request.
6.2. Use of Proceeds. The Borrower will, and will cause each
Subsidiary to, use the proceeds of the Advances for general corporate purposes
(including, without limitation, to refinance existing Indebtedness of Capsure
Holdings as of the Effective Date). The Borrower will not, nor will it permit
any Subsidiary to, use any of the proceeds of the Advances to purchase or carry
any "margin stock" (as defined in Regulation U).
6.3. Certain Notices. The Borrower will give prompt notice in
writing to the Administrative Agent and the Lenders of (a) the occurrence of any
Default or Unmatured Default, (b) any other development, financial or otherwise,
relating specifically to the Borrower which could reasonably be
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expected to have a Material Adverse Effect, (c) the receipt of any notice from
any Governmental Authority of the expiration without renewal, revocation or
suspension of, or the institution of any proceedings to revoke or suspend, any
License now or hereafter held by any Significant Insurance Subsidiary which is
required to conduct insurance business in compliance with all applicable laws
and regulations, other than such expiration, revocation or suspension which,
individually or in the aggregate, could not reasonably be expected to have a
Material Adverse Effect, (d) the receipt of any notice from any Governmental
Authority of the institution of any disciplinary proceedings against or in
respect of any Significant Insurance Subsidiary, or the issuance of any order,
the taking of any action or any request for an extraordinary audit for cause by
any Governmental Authority which, if adversely determined, could reasonably be
expected to have a Material Adverse Effect or (e) any judicial or administrative
order limiting or controlling the insurance business of any Significant
Insurance Subsidiary (and not the insurance industry generally) which has been
issued or adopted and which could reasonably be expected to have a Material
Adverse Effect.
6.4. Conduct of Business. The Borrower will, and will cause
each Significant Subsidiary to, do all things necessary (if applicable) to
remain duly incorporated, validly existing and in good standing as a domestic
corporation in its jurisdiction of incorporation and maintain all requisite
authority to conduct its business in each jurisdiction in which its business is
conducted except where such failure to remain in good standing or to maintain
such authority may not reasonably be expected to have a Material Adverse Effect.
The Borrower will cause each Significant Insurance Subsidiary to (a) carry on or
otherwise be associated with the business of a licensed insurance carrier and
(b) do all things necessary to renew, extend and continue in effect all Licenses
which may at any time and from time to time be necessary for such Significant
Insurance Subsidiary to operate its insurance business in compliance with all
applicable laws and regulations; provided, however, that any such Significant
Insurance Subsidiary may withdraw from one or more states as an admitted
insurer, change the state of its domicile or fail to keep in effect any License
if such withdrawal, change or failure is in the best interests of the Borrower
and such Significant Insurance Subsidiary and could not reasonably be expected
to have a Material Adverse Effect.
6.5. Taxes. The Borrower will, and will cause each Subsidiary
to, pay when due all material taxes, assessments and governmental charges and
levies upon it or its income, profits or Property, except those which are being
contested in good faith by appropriate proceedings and with respect to which
adequate reserves have been set aside. The Borrower will, and
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will cause each Subsidiary to, pay all other obligations, that, if not paid,
could result in a Material Adverse Effect before the same shall become
delinquent or in default, except those which are being contested in good faith
by appropriate proceedings and with respect to which adequate reserves have been
set aside.
6.6. Insurance. The Borrower will, and will cause each
Significant Subsidiary to, maintain with financially sound and reputable
insurance companies insurance on all or substantially all of its Property, or
shall maintain self-insurance, in such amounts and covering such risks as is
consistent with sound business practice for Persons in substantially the same
industry as the Borrower or such Subsidiary, and the Borrower will furnish to
any Lender upon request full information as to the insurance carried.
6.7. Compliance with Laws. The Borrower will, and will cause
each Subsidiary to, comply with all laws, rules, regulations, orders, writs,
judgments, injunctions, decrees or awards to which it may be subject, except
where the failure to so comply could not reasonably be expected to have a
Material Adverse Effect.
6.8. Maintenance of Properties. The Borrower will, and will
cause each Significant Subsidiary to, do all things necessary to maintain,
preserve, protect and keep its Property in good repair, working order and
condition, and make all necessary and proper repairs, renewals and replacements
so that its business carried on in connection therewith may be properly
conducted at all times, except where the failure to so maintain, preserve,
protect and repair could not reasonably be expected to have a Material Adverse
Effect.
6.9. Inspection. The Borrower will, and will cause each
Subsidiary to, permit the Administrative Agent and the Lenders (coordinated
through the Administrative Agent), by their respective representatives and
agents, to inspect any of the Property, corporate books and financial records of
the Borrower and each Subsidiary, to examine and make copies of the books of
accounts and other financial records of the Borrower and each Subsidiary, and to
discuss the affairs, finances and accounts of the Borrower and each Subsidiary
with, and to be advised as to the same by, their respective officers upon
reasonable notice and at such reasonable times and intervals as the Lenders may
designate.
6.10. Merger. The Borrower will not, nor will it permit any
Significant Subsidiary to, merge or consolidate with or into any other Person,
except that (a) a Significant Subsidiary may merge into the Borrower or a
Wholly-Owned Subsidiary and (b) the Borrower or any Significant Subsidiary may
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merge or consolidate with any other Person, provided that the Borrower or such
Significant Subsidiary shall be the continuing or surviving corporation and,
prior to and after giving effect to such merger or consolidation, no Default or
Unmatured Default shall exist.
6.11. Sale of Assets. The Borrower will not, nor will it
permit any Subsidiary to, lease, sell or otherwise dispose of a Substantial
Portion of its Property to any other Person(s) in any twelve month period;
provided, however, that Insurance Subsidiaries shall be permitted to sell assets
for fair market value in arms length transactions (as determined, in
transactions out of the ordinary course of business, by the Board of Directors
of the selling Insurance Subsidiary acting in good faith).
6.12. Liens. The Borrower will not, nor will it permit any
Subsidiary to, create, incur, or suffer to exist any Lien in or on the Property
of the Borrower or any of its Subsidiaries, except:
(a) Liens for taxes, assessments or governmental charges or
levies on its Property if the same shall not at the time be delinquent or
thereafter can be paid without penalty, or are being contested in good faith and
by appropriate proceedings and for which adequate reserves in accordance with
Agreement Accounting Principles shall have been set aside on its books;
(b) Liens imposed by law, such as carriers', warehousemen's
and mechanics' liens and other similar liens arising in the ordinary course of
business which secure payment of obligations not more than 60 days past due or
which are being contested in good faith by appropriate proceedings and for which
adequate reserves shall have been set aside on its books;
(c) Liens arising out of pledges or deposits under worker's
compensation laws, unemployment insurance, old age pensions, or other social
security or retirement benefits, or similar legislation, including, without
limitation, statutory deposits under applicable insurance laws;
(d) Utility easements, building restrictions and such other
encumbrances or charges against real property as are of a nature generally
existing with respect to properties of a similar character and which do not in
any material way affect the marketability of the same or interfere with the use
thereof in the business of the Borrower or the Subsidiaries;
(e) Liens existing on the date hereof and described in
Schedule 5.17 hereto;
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(f) Liens upon the Property of Insurance Subsidiaries incurred
in the ordinary course of their business; and
(g) Other Liens securing Indebtedness for borrowed money not
exceeding at any time $5,000,000 in aggregate principal amount.
6.13. Indebtedness. The Borrower will not, and will not permit
any Subsidiary to, create, incur, assume or permit to exist any Indebtedness,
except:
(a) Indebtedness created hereunder;
(b) Indebtedness existing on the date hereof and set forth in
Schedule 6.13;
(c) Indebtedness of the Borrower to any Subsidiary and of any
Subsidiary to the Borrower or any other Subsidiary;
(d) Contingent Obligations (i) of the Borrower with respect to
obligations or liabilities of any Subsidiary and (ii) of any Subsidiary
with respect to obligations or liabilities of the Borrower or any other
Subsidiary; and
(e) other unsecured Indebtedness in an aggregate principal
amount not exceeding $5,000,000 at any time outstanding.
6.14. Consolidated Capitalization. The Borrower will maintain
at all times a Consolidated Capitalization Ratio of not greater than 0.40 to
1.0.
6.15. Insurance Company Surplus. The Borrower shall cause the
combined Surplus as Regards Policyholders of its Insurance Subsidiaries to be at
all times at least equal to $100,000,000.
6.16. Maximum Statutory Net Written Premiums. The Borrower
will not permit the ratio of (a) Statutory Net Written Premiums during any
period of four consecutive fiscal quarters to (b) the combined Surplus as
Regards Policyholders of its Insurance Subsidiaries to exceed 3.0 to 1.0.
6.17. Investments, Loans, Advances, Guarantees and
Acquisitions. (a) The Borrower will not, and will not permit any of its
Subsidiaries to, purchase, hold or acquire (including pursuant to any merger
with any Person that was not a wholly owned Subsidiary prior to such merger) any
capital stock, evidences of indebtedness or other securities (including any
option, warrant or other right to acquire any of the foregoing) of, make or
permit to exist any loans or advances to, undertake
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or assume any Contingent Obligations of, or make or permit to exist any
investment or any other interest in, any other Person, or purchase or otherwise
acquire (in one transaction or a series of transactions) any assets of any other
Person constituting a business unit, except:
(i) Permitted Investments;
(ii) investments of Insurance Subsidiaries not prohibited
by Section 6.17(b);
(iii) investments by the Borrower existing on the date hereof
in the capital stock of its Subsidiaries;
(iv) loans or advances made by the Borrower to any Subsidiary
and made by any Subsidiary to the Borrower or any other Subsidiary;
(v) Contingent Obligations constituting Indebtedness
permitted by Section 6.13; and
(vi) equity investments in Persons other than the Borrower
and its Affiliates in an aggregate amount up to but not exceeding
$15,000,000.
(b) The Borrower will not permit any of its Insurance
Subsidiaries to make any investment if, on the date on which such investment is
made and after giving effect thereto, the aggregate value of investments (other
than equity investments) held by such Insurance Subsidiary that are rated lower
than "2", or that are not rated, by the NAIC would exceed 15% of the value of
the total invested assets. As used in this Section 6.17(b), the "value" of an
investment refers to the value of such investment that would be shown on the
most recent Annual Statement or Quarterly Statement, as the case may be, of the
relevant Insurance Subsidiary prepared in accordance with SAP.
6.18. Transactions with Affiliates. The Borrower will not, and
will not permit any of its Subsidiaries to, sell, lease or otherwise transfer
any property or assets to, or purchase, lease or otherwise acquire any property
or assets from, or otherwise engage in any other transactions with, any of its
Affiliates, except (a) in the ordinary course of business at prices and on terms
and conditions not less favorable to the Borrower or such Subsidiary than could
be obtained on an arm's-length basis from unrelated third parties and (b)
transactions between or among the Borrower and its Wholly-Owned Subsidiaries not
involving any other Affiliate.
6.19. Restrictive Agreements. The Borrower will not, and will
not permit any of its Subsidiaries to, directly or
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indirectly, enter into, incur or permit to exist any agreement or other
arrangement that prohibits, restricts or imposes any condition upon (a) the
ability of the Borrower or any Subsidiary to create, incur or permit to exist
any Lien upon any of its property or assets, or (b) the ability of any
Subsidiary to pay dividends or other distributions with respect to any shares of
its capital stock or to make or repay loans or advances to the Borrower or any
other Subsidiary or to undertake or assume Contingent Obligations of the
Borrower or any other Subsidiary; provided that (i) the foregoing shall not
apply to restrictions and conditions imposed by law or by this Agreement, (ii)
the foregoing shall not apply to restrictions and conditions existing on the
date hereof identified on Schedule 5.18 (but shall apply to any extension or
renewal of, or any amendment or modification expanding the scope of, any such
restriction or condition), (iii) the foregoing shall not apply to customary
restrictions and conditions contained in agreements relating to the sale of a
Subsidiary pending such sale, provided such restrictions and conditions apply
only to the Subsidiary that is to be sold and such sale is permitted hereunder,
(iv) clause (a) of the foregoing shall not apply to restrictions or conditions
imposed by any agreement relating to secured Indebtedness permitted by this
Agreement if such restrictions or conditions apply only to the property or
assets securing such Indebtedness and (v) clause (a) of the foregoing shall not
apply to customary provisions in leases and other contracts restricting the
assignment thereof.
6.20. Leases. The Borrower will not permit the aggregate
amount of fixed and contingent rentals payable by the Borrower and its
Subsidiaries, determined on a consolidated basis in accordance with Agreement
Accounting Principles, with respect to leases of real and personal property to
exceed $10,000,000 for any fiscal year of the Borrower.
6.21. Sale and Leaseback. The Borrower will not, and will not
permit any of its Subsidiaries to, enter into any arrangement with any Person
providing for the leasing by the Borrower or any Subsidiary of real or personal
property which has been or is to be sold or transferred by the Borrower or such
Subsidiary to such Person.
6.22. Fiscal Year. The Borrower will not permit the last day
of its fiscal year to end on a day other than December 31st.
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ARTICLE VII
DEFAULTS
The occurrence of any one or more of the following events
shall constitute a Default:
7.1. Any representation or warranty made or deemed made by or
on behalf of the Borrower or any of its Subsidiaries to the Lenders or the
Administrative Agent in this Agreement or in any other certificate, financial
statement or other document delivered pursuant to the provisions hereof shall be
false or misleading in any material respect on the date as of which made or
deemed made.
7.2. Nonpayment of principal of any Loan when due; or
nonpayment of interest upon any Loan or of any facility fee or other obligations
under any of the Loan Documents within five days after the same becomes due.
7.3. The breach by the Borrower of any of the terms or
provisions of Section 6.2, Section 6.3(a) or Sections 6.10 through 6.21,
inclusive.
7.4. The breach by the Borrower (other than a breach which
constitutes a Default under Section 7.1, 7.2 or 7.3) of any of the terms or
provisions of this Agreement which is not remedied within thirty days after
written notice from the Administrative Agent or any Lender.
7.5. Failure of the Borrower or any of its Subsidiaries to pay
when due any Indebtedness (other than the Loans) or any amount under any
agreement with respect to Rate Hedging Obligations providing for termination or
liquidation payments (for purposes of this Section 7.5, "Hedging Indebtedness")
in excess of, singly or in the aggregate for the Borrower and all such
Subsidiaries, $5,000,000; or the default by the Borrower or any of its
Subsidiaries in the performance of any term, provision or condition contained in
any agreement under which any such Indebtedness or Hedging Indebtedness was
created or is governed, or any other event shall occur or condition exist, the
effect of which is to cause, or to permit the holder or holders of such
Indebtedness or Hedging Indebtedness to cause, such Indebtedness or such Hedging
Indebtedness to become due prior to its stated maturity; or any such
Indebtedness or Hedging Indebtedness of the Borrower or any Subsidiary shall be
declared to be due and payable or required to be prepaid (other than by a
regularly scheduled payment) prior to the stated maturity thereof.
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7.6. The Borrower or any of its Significant Subsidiaries shall
(a) have an order for relief entered with respect to it under the Federal
bankruptcy laws as now or hereafter in effect, (b) make an assignment for the
benefit of creditors, (c) apply for, seek, consent to, or acquiesce in, the
appointment of a receiver, custodian, trustee, examiner, liquidator or similar
official for it or any substantial part of its Property, (d) institute any
proceeding seeking an order for relief under the Federal bankruptcy laws as now
or hereafter in effect or seeking to adjudicate it a bankrupt or insolvent, or
seeking dissolution, winding up, liquidation, rehabilitation, supervision,
reorganization, arrangement, adjustment or composition of it or its debts under
any law relating to bankruptcy, insolvency or reorganization or relief of
debtors or fail to file an answer or other pleading denying the material
allegations of any such proceeding filed against it, (e) take any corporate
action to authorize or effect any of the foregoing actions set forth in this
Section 7.6 or (f) fail to contest in good faith any appointment or proceeding
described in Section 7.7 or (g) become unable to pay, not pay, or admit in
writing its inability to pay, its debts generally as they become due.
7.7. Without the application, approval or consent of the
Borrower or any of its Significant Subsidiaries, a receiver, trustee, examiner,
liquidator or similar official shall be appointed for the Borrower or any of its
Subsidiaries or any Substantial Portion of its Property, or a proceeding
described in Section 7.6(d) shall be instituted against the Borrower or any of
its Significant Subsidiaries and such appointment continues undischarged or such
proceeding continues undismissed or unstayed for a period of thirty consecutive
days.
7.8. The Borrower or any of its Subsidiaries shall fail within
thirty days to pay, bond or otherwise discharge any judgment or order for the
payment of money, either singly or in the aggregate, in excess of $5,000,000,
which is not stayed on appeal or otherwise being appropriately contested in good
faith.
7.9. The Borrower shall terminate, or the PBGC shall institute
proceedings under Title IV of ERISA to terminate, or to impose liability (other
than for premiums under Section 4007 of ERISA) in respect of, or to cause a
trustee to be appointed to administer, any Single Employer Plan having Unfunded
Liabilities in excess of $5,000,000.
7.10. Any Change in Control shall occur.
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ARTICLE VIII
ACCELERATION, WAIVERS, AMENDMENTS AND REMEDIES
8.1. Acceleration. If any Default described in Section 7.6 or
7.7 occurs with respect to the Borrower, the obligations of the Lenders to make
Loans hereunder shall automatically terminate and the Obligations shall
immediately become due and payable without any election or action on the part of
the Administrative Agent or any Lender. If any other Default occurs, the
Required Lenders (or the Administrative Agent with the consent of the Required
Lenders) may terminate or suspend the obligations of the Lenders to make Loans
hereunder, or declare the Obligations to be due and payable, or both, whereupon
the Obligations shall become immediately due and payable, without presentment,
demand, protest or notice of any kind, all of which the Borrower hereby
expressly waives.
8.2. Amendments. Subject to the provisions of this Article
VIII, the Required Lenders (or the Administrative Agent with the consent in
writing of the Required Lenders) and the Borrower may enter into agreements
supplemental hereto for the purpose of adding or modifying any provisions to the
Loan Documents or changing in any manner the rights of the Lenders or the
Borrower hereunder or thereunder or waiving any Default hereunder or thereunder;
provided, however, that no such supplemental agreement shall, without the
consent of each Lender:
(a) extend the Termination Date or the final maturity
of any Loan or reduce the principal amount thereof or reduce the rate
or extend the time of payment of any interest or any fee payable
hereunder;
(b) reduce the percentage specified in the
definition of Required Lenders;
(c) increase the amount of the Aggregate Commitment
or the Commitment of any Lender hereunder;
(d) permit the Borrower to assign its rights under
this Agreement; or
(e) amend this Section 8.2.
No amendment of any provision of this Agreement relating to the Administrative
Agent shall be effective without the written consent of the Administrative
Agent. The Administrative Agent may waive payment of the fee required under
Section 12.3.1 without obtaining the consent of any other party to this
Agreement.
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8.3. Preservation of Rights. No delay or omission of the
Lenders or the Administrative Agent to exercise any right under the Loan
Documents shall impair such right or be construed to be a waiver of any Default
or Unmatured Default or an acquiescence therein, and the making of a Loan
notwithstanding the existence of a Default or Unmatured Default or the inability
of the Borrower to satisfy the conditions precedent to such Loan shall not
constitute any waiver or acquiescence. Any single or partial exercise of any
such right shall not preclude other or further exercise thereof or the exercise
of any other right, and no waiver, amendment or other variation of the terms,
conditions or provisions of the Loan Documents whatsoever shall be valid unless
in writing signed by the Lenders required pursuant to Section 8.2, and then only
to the extent in such writing specifically set forth. All remedies contained in
the Loan Documents or by law afforded shall be cumulative and all shall be
available to the Administrative Agent and the Lenders until the Obligations have
been paid in full.
ARTICLE IX
GENERAL PROVISIONS
9.1. Survival of Representations. All representations and
warranties of the Borrower contained in this Agreement shall survive the making
of the Loans herein contemplated.
9.2. Headings. Section headings in the Loan Documents are for
convenience of reference only, and shall not govern the interpretation of any of
the provisions of the Loan Documents.
9.3. Entire Agreement. The Loan Documents embody the entire
agreement and understanding among the Borrower, the Administrative Agent and the
Lenders and supersede all prior agreements and understandings among the
Borrower, the Administrative Agent and the Lenders relating to the subject
matter thereof other than the Commitment Letter and that certain fee letter
agreement in each case by and between the Borrower and Chase.
9.4. Several Obligations; Benefits of this Agreement. The
respective obligations of the Lenders hereunder are several and not joint and no
Lender shall be the partner or agent of any other (except to the extent to which
the Administrative Agent is authorized to act as such). The failure of any
Lender to perform any of its obligations hereunder shall not relieve any other
Lender from any of its obligations hereunder. This Agreement shall not be
construed so as to confer
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any right or benefit upon any Person other than the parties to this Agreement
and their respective successors and assigns.
9.5. Expenses; Indemnification; Damage Waiver.
(a) The Borrower shall pay (i) all reasonable out-of-pocket
expenses incurred by the Administrative Agent and its Affiliates, including the
reasonable fees, charges and disbursements of counsel for the Administrative
Agent, in connection with the syndication of the credit facilities provided for
herein, the preparation and administration of this Agreement or any amendments,
modifications or waivers of the provisions hereof (whether or not the
transactions contemplated hereby or thereby shall be consummated) and (ii) all
out-of-pocket expenses incurred by the Administrative Agent or any Lender,
including the fees, charges and disbursements of any counsel for the
Administrative Agent or any Lender, in connection with the enforcement or
protection of its rights in connection with this Agreement, including its rights
under this Section, or in connection with the Loans made hereunder, including
all such out-of-pocket expenses incurred during any workout, restructuring or
negotiations in respect of such Loans.
(b) The Borrower shall indemnify the Administrative Agent and
each Lender, and each Related Party of any of the foregoing Persons (each such
Person being called an "Indemnitee") against, and hold each Indemnitee harmless
from, any and all losses, claims, damages, liabilities and related expenses,
including the fees, charges and disbursements of any counsel for any Indemnitee,
incurred by or asserted against any Indemnitee arising out of, in connection
with, or as a result of (i) the execution or delivery of this Agreement or any
agreement or instrument contemplated hereby, the performance by the parties
hereto of their respective obligations hereunder or the consummation of the
Closing Transactions or any other transactions contemplated hereby, (ii) any
Loan or the use of the proceeds therefrom or (iv) any actual or prospective
claim, litigation, investigation or proceeding relating to any of the foregoing,
whether based on contract, tort or any other theory and regardless of whether
any Indemnitee is a party thereto; provided that such indemnity shall not, as to
any Indemnitee, be available to the extent that such losses, claims, damages,
liabilities or related expenses are determined by a court of competent
jurisdiction by final and nonappealable judgment to have resulted from the gross
negligence or wilful misconduct of such Indemnitee.
(c) To the extent permitted by applicable law, the Borrower
shall not assert, and hereby waives, any claim against any Indemnitee, on any
theory of liability, for special, indirect, consequential or punitive damages
(as opposed to direct
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or actual damages) arising out of, in connection with, or as a result of, this
Agreement or any agreement or instrument contemplated hereby, the Closing
Transactions, any Loan or the use of the proceeds thereof.
(d) All amounts due under this Section shall be payable
promptly after written demand therefor.
(e) The obligations of the Borrower under this Section 9.5
shall survive the termination of this Agreement.
9.6. Numbers of Documents. All statements, notices, closing
documents, and requests hereunder shall be furnished to the Administrative Agent
with sufficient counterparts so that the Administrative Agent may furnish one to
each of the Lenders.
9.7. Accounting. Except as provided to the contrary herein,
all accounting terms used herein shall be interpreted and all accounting
determinations hereunder shall be made in accordance with Agreement Accounting
Principles.
9.8. Severability of Provisions. Any provision in any Loan
Document that is held to be inoperative, unenforceable, or invalid in any
jurisdiction shall, as to that jurisdiction, be inoperative, unenforceable, or
invalid without affecting the remaining provisions in that jurisdiction or the
operation, enforceability, or validity of that provision in any other
jurisdiction, and to this end the provisions of all Loan Documents are declared
to be severable.
9.9. Nonliability of Lenders. The relationship between the
Borrower and the Lenders and the Administrative Agent shall be solely that of
borrower and lender. Neither the Administrative Agent nor any Lender shall have
any fiduciary responsibilities to the Borrower. Neither the Administrative Agent
nor any Lender undertakes any responsibility to the Borrower to review or inform
the Borrower of any matter in connection with any phase of the Borrower's
business or operations.
9.10. Governing Law. This Agreement shall be construed in
accordance with and governed by the law of the State of New York.
9.11. Jurisdiction; Consent to Service of Process.
(a) The Borrower hereby irrevocably and unconditionally
submits, for itself and its property, to the nonexclusive jurisdiction of the
Supreme Court of the State of New York sitting in New York County and of the
United States
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District Court of the Southern District of New York, and any appellate court
from any thereof, in any action or proceeding arising out of or relating to this
Agreement, or for recognition or enforcement of any judgment, and each of the
parties hereto hereby irrevocably and unconditionally agrees that all claims in
respect of any such action or proceeding may be heard and determined in such New
York State or, to the extent permitted by law, in such Federal court. Each of
the parties hereto agrees that a final judgment in any such action or proceeding
shall be conclusive and may be enforced in other jurisdictions by suit on the
judgment or in any other manner provided by law. Nothing in this Agreement shall
affect any right that the Administrative Agent or any Lender may otherwise have
to bring any action or proceeding relating to this Agreement against the
Borrower or its properties in the courts of any jurisdiction.
(b) The Borrower hereby irrevocably and unconditionally
waives, to the fullest extent it may legally and effectively do so, any
objection which it may now or hereafter have to the laying of venue of any suit,
action or proceeding arising out of or relating to this Agreement in any court
referred to in paragraph (a) of this Section. Each of the parties hereto hereby
irrevocably waives, to the fullest extent permitted by law, the defense of an
inconvenient forum to the maintenance of such action or proceeding in any such
court.
(c) Each party to this Agreement irrevocably consents to
service of process in the manner provided for notices in Section 13.1. Nothing
in this Agreement will affect the right of any party to this Agreement to serve
process in any other manner permitted by law.
9.12. Confidentiality. Each Lender agrees to hold any
confidential information which it may receive from the Borrower pursuant to this
Agreement in confidence and for use in connection with this Agreement, including
without limitation, for use in connection with its rights and remedies
hereunder, except for disclosure (a) to other Lenders and their respective
Affiliates, (b) to legal counsel, accountants, and other professional advisors
to that Lender, (c) to regulatory officials, (d) as requested pursuant to or as
required by law, regulation, or legal process, (e) in connection with any legal
proceeding to which that Lender is a party, and (f) permitted by Section 12.4.
9.13. WAIVER OF JURY TRIAL. EACH PARTY HERETO HEREBY WAIVES,
TO THE FULLEST EXTENT PERMITTED BY APPLICABLE LAW, ANY RIGHT IT MAY HAVE TO A
TRIAL BY JURY IN ANY LEGAL PROCEEDING DIRECTLY OR INDIRECTLY ARISING OUT OF OR
RELATING TO THIS AGREEMENT OR THE TRANSACTIONS CONTEMPLATED HEREBY (WHETHER
BASED ON CONTRACT, TORT OR ANY OTHER THEORY). EACH PARTY HERETO (A)
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CERTIFIES THAT NO REPRESENTATIVE, AGENT OR ATTORNEY OF ANY OTHER PARTY HAS
REPRESENTED, EXPRESSLY OR OTHERWISE, THAT SUCH OTHER PARTY WOULD NOT, IN THE
EVENT OF LITIGATION, SEEK TO ENFORCE THE FOREGOING WAIVER AND (B) ACKNOWLEDGES
THAT IT AND THE OTHER PARTIES HERETO HAVE BEEN INDUCED TO ENTER INTO THIS
AGREEMENT BY, AMONG OTHER THINGS, THE MUTUAL WAIVERS AND CERTIFICATIONS IN THIS
SECTION.
9.14. Disclosure. Each Lender hereby (a) acknowledges and
agrees that Chase and/or its Affiliates from time to time may hold other
investments in, make other loans to or have other relationships with the
Borrower and its Subsidiaries, including, without limitation, in connection with
any interest rate hedging instruments or agreements or swap transactions, and
(b) to the extent that any such liability would not exist but for Chase's status
as Administrative Agent hereunder, waives any liability of Chase or such
Affiliate to any Lender arising out of or resulting from such investments, loans
or other relationships other than liabilities arising out of the gross
negligence or willful misconduct of Chase or its Affiliates.
9.15. Counterparts. This Agreement may be executed in any
number of counterparts, all of which taken together shall constitute one
agreement, and any of the parties hereto may execute this Agreement by signing
any such counterpart. This Agreement shall be effective when it has been
executed by the Borrower, the Administrative Agent and the Lenders.
ARTICLE X
THE ADMINISTRATIVE AGENT
10.1. Appointment. The Chase Manhattan Bank is hereby
appointed administrative agent for the Lenders hereunder and under each other
Loan Document, and each of the Lenders irrevocably authorizes the Administrative
Agent to act as the agent of such Lender. The Administrative Agent agrees to act
as such upon the express conditions contained in this Article X. The
Administrative Agent shall not have a fiduciary relationship in respect of the
Borrower or any Lender by reason of this Agreement or any other Loan Document.
10.2. Powers. The Administrative Agent shall have and may
exercise such powers under the Loan Documents as are specifically delegated to
the Administrative Agent by the terms of each thereof, together with such powers
as are reasonably incidental thereto. The Administrative Agent shall have no
implied duties to the Lenders, or any obligation to the Lenders to take any
action thereunder, except any action specifically
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provided by the Loan Documents to be taken by the Administrative Agent.
10.3. General Immunity. Neither the Administrative Agent nor
any of its directors, officers, agents or employees shall be liable to the
Borrower or any Lender for any action taken or omitted to be taken by it or them
hereunder or under any other Loan Document or in connection herewith or
therewith except for its or their own gross negligence or willful misconduct.
10.4. No Responsibility for Loans, Recitals, etc. Neither the
Administrative Agent nor any of its directors, officers, agents or employees
shall be responsible for or have any duty to ascertain, inquire into, or verify
(a) any statement, warranty or representation made in connection with any Loan
Document or any borrowing hereunder; (b) the performance or observance of any of
the covenants or agreements of any obligor under any Loan Document, including,
without limitation, any agreement by an obligor to furnish information directly
to each Lender; (c) the satisfaction of any condition specified in Article IV,
except receipt of items required to be delivered to the Administrative Agent and
not waived at closing; or (d) the validity, enforceability, effectiveness,
sufficiency or genuineness of any Loan Document or any other instrument or
writing furnished in connection therewith. The Administrative Agent shall have
no duty to disclose to the Lenders information that is not required to be
furnished by the Borrower to the Administrative Agent at such time, but is
voluntarily furnished by the Borrower to the Administrative Agent (either in its
capacity as Administrative Agent or in its individual capacity) and which is not
otherwise expressly required by this Agreement to be delivered by the
Administrative Agent to the Lenders.
10.5. Action on Instructions of Lenders. The Administrative
Agent shall in all cases be fully protected in acting, or in refraining from
acting, hereunder and under any other Loan Document in accordance with written
instructions signed by the Required Lenders (or, to the extent required by
Section 8.2, by all the Lenders), and such instructions and any action taken or
failure to act pursuant thereto shall be binding on all of the Lenders. The
Administrative Agent shall be fully justified in failing or refusing to take any
action hereunder and under any other Loan Document unless it shall first be
indemnified to its satisfaction by the Lenders pro-rata against any and all
liability, cost and expense that it may incur by reason of taking or continuing
to take any such action.
10.6. Employment of Administrative Agents and Counsel. The
Administrative Agent may execute any of its duties as Administrative Agent
hereunder and under any other Loan Document by or through employees, agents, and
attorneys-in-fact
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and shall not be answerable to the Lenders, except as to money or securities
received by it or its authorized agents, for the default or misconduct of any
such agents or attorneys-in-fact selected by it with reasonable care. The
Administrative Agent shall be entitled to advice of counsel concerning all
matters pertaining to the agency hereby created and its duties hereunder and
under any other Loan Document.
10.7. Reliance on Documents; Counsel. The Lenders agree that
the Administrative Agent shall be entitled to rely upon any notice, consent,
certificate, affidavit, letter, telegram, statement, paper or document believed
by it to be genuine and correct and to have been signed or sent by the proper
person or persons, and, in respect to legal matters, upon the opinion of counsel
selected by the Administrative Agent, which counsel may be employees of the
Administrative Agent.
10.8. Administrative Agent's Reimbursement and
Indemnification. The Lenders agree to reimburse and indemnify the Administrative
Agent ratably in proportion to their respective Commitments (or, if the
Commitments have been terminated, in proportion to their Commitments immediately
prior to such termination) (a) for any amounts not reimbursed by the Borrower
for which the Administrative Agent is entitled to reimbursement by the Borrower
under the Loan Documents, (b) to the extent not reimbursed by the Borrower, for
any other expenses incurred by the Administrative Agent on behalf of the
Lenders, in connection with the preparation, execution, delivery, administration
and enforcement of the Loan Documents and (c) to the extent not reimbursed by
the Borrower, for any liabilities, obligations, losses, damages, penalties,
actions, judgments, suits, costs, expenses or disbursements of any kind and
nature whatsoever which may be imposed on, incurred by or asserted against the
Administrative Agent in any way relating to or arising out of the Loan Documents
or any other document delivered in connection therewith or the transactions
contemplated thereby, or the enforcement of any of the terms thereof or of any
such other documents, provided that no Lender shall be liable for any of the
foregoing to the extent they arise from the gross negligence or willful
misconduct of the Administrative Agent as finally determined by a court of
competent jurisdiction. The obligations of the Lenders under this Section 10.8
shall survive payment of the Obligations and termination of this Agreement.
10.9. Notice of Default. The Administrative Agent shall not be
deemed to have knowledge or notice of the occurrence of any Default or Unmatured
Default hereunder unless the Administrative Agent has received written notice
from a Lender or the Borrower referring to this Agreement describing such
Default or Unmatured Default and stating that such notice is a "notice of
default". In the event that the Administrative Agent receives
<PAGE> 69
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such a notice, the Administrative Agent shall give prompt notice thereof to the
Lenders.
10.10. Rights as a Lender. In the event the Administrative
Agent is a Lender, the Administrative Agent shall have the same rights and
powers hereunder and under any other Loan Document as any Lender and may
exercise the same as though it were not the Administrative Agent, and the term
"Lender" or "Lenders" shall, at any time when the Administrative Agent is a
Lender, unless the context otherwise indicates, include the Administrative Agent
in its individual capacity. The Administrative Agent may accept deposits from,
lend money to, and generally engage in any kind of trust, debt, equity or other
transaction, in addition to those contemplated by this Agreement or any other
Loan Document, with the Borrower or any of its Subsidiaries in which the
Borrower or such Subsidiary is not restricted hereby from engaging with any
other Person. The Administrative Agent, in its individual capacity, is not
obligated to remain a Lender.
10.11. Lender Credit Decision. Each Lender acknowledges that
it has, independently and without reliance upon the Administrative Agent or any
other Lender and based on the financial statements prepared by the Borrower and
such other documents and information as it has deemed appropriate, made its own
credit analysis and decision to enter into this Agreement and the other Loan
Documents. Each Lender also acknowledges that it will, independently and without
reliance upon the Administrative Agent or any other Lender and based on such
documents and information as it shall deem appropriate at the time, continue to
make its own credit decisions in taking or not taking action under this
Agreement and the other Loan Documents.
10.12. Successor Administrative Agent. The Administrative
Agent may resign at any time by giving written notice thereof to the Lenders and
the Borrower, such resignation to be effective upon the appointment of a
successor Administrative Agent or, if no successor Administrative Agent has been
appointed, thirty days after the retiring Administrative Agent gives notice of
its intention to resign. Upon any such resignation and with the consent of the
Borrower (so long as no Default is then pending), which consent shall not be
unreasonably withheld or delayed, the Required Lenders shall have the right to
appoint, on behalf of the Borrower and the Lenders, a successor Administrative
Agent. If no successor Administrative Agent shall have been so appointed by the
Required Lenders and shall have accepted such appointment within thirty days
after the resigning Administrative Agent's giving notice of its intent to
resign, then the resigning Administrative Agent may appoint, on behalf of the
Borrower and the Lenders, a successor Administrative Agent. If the
Administrative Agent has resigned and no successor
<PAGE> 70
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Administrative Agent has been appointed, the Lenders may perform all the duties
of the Administrative Agent hereunder and the Borrower shall make all payments
in respect of the Obligations to the applicable Lenders and for all other
purposes shall deal directly with the Lenders. No successor Administrative
Agent shall be deemed to be appointed hereunder until such successor
Administrative Agent has accepted the appointment. Any such successor
Administrative Agent shall be a Lender or another commercial bank having
capital and retained earnings of at least $500,000,000. Upon the acceptance of
any appointment as Administrative Agent hereunder by a successor Administrative
Agent, such successor Administrative Agent shall thereupon succeed to and
become vested with all the rights, powers, privileges and duties of the
resigning Administrative Agent. Upon the effectiveness of the resignation of
the Administrative Agent, the resigning Administrative Agent shall be
discharged from its duties and obligations hereunder and under the other Loan
Documents. After the effectiveness of the resignation of an Administrative
Agent, the provisions of this Article X shall continue in effect for the
benefit of such Administrative Agent in respect of any actions taken or omitted
to be taken by it while it was acting as the Administrative Agent hereunder and
under the other Loan Documents.
ARTICLE XI
SETOFF; RATABLE PAYMENTS
11.1. Setoff. In addition to, and without limitation of, any
rights of the Lenders under applicable law, if the Borrower becomes insolvent,
however evidenced, or any Default occurs, any and all deposits (including all
account balances, whether provisional or final and whether or not collected or
available) and any other Indebtedness at any time held or owing by any Lender to
or for the credit or account of the Borrower may be offset and applied toward
the payment of the Obligations owing to such Lender, whether or not the
Obligations, or any part hereof, shall then be due.
11.2. Ratable Payments. Except for payments received from the
Administrative Agent pursuant to Section 2.11, if any Lender, whether by setoff
or otherwise, has payment made to it upon its Loans (other than payments
received pursuant to Sections 3.1, 3.2 or 3.4) in a greater proportion than its
ratable share of such Loans, such Lender agrees, promptly upon demand, to
purchase a portion of the Loans held by the other Lenders so that after such
purchase each Lender will hold its ratable proportion of Loans. If any Lender,
whether in connection with setoff or amounts which might be subject to setoff or
otherwise, receives collateral or other protection for
<PAGE> 71
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its Obligations or such amounts which may be subject to setoff, such Lender
agrees, promptly upon demand, to take such action necessary such that all
Lenders share in the benefits of such collateral ratably in proportion to their
Loans. In case any such payment is disturbed by legal process, or otherwise,
appropriate further adjustments shall be made.
ARTICLE XII
BENEFIT OF AGREEMENT; ASSIGNMENTS; PARTICIPATIONS
12.1. Successors and Assigns. The terms and provisions of the
Loan Documents shall be binding upon and inure to the benefit of the Borrower
and the Lenders and their respective successors and assigns, except that (a) the
Borrower shall not have the right to assign its rights or obligations under the
Loan Documents and (b) any assignment by any Lender must be made in compliance
with Section 12.3. Notwithstanding clause (b) of the immediately preceding
sentence, any Lender may at any time, without the consent of the Borrower or the
Administrative Agent, assign all or any portion of its rights under this
Agreement and any promissory note issued to it hereunder to a Federal Reserve
Bank; provided, however, that no such assignment to a Federal Reserve Bank shall
release the transferor Lender from its obligations hereunder.
12.2. Participations.
12.2.1. Permitted Participants; Effect. Any Lender may, in the
ordinary course of its business and in accordance with applicable law, at any
time sell to one or more banks or other entities ("Participants") participating
interests in any Loan owing to such Lender, any promissory note issued hereunder
held by such Lender, any Commitment of such Lender or any other interest of such
Lender under the Loan Documents. In the event of any such sale by a Lender of
participating interests to a Participant, such Lender's obligations under the
Loan Documents shall remain unchanged, such Lender shall remain solely
responsible to the other parties hereto for the performance of such obligations,
such Lender shall remain the holder of any such note for all purposes under the
Loan Documents, all amounts payable by the Borrower under this Agreement shall
be determined as if such Lender had not sold such participating interests, and
the Borrower and the Administrative Agent shall continue to deal solely and
directly with such Lender in connection with such Lender's rights and
obligations under the Loan Documents.
12.2.2. Voting Rights. Each Lender shall retain the sole right
to approve, without the consent of any Participant, any amendment, modification
or waiver of any provision of the
<PAGE> 72
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Loan Documents other than any amendment, modification or waiver with respect to
any Loan or Commitment in which such Participant has an interest which forgives
principal, interest or fees or reduces the interest rate or fees payable with
respect to any such Loan or Commitment, postpones any date fixed for any
regularly-scheduled payment of principal of, or interest or fees on, any such
Loan or Commitment, or extends the Termination Date.
12.2.3. Benefit of Setoff. The Borrower agrees that each
Participant shall be deemed to have the right of setoff provided in Section 11.1
in respect of its participating interest in amounts owing under the Loan
Documents to the same extent as if the amount of its participating interest were
owing directly to it as a Lender under the Loan Documents; provided that each
Lender shall retain the right of setoff provided in Section 11.1 with respect to
the amount of participating interests sold to each Participant. Each
Participant, by exercising the right of setoff provided in Section 11.1, agrees
to share with each Lender, any amount received pursuant to the exercise of its
right of setoff, such amounts to be shared in accordance with Section 11.2 as if
each Participant were a Lender.
12.3. Assignments.
12.3.1. Permitted Assignments. Any Lender may, in the ordinary
course of its business and in accordance with applicable law, at any time assign
to one or more banks or other entities ("Purchasers") all or any part of its
rights and obligations under the Loan Documents; provided, however, that in the
case of a partial assignment to an entity which is not a Lender or an Affiliate
of a Lender, such assignment shall be in a minimum amount of $10,000,000 (or
such lesser amount as the Borrower and the Administrative Agent may approve with
respect to any specific proposed assignment). Such assignment shall be
substantially in the form of Exhibit "F" hereto or any other form as may be
agreed to by the parties thereto and approved by the Agent (in each case, an
"Assignment and Acceptance"). The consent of the Borrower and the Administrative
Agent (which consent shall not be unreasonably withheld or delayed) shall be
required prior to an assignment becoming effective with respect to a Purchaser
which is not a Lender or an Affiliate thereof; provided, however, that the
consent of the Borrower shall not be required if, on the date of such
assignment, a Default shall have occurred and be continuing. The parties to each
assignment shall deliver to the Administrative Agent a processing and
recordation fee of $3,500 and, if the assignee is not a Lender, an
Administrative Questionnaire.
12.3.2. Register. The Administrative Agent, acting for this
purpose as an agent of the Borrower, shall maintain at one of its offices in The
City of New York a copy of each
<PAGE> 73
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Assignment and Acceptance delivered to it and a register for the recordation of
the names and addresses of the Lenders, and the Commitment of, and principal
amount of the Loans owing to, each Lender pursuant to the terms hereof from time
to time (the "Register"). The entries in the Register shall be conclusive, and
the Borrower, the Administrative Agent, the Lenders may treat each Person whose
name is recorded in the Register pursuant to the terms hereof as a Lender
hereunder for all purposes of this Agreement, notwithstanding notice to the
contrary. The Register shall be available for inspection by the Borrower and any
Lender, at any reasonable time and from time to time upon reasonable prior
notice.
12.3.3. Effect; Effective Date. Upon its receipt of a duly
completed Assignment and Acceptance executed by an assigning Lender and an
assignee, the assignee's completed Administrative Questionnaire (unless the
assignee shall already be a Lender hereunder), the processing and recordation
fee referred to in Section 12.3.1 and any written consent to such assignment
required by Section 12.3.1, the Administrative Agent shall accept such
Assignment and Acceptance and record the information contained therein in the
Register. No assignment shall be effective for purposes of this Agreement unless
it has been recorded in the Register as provided in this paragraph. On and after
the effective date of such assignment, such Purchaser shall for all purposes be
a Lender party to this Agreement and any other Loan Document executed by the
Lenders and shall have all the rights and obligations of a Lender under the Loan
Documents, to the same extent as if it were an original party hereto, and the
transferor Lender shall be released with respect to the percentage of the
Aggregate Commitment and Loans assigned to such Purchaser without any further
consent or action by the Borrower, the Lenders or the Administrative Agent.
12.4. Dissemination of Information. The Borrower authorizes
each Lender to disclose to any Participant or Purchaser or any other Person
acquiring an interest in the Loan Documents by operation of law (each a
"Transferee") and any prospective Transferee any and all information in such
Lender's possession concerning the creditworthiness of the Borrower and its
Subsidiaries; provided that each Transferee and prospective Transferee agrees to
be bound by Section 9.12 of this Agreement.
12.5. Tax Treatment. If any interest in any Loan Document is
transferred to any Transferee which is organized under the laws of any
jurisdiction other than the United States or any State thereof, the transferor
Lender shall cause such Transferee, concurrently with the effectiveness of such
transfer, to comply with the provisions of Section 2.17.
<PAGE> 74
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ARTICLE XIII
NOTICES
13.1. Giving Notice.
Except as otherwise permitted by Section 2.12 with respect to borrowing
notices, all notices and other communications provided to any party hereto under
this Agreement or any other Loan Document shall be in writing, by facsimile,
first class U.S. mail or overnight courier and addressed or delivered to such
party at (i) in the case of the Borrower or the Administrative Agent, its
address set forth below its signature hereto or (ii) in the case of a Lender, at
the address set forth in its Administrative Questionnaire, or at such other
address as may be designated by such party in a notice to the other parties. Any
notice, if personally delivered or mailed (properly addressed with postage
prepaid), shall be deemed given three (3) Business Days after deposit in the
U.S. mail; any notice, if transmitted by telecopy, shall be deemed given when
transmitted; and any notice given by courier shall be deemed given when received
by the addressee.
13.2. Change of Address.
The Borrower, the Administrative Agent and any Lender may each change the
address for service of notice upon it by a notice in writing to the other
parties hereto.
<PAGE> 75
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IN WITNESS WHEREOF, the Borrower, the Lenders and the Administrative
Agent have executed this Agreement as of the date first above written.
CNA SURETY CORPORATION
By ???
--------------------------------
Title:
Address for Notices:
CNA Surety Corporation
CNA Plaza, 13S
Chicago, Illinois 60685
Attention: John S. Heneghan
Telephone: (312) 822-1908
Telecopy: (312) 755-3737
<PAGE> 76
- 70 -
THE CHASE MANHATTAN BANK,
individually and as
Administrative Agent,
By:/s/Heather Lindstrom
--------------------------------
Title: Vice President
Address for Notices:
The Chase Manhattan Bank
Loan and Agency Services
One Chase Manhattan Plaza
8th Floor
New York, New York 10081
Attention: Laura Rebecca
Telephone: (212) 552-7253
Telecopy: (212) 552-7490
<PAGE> 77
- 71 -
THE FIRST NATIONAL BANK OF CHICAGO
By: Deborah A. Ryne
--------------------------------
Title: First Vice President
BANK OF MONTREAL
By: Robert C. Meyer
--------------------------------
Title: Director
THE BANK OF NEW YORK
By: ???
--------------------------------
Title: Vice President
FLEET BANK, NATIONAL ASSOCIATION
By: Mildred Chararreg Jones
--------------------------------
Title: Vice President
MELLON BANK, N.A.
By: Jeanna Patterson
--------------------------------
Title: Officer
<PAGE> 78
EXHIBIT "A"
COMPETITIVE BID QUOTE REQUEST
(Section 2.3.2)
________________, 19__
To: The Chase Manhattan Bank, as agent (the "Administrative Agent")
From: CNA Surety Corporation ("Borrower")
Re: Credit Agreement dated as of September 30, 1997, among the Borrower,
the Lenders party thereto and The Chase Manhattan Bank, as
Administrative Agent (the "Agreement")
We hereby give notice pursuant to Section 2.3.2 of the Agreement
that we request Competitive Bid Quotes for the following proposed Competitive
Bid Advance(s):
Borrowing Date: , 19
---------------
Principal Amount: $ [1]
-----------
Interest Period: [2]
-----------
Such Competitive Bid Quotes should offer a [Competitive Bid Margin]
[Absolute Rate].
Upon acceptance by the undersigned of any or all of the Competitive Bid
Advances offered by Lenders in response to this request, the undersigned shall
be deemed to affirm as of such date the representations and warranties made in
the Agreement to the extent specified in Section 4.2(b) thereof. Capitalized
terms used herein have the meanings assigned to them in the Agreement.
CNA SURETY CORPORATION
By:
---------------------------------
Title:
------------------------------
- - ------------------------------------
1 Amount must be at least $10,000,000 and an integral multiple of $1,000,000.
2 One, two, three or six months (Eurodollar Auction) or at least seven
and up to 360 days (Absolute Rate Auction), subject to the provisions
of the definitions of Eurodollar Interest Period and Absolute Rate
Interest Period.
<PAGE> 79
EXHIBIT "B"
INVITATION FOR COMPETITIVE BID QUOTES
(Section 2.3.3)
___________________, 19_____
To: [Name of Lender]
Re: Invitation for Competitive Bid Quotes to CNA Financial Corporation
(the "Borrower")
Pursuant to Section 2.3.3 of the Credit Agreement dated as of September
30, 1997 (the "Agreement") among the Borrower, the Lenders parties thereto and
the undersigned, as Administrative Agent, we are pleased on behalf of the
Borrower to invite you to submit Competitive Bid Quotes to the Borrower for the
following proposed Competitive Bid Advance(s):
Borrowing Date: , 19
--------------
Principal Amount: $
--------------
Interest Period:
--------------
Such Competitive Bid Quotes should offer a [Competitive Bid Margin]
[Absolute Rate]. Your Competitive Bid Quote must comply with Section 2.3.4 of
the Agreement and the foregoing terms in which the Competitive Bid Quote Request
was made. Capitalized terms used herein have the meanings assigned to them in
the Agreement.
Please respond to this invitation by no later than 10:00 a.m. New York
time on , 19 .
------------- -----
THE CHASE MANHATTAN BANK, as
Administrative Agent
By:
--------------------------------
Authorized Officer
<PAGE> 80
EXHIBIT "C"
COMPETITIVE BID QUOTE
(Section 2.3.4)
________________, 19___
To: The Chase Manhattan Bank, as Administrative Agent
Attn:
Re: Competitive Bid Quote to CNA Surety Corporation (the "Borrower")
In response to your invitation on behalf of the Borrower dated
___________, 19__, we hereby make the following Competitive Bid Quote pursuant
to Section 2.3.4 of the Credit Agreement hereinafter referred to and on the
following terms:
1. Quoting Lender:
2. Person to contact at Quoting Lender:
3. Borrowing Date:_____________, 19__1
4. We hereby offer to make Competitive Bid Loan(s) in
the following principal amounts, for the following
Interest Periods and at the following rates:
<TABLE>
<CAPTION>
Principal Interest [Competitive [Absolute Minimum
Amount2 Period3 Bid Margin4] Rate5] Amount6
- - ------- ------- ------------ ------ -------
<S> <C> <C> <C> <C>
$
</TABLE>
- - ----------------------------------------
1 As specified in the related Invitation.
2 Principal amount bid for each Interest Period may not exceed principal
amount requested. Bids must be made for $10,000,000 and an integral
multiple of $1,000,000.
3 One, two, three or six months or at least seven and up to 360 days, as
specified in the related Invitation.
4 Competitive Bid Margin over or under the Eurodollar Base Rate determined
for the applicable Interest Period. Specify percentage (rounded to the
nearest 1/100 of 1%) and specify whether "PLUS" or "MINUS".
5 Specify rate of interest per annum (rounded to the nearest 1/100 of 1%).
6 Specify minimum amount which the Borrower may accept (see Section 2.3.4
(b)(iv)).
<PAGE> 81
- 2 -
We understand and agree that the offer(s) set forth above,
subject to the satisfaction of the applicable conditions set forth in the Credit
Agreement dated as of September 30, 1997 among the Borrower, the Lenders party
thereto and yourself, as Administrative Agent irrevocably obligates us to make
the Competitive Bid Loan(s) for which any offer(s) are accepted, in whole or in
part.
Very truly yours,
[NAME OF LENDER]
Dated:_____________, 19__ By:______________________
Authorized Officer
<PAGE> 82
EXHIBIT "D"
[Opinion of Counsel to the Borrower]
September 30, 1997
The Chase Manhattan Bank,
as Administrative Agent
and
Each of the Financial Institutions
identified on Schedule I hereto
Ladies/Gentlemen:
I am counsel for Continental Casualty Company, and in such
capacity, am representing CNA Surety Corporation (the "Borrower") in connection
with its execution and delivery of a Credit Agreement dated as of September 30,
1997 (the "Agreement") among the Borrower, the Lenders named therein and The
Chase Manhattan Bank, as Administrative Agent for the Lenders, providing for
Advances in an aggregate principal amount not exceeding $130,000,000 at any one
time outstanding. All capitalized terms used in this opinion and not otherwise
defined shall have the meanings attributed to them in the Agreement. This
opinion is being delivered to the addressees at the request of the Borrower
pursuant to Section 4.1(g) of the Agreement.
I have examined originals, or copies certified or otherwise
identified to my satisfaction, of such corporate records, agreements,
instruments and documents of the Borrower and its Subsidiaries and certificates
and other statements of public officials and corporate officers, and have made
such other investigation of fact and law, as I have deemed necessary in
connection with the opinions set forth herein. In my examination, I have assumed
the genuineness of all documents submitted to me as originals and the conformity
to originals of all documents submitted to me as copies.
Based upon the foregoing, and subject to the comments and
exceptions hereinafter set forth, I am of the opinion that:
1. The Borrower and each Significant Subsidiary are
corporations duly incorporated, validly existing and in good standing under the
laws of their respective states of incorporation. The Borrower has all requisite
power and authority to conduct its business in each jurisdiction in which its
business is conducted.
<PAGE> 83
- 2 -
2. The execution and delivery of the Loan Documents by the
Borrower and the performance by the Borrower of the Obligations have been duly
authorized by all necessary corporate action and proceedings on the part of the
Borrower and will not:
(a) require any consent of the Borrower's shareholders;
(b) violate any law, rule, regulation, order, writ, judgment,
injunction, decree or award binding on the Borrower or any of its
Subsidiaries or the Borrower's articles of incorporation or by-laws or
any material indenture, instrument or agreement known to me and binding
upon the Borrower or any of its Subsidiaries; or
(c) result in, or require, the creation or imposition of any
Lien pursuant to the provisions of any material indenture, instrument
or agreement binding upon the Borrower or any of its Subsidiaries.
3. The Loan Documents have been duly executed and delivered by
the Borrower and constitute legal, valid and binding obligations of the Borrower
enforceable against the Borrower in accordance with their terms except to the
extent the enforcement thereof may be limited by bankruptcy, insolvency or
similar laws affecting the enforcement of creditors' rights generally and
subject also to the availability of equitable remedies if equitable remedies are
sought.
4. To my knowledge after due inquiry, there is no action,
suit, proceeding, governmental investigation or arbitration pending or
threatened against the Borrower or any of its Subsidiaries before any court or
arbitrator or any governmental or administrative body, agency or official which
(a) challenges the validity, or seeks to enjoin the performance of, the Loan
Documents or Reorganization Documents or the consummation of any of the Closing
Transactions or (b) could reasonably be expected to have a Material Adverse
Effect.
5. No approval, authorization, consent, adjudication or order
of any Governmental Authority, which has not been obtained by the Borrower or
any of its Subsidiaries, is required to be obtained by the Borrower or any of
its Subsidiaries in connection with the execution and delivery of the Loan
Documents, the borrowings under the Agreement, the Merger, or in connection with
the payment by the Borrower of the Obligations.
6. The Merger has become effective in accordance with the
terms of the Reorganization Documents and in compliance with applicable law.
<PAGE> 84
- 3 -
This opinion is limited to the law of the State of New York,
the General Corporation Law of the State of Delaware and the federal laws of the
United States of America.
This opinion may be relied on by any party that becomes a
Participant, Lender or Administrative Agent under the Agreement after the date
hereof pursuant to the Agreement.
Very truly yours,
<PAGE> 85
SCHEDULE I
THE CHASE MANHATTAN BANK
THE FIRST NATIONAL BANK OF CHICAGO
BANK OF MONTREAL
THE BANK OF NEW YORK
FLEET BANK, NATIONAL ASSOCIATION
MELLON BANK, N.A.
<PAGE> 86
EXHIBIT "E"
COMPLIANCE CERTIFICATE
To: The Lenders parties to the Credit Agreement Described Below
This Compliance Certificate is furnished pursuant to that
certain Credit Agreement dated as of September 30, 1997 (as amended, modified,
renewed or extended from time to time, the "Agreement") among the Borrower, the
lenders party thereto, The Chase Manhattan Bank, as Administrative Agent for the
Lenders. Unless otherwise defined herein, capitalized terms used in this
Compliance Certificate have the meanings ascribed thereto in the Agreement.
THE UNDERSIGNED HEREBY CERTIFIES THAT:
1. I am the duly elected_______________of the Borrower;
2. I have reviewed the terms of the Agreement and I have made,
or have caused to be made under my supervision, a detailed review of the
transactions and conditions of the Borrower and its Subsidiaries during the
accounting period covered by the attached financial statements;
3. The examinations described in paragraph 2 did not disclose,
and I have no knowledge of, the existence of any condition or event which
constitutes a Default or Unmatured Default during or at the end of the
accounting period covered by the attached financial statements or as of the date
of this Certificate, except as set forth below; and
4. Schedule I attached hereto sets forth financial data and
computations evidencing the Borrower's compliance with certain covenants of the
Agreement, all of which data and computations are true, complete and correct.
Described below are the exceptions, if any, to paragraph 3 by
listing, in detail, the nature of the condition or event, the period during
which it has existed and the action which the Borrower has taken, is taking, or
proposes to take with respect to each such condition or event:
____________________________________________________________
____________________________________________________________
____________________________________________________________
____________________________________________________________
<PAGE> 87
- 2 -
The foregoing certifications, together with the computations
set forth in Schedule I hereto and the financial statements delivered with this
Certificate in support hereof, are made and delivered this_____ day of________ ,
19___.
____________________________
<PAGE> 88
SCHEDULE I TO COMPLIANCE CERTIFICATE
Schedule of Compliance as of ________ __, ____ with
Provisions of Sections 6.14, 6.15 and 6.16 of
the Agreement
1. Section 6.14 - Consolidated Capitalization Ratio
A. Consolidated Indebtedness of
the Borrower and its Subsidiaries $__________
B. Consolidated Capitalization
(i) Consolidated Indebtedness of the
Borrower and its
Subsidiaries $__________
(ii) Consolidated Net Worth $__________
(iii) Sum of (i) and (ii) $__________
C. Ratio of A to B _______:1.0
D. Permitted Ratio Not greater than 0.40:1.0
Complies________________ Does Not Comply______________
2. Section 6.15 - Insurance Company Surplus as Regards Policyholders
A. Surplus as Regards Policyholders
of Insurance Subsidiaries $__________
B. Minimum Combined Surplus as
Regards Policyholders per Covenant $100,000,000
Complies_______________ Does Not Comply_______________
3. Section 6.13 - Combined Ratio of Net Written Premiums
to Capital and Surplus
A. Net Written Premiums $___________
B. Capital and Surplus $___________
C. Ratio of A to B ________:1.0
D. Permitted Ratio Not more than 3.0:1.0
Complies_______________ Does Not Comply_______________
<PAGE> 89
EXHIBIT "F"
[FORM OF ASSIGNMENT AND ACCEPTANCE]
ASSIGNMENT AND ACCEPTANCE
Reference is made to the Credit Agreement dated as of
September 30, 1997 (as amended and in effect on the date hereof, the "Credit
Agreement"), among CNA Surety Corporation, the Lenders named therein and The
Chase Manhattan Bank, as Administrative Agent for the Lenders. Terms defined in
the Credit Agreement are used herein with the same meanings.
The Assignor named on the reverse hereof hereby sells and
assigns, without recourse, to the Assignee named on the reverse hereof, and the
Assignee hereby purchases and assumes, without recourse, from the Assignor,
effective as of the Assignment Date set forth on the reverse hereof, the
interests set forth on the reverse hereof (the "Assigned Interest") in the
Assignor's rights and obligations under the Credit Agreement, including, without
limitation, the interests set forth on the reverse hereof in the Commitment of
the Assignor on the Assignment Date and Competitive Bid Loans and Ratable Loans
owing to the Assignor which are outstanding on the Assignment Date, but
excluding accrued interest and fees to and excluding the Assignment Date. The
Assignee hereby acknowledges receipt of a copy of the Credit Agreement. From and
after the Assignment Date (i) the Assignee shall be a party to and be bound by
the provisions of the Credit Agreement and, to the extent of the Assigned
Interest, have the rights and obligations of a Lender thereunder and (ii) the
Assignor shall, to the extent of the Assigned Interest, relinquish its rights
and be released from its obligations under the Credit Agreement.
This Assignment and Acceptance is being delivered to the
Administrative Agent together with (i) if the Assignee is not organized under
the laws of the United States of America, any documentation required to be
delivered by the Assignee pursuant to Section 2.17(b) of the Credit Agreement,
duly completed and executed by the Assignee, and (ii) if the Assignee is not
already a Lender under the Credit Agreement, an Administrative Questionnaire in
the form supplied by the Administrative Agent, duly completed by the Assignee.
The [Assignee/Assignor] shall pay the fee payable to the Administrative Agent
pursuant to Section 12.3.2 of the Credit Agreement.
This Assignment and Acceptance shall be governed by and
construed in accordance with the laws of the State of New York.
<PAGE> 90
- 2 -
Date of Assignment:
Legal Name of Assignor:
Legal Name of Assignee:
Assignee's Address for Notices:
Effective Date of Assignment
("Assignment Date")1:
Percentage
Principal Amount Assigned
Assigned (and (set forth, to at
identifying least 8 decimals, as a
information as to percentage of the
individual aggregate Commitments
Competitive of all Lenders
Facility Bid Loans) thereunder)
________ _________________ _______________________
Commitment Assigned: $ %
Ratable Loans:
Competitive Bid Loans:
The terms set forth above and on the reverse side hereof are hereby agreed to:
[NAME OF ASSIGNOR], as Assignor
By:__________________________________
Name:
Title:
[NAME OF ASSIGNEE], as Assignee
By:__________________________________
Name:
Title:
______________________________
1 Must be at least five Business Days after execution hereof by all required
parties.
<PAGE> 91
- 3 -
The undersigned hereby consent to the within assignment:2
CNA SURETY CORPORATION THE CHASE MANHATTAN BANK,
as Administrative Agent,
By:_________________________ By:_________________________
Name: Name:
Title: Title:
____________________
1 Consents to be incuded to the extent required by Section 9.04 (b) of the
Credit Agreement.
<PAGE> 92
SCHEDULE 1
COMMITMENTS
Lender Commitment
______ __________
THE CHASE MANHATTAN BANK $25,000,000
THE FIRST NATIONAL BANK OF CHICAGO $22,000,000
BANK OF MONTREAL $20,750,000
THE BANK OF NEW YORK $20,750,000
FLEET BANK, NATIONAL ASSOCIATION $20,750,000
MELLON BANK, N.A. $20,750,000
<PAGE> 93
SCHEDULE 5.3
APPROVALS AND CONSENTS
The Merger required the approval of the stockholders of Capsure Holdings. Such
approval was obtained at the special meeting of stockholders held on September
23, 1997.
<PAGE> 94
SCHEDULE 5.7
TAX MATTERS
None
<PAGE> 95
SCHEDULE 5.8
LITIGATION
None
<PAGE> 96
SCHEDULE 5.9
CAPITALIZATION AND SUBSIDIARIES
(a) CNA Surety Corporation Capitalization
The following table sets forth the consolidated capitalization of CNA
Surety Corporation as of June 30, 1997 on a pro-forma basis, adjusted to
give effect to the merger with Capsure Holdings and issuance of debt on
September 30, 1997 (in millions of dollars).
<TABLE>
<CAPTION>
As reported As reported PRO-FORMA
CCC Surety Adjusted
Capsure Operations CNA Surety
------- ---------- ----------
<S> <C> <C> <C>
Long-term Debt:
Revolving credit facility due March 31, 2003 54.0
Revolving credit facility due September 30, 2002 105.0
----- ----- -----
Total long-term debt 54.0 0.0 105.0
Stockholders' Equity:
Preferred stock
(CNA Surety: $0.01 par value; authorized 20,000,000;
issued and outstanding - 0 -)
Common stock 0.8
(CNA Surety; $0.01 par value; authorized 100,000,000;
issued and outstanding 43,880,708) 0.4
Additional paid-in capital 118.6 244.9
Retained earnings 9.8 0.0
Net unrealized gain on securities 0.3 0.0
----- ----- -----
Total stockholders equity 129.5 0.0 254.3
----- ----- -----
Total Capitalization 183.5 0.0 350.3
----- ----- -----
</TABLE>
(b) CNA Surety Corporation Subsidiaries
<TABLE>
<CAPTION>
State of % of Capital
Company Incorporation Stock Owned
- - ---------------------------------------- ------------- -----------
<S> <C> <C>
Capsure Holdings Corp. Delaware 100%
Capital Dredge & Dock Corp. Ohio 100%
Capsure Financial Group, Inc. Oklahoma 100%
NI Acquisition Corp. Texas 100%
Nucorp Management Company Ohio 100%
Nucorp Properties, Inc. Ohio 100%
Pin Oak Petroleum, Inc. Texas 100%
SI Acquisition Corp. Texas 100%
SMCI Incorporated Mississippi 100%
Surety Bonding Company of America South Dakota 100%
Surewest Financial Corp. Delaware 100%
Troy Fain Insurance, Inc. Florida 100%
Universal Surety Holding Corp. Texas 100%
Universal Surety of America Texas 100%
Western Surety Company South Dakota 100%
</TABLE>
<PAGE> 97
SCHEDULE 5.17
LIENS
None
<PAGE> 98
SCHEDULE 5.18
RESTRICTIVE AGREEMENTS
None
<PAGE> 99
SCHEDULE 6.13
EXISTING INDEBTEDNESS
1. Closing cash dividend to Capsure stockholders of $10.6 million. See
attached News Release.
2. Obligations under Employment Agreement as follows:
a. Employment Agreement as of the 30th day of September, 1995, by and
between Capsure Holdings Corp. and Bruce A. Esselborn.
b. Employment Agreement as of the 30th day of September, 1995, by and
between Caspsure Holdings Corp. and Mary Jane Robertson.
Upon the closing of the merger to form CNA Survey Corporation, the
Esselborn and Roberson employment contracts grant the employee the right,
at the employee's option, to have the Company make an option payment in
cash to the employee equal to the excess of the fair market value of the
employee's unexercised Capsure Options over the Capsure Options exercise
price. The cash payment for Capsure Options under the Esselborn and
Robertson employee agreements would be approximately $3.6 million.
<PAGE> 1
EXHIBIT 10.14
SURETY SECOND EXCESS OF LOSS
REINSURANCE CONTRACT
(HEREINAFTER REFERRED TO AS "CONTRACT")
EFFECTIVE DATE: OCTOBER 1, 1997
(hereinafter referred to as "Effective Date")
entered into by and between
WESTERN SURETY COMPANY
UNIVERSAL SURETY OF AMERICA
SURETY BONDING COMPANY OF AMERICA
(hereinafter collectively referred to as "Company")
and
CONTINENTAL CASUALTY COMPANY
(hereinafter referred to as "Reinsurer")
Witnesseth:
In consideration of the mutual covenants contained herein, and upon the terms
and conditions hereinafter set forth the Company and the Reinsurer hereby agree
as follows:
ARTICLE 1 - SCOPE OF THE CONTRACT
This Contract is solely between the Company and the Reinsurer. Performance of
respective obligations of each party under this Contract shall be rendered
solely to the other party, except as specifically and expressly provided for in
the Insolvency Article. The provisions of this Contract are intended solely
for the benefit of the parties to and executing this Contract, and nothing in
this Contract shall in any manner create, or be construed to create, any
obligations to or establish any rights against any party to this Contract in
favor of any third parties or other persons not parties to and executing this
Contract.
ARTICLE 2 - BUSINESS COVERED
The Company shall reinsure with the Reinsurer and the Reinsurer shall accept as
reinsurance from the Company the Company's net excess liability under the
surety business written or renewed and surety reinsurance assumed (hereinafter
referred to as Bonds) by the Company on behalf of Each Principal each Contract
Year hereunder in excess of $135,000.000.
Page 1 of 11
<PAGE> 2
ARTICLE 3 - RETENTION OF COMPANY & LIABILITY OF THE REINSURER
The retention of the Company and the liability of the Reinsurer and all other
benefits accruing to the Company, as provided in this Contract or any
amendments thereof, shall apply to the parties comprising the Company as a
group and not separately to each of the parties. Any payment by the Reinsurer
to any of the parties comprising the Company shall discharge the Reinsurer's
liability under this Contract to the extent of such payment with respect to
that loss.
Reinsurance hereunder shall be on an excess of loss basis and shall apply to
that portion of coverage which the Company retains net for its own account in
accordance with the provisions set forth under this Contract.
The Reinsurer shall pay to the Company the amount of loss in excess of the
Company's Retention of $135,000,000 any one Principal any one Contract Year.
It is understood and agreed that any underlying reinsurance maintained by the
Company on the business reinsured hereunder, including but not limited to
reinsurance ceded by the Company on a stop loss basis, shall not be deducted in
determining the Company's Retention, including amounts retained by the Company
or its affiliated companies under common management or common ownership.
ARTICLE 4 - COMMENCEMENT AND TERMINATION
The Contract shall take effect at 12:01AM, Central Standard Time, on the
Effective Date and shall remain in full force and effect until Midnight,
Central Standard Time, September 30, 2002 and provides cover for losses
discovered on Bonds in force at the Effective Date of this contract, and losses
discovered on new and renewal business written, renewed or assumed during the
term of this Contract all as respects business classified by the Company as
Surety Business as described in Article 2.
Upon termination of this Contract, the Reinsurer shall be liable for losses
discovered within three years after the effective date of termination on
business covered by this Contract and written, renewed or assumed prior to the
date of termination of this Contract.
ARTICLE 5 - DEFINITIONS
"Contract year" shall mean each year beginning with October 1, and ending with
September 30, both days inclusive.
"Each Principal" shall mean one or more firms or corporations under the same
management or control, or one or more persons or entities for whom bonds were
executed in reliance upon the indemnity of the same person, firm or
corporation, or in reliance upon the indemnity of a related group of persons,
firms or corporations.
"Net Written Premium" shall mean the Company's written premium on the business
covered hereunder net of applicable returns and cancellations and net of
premiums on inuring reinsurance.
Page 2 of 11
<PAGE> 3
"Loss(es) Discovered" shall mean that the Company shall have discovered a loss
when:
a) a claim or a collection of claims on the Bond business for Each Principal
exceeds $30,000,000, whether or not the Company has an incurred loss on
such principal through the establishment of a reserve or payment of loss
or allocated expenses; or
b) when the Company has incurred a loss of $30,000,000 or more for each
principal through the establishment of a reserve, payment of loss or
allocated expenses, assumption of a liability to prevent a default or a
combination thereof.
"Net Loss" shall mean all loss and allocated expense payments made by the
Company (1) in the investigation, defense, settlement, or mitigation of claims
or potential claims (including the prevention of defaults) on the Bond business
of Each Principal of the Company, and (2) in the recovery or attempted recovery
of such loss and expense payments, less salvage and subrogation. The Company's
office expenses and salaries of its employees are not allocated expenses. "Net
Loss" shall include extra contractual obligations and losses in excess of
original policy limits to the extent that any underlying excess of loss
reinsurance purchased by the Company covers such obligations and losses. It is
understood and agreed that any underlying reinsurance maintained by the Company
on the business reinsured hereunder, including but not limited to reinsurance
ceded by the Company on a stop loss basis, shall not be deducted in determining
the Company's Net Loss.
ARTICLE 6 - PREMIUM
The Company shall pay to the Reinsurer for each quarter that this Contract is
in force 1.0% of the Company's Net Written Premium during each such quarter for
those Bonds where the Company's aggregate exposure under the Bonds for Each
Principal for any Contract Year exceeds $135,000,000, subject to a minimum
premium of $5,000 for each such quarter.
ARTICLE 7 - REPORTS & REMITTANCES
Within 45 days after each calendar quarter that this Contract is in force, the
Company shall report to the Reinsurer its Net Written Premium for the business
covered hereunder for said quarter. The reinsurance rate set forth in Article
6 shall be used to determine the reinsurance premium. Said due calculated
premium, subject to the minimum premium, shall be remitted by the Company with
its report to the Reinsurer.
ARTICLE 8 - NOTICE OF LOSS & SETTLEMENTS
The Company shall investigate and settle or defend all claims and losses
including those involving the extension of credit or the advancement of money.
All payments of claims or losses by the Company within the sum or limits of its
Bonds and within the amount of reinsurance set forth in Article 3 shall be
binding on the Reinsurer, subject to the terms of this Contract.
Page 3 of 11
<PAGE> 4
The Reinsurer shall pay to the Company the Reinsurer's portion of net loss
within thirty days after receipt of the proof of loss from the Company. Any
subsequent changes in the amount of net loss shall be reported by the Company
to the Reinsurer, and the amount due either party shall be remitted within
thirty days after receipt of such report.
ARTICLE 9 - CO-SURETY
It is understood and agreed by the parties to this Contract that Continental
Casualty Company and any one of its affiliated insurers shall act as co-surety
as respects business covered by this Contract, when so requested by the
Company.
ARTICLE 10 - EXCESS OF ORIGINAL POLICY LIMITS
This Contract shall protect the Company as provided in Article 2 - Business
Covered in connection with loss in excess of the limit of the original policy,
such loss in excess of the limit having been incurred because of failure by the
Company to settle within the policy limit or by reason of alleged or actual
negligence, fraud or bad faith in rejecting an offer of settlement or in the
preparation of the defense or in the, trial of any action against its insured
or reinsured or in the preparation or prosecution of an appeal consequent upon
such action.
However, this Article shall not apply where the loss has been incurred due to
fraud by a member of the Board of Directors or a corporate officer of the
Company acting individually or collectively or in collusion with any individual
or corporation or any other organization or party involved in the presentation,
defense or settlement of any claim covered hereunder.
For the purpose of this Article, the word "loss" shall mean any amounts for
which the Company would have been contractually liable to pay had it not been
for the limit of the original policy. The date on which any Excess of Original
Policy Limit loss is incurred by the Company shall be deemed, in all
circumstances, to be the date of the original loss.
ARTICLE 11 - EXTRA CONTRACTUAL OBLIGATIONS
This Contract shall protect the Company as provided in Article 2 - Business
Covered where the loss includes any extra contractual obligations.
The term "Extra Contractual Obligations" is defined as those liabilities not
covered under any other provision of this Contract and which arise from the
handling of any claim on business covered hereunder, such liabilities arising
because of, but not limited to, the following: failure by the Company to settle
within the policy limit, or by reason of alleged or actual negligence, fraud or
bad faith in rejecting an offer of settlement or in preparation of the defense
or in the trial of any action against its insured or reinsured or in the
preparation or prosecution of an appeal consequent upon such action.
The date on which any Extra Contractual Obligation loss is incurred by the
Company shall be deemed, in all circumstances, to be the date of the original
loss.
Page 4 of 11
<PAGE> 5
However, this Article shall not apply where the loss has been incurred due to
fraud by a member of the Board of Directors or a corporate officer of the
Company acting individually or collectively or in collusion with any individual
or corporation or any other organization or party involved in the presentation,
defense or settlement of any loss covered hereunder.
ARTICLE 12 - SALVAGE & SUBROGATION
The Reinsurer shall be subrogated to the rights of the Company to the extent of
its loss payments to the Company. The Company agrees to enforce its rights of
salvage and subrogation by taking whatever action is necessary to recover its
loss from an obligee, principal, indemnitor, or any other party who caused or
contributed to its loss or part thereof, or to assign those rights to the
Reinsurer, unless enforcement is waived by the mutual consent of the Company
and the Reinsurer. Recoveries shall be distributed to the parties in an order
inverse to that in their liabilities accrued.
ARTICLE 13 - OFFSET
The Company or the Reinsurer shall have the right to offset any balance or
amounts due from one party to the other under the terms of this Contract or
under the Surety Quota Share Treaty, the Surety Excess of Loss Reinsurance
Contract and/or the Aggregate Stop Loss Contract between certain of the parties
hereto. The party asserting the right of offset may exercise such right at any
time whether the balances due are on account of premiums or losses. In the
instance of insolvency of one or more of the reinsured Companies, applicable
state law will apply.
ARTICLE 14 - CURRENCY
Whenever the word "Dollars" or the "$" sign appears in this Contract, they
shall be construed to mean United States Dollars and all transactions under
this Contract shall be in United States Dollars.
Amounts paid or received by the Company in any other currency shall be
converted to United States Dollars at the rate of exchange at the date such
transaction is entered on the books of the Company.
ARTICLE 15 - ACCESS TO RECORDS
The Company shall allow the Reinsurer to inspect, at reasonable times, the
records of the Company relevant to the business reinsured under this Contract,
including but not limited to Company files concerning premium, underwriting,
claims, losses or legal proceedings which involve or may involve the Reinsurer
and the Reinsurer may make copies of any records
Page 5 of 11
<PAGE> 6
pertaining thereto. This right of inspection, audit and information shall
survive termination of this Contract and shall run to the natural expiry of all
liabilities under the Bonds reinsured.
ARTICLE 16 - ERRORS AND OMISSIONS
Any inadvertent delay, omission or error shall not be held to relieve either
party hereto from any liability which would attach to it hereunder if such
delay, omission, or error had not been made, provided such omission or error is
rectified as soon as possible after discovery.
ARTICLE 17 - TAXES
The Reinsurer shall maintain the required reserves as to the Reinsurer's
portion of claims and losses. The Company shall be liable for all premium
taxes on business covered hereunder. If the Reinsurer is obligated to pay any
premium taxes on this business, the Company shall reimburse the Reinsurer,
however, the Company shall not be required to pay taxes twice of the same
premium.
ARTICLE 18 - INSOLVENCY
This reinsurance shall be payable by the Reinsurer on the basis of the
liability of the reinsured Company(ies) under Bonds reinsured hereunder without
diminution, because of the insolvency of one or more than one of the Companies,
to the Company(ies) or its liquidator, receiver, or statutory successor.
In the event of insolvency of one or more than one of the Companies, the
liquidator or receiver or statutory successor of the Company(ies) shall give
written notice to the Reinsurer of the pendency of a claim filed against the
Company(ies) on the Bond or Bonds reinsured within a reasonable time after such
claim is filed in the insolvency proceeding. During the pendency of such claim
the Reinsurer may investigate such claim and interpose, at its own expense, in
the proceeding where such claim is to be adjudicated, any defense or defenses
which it may deem available to the Company(ies) or its liquidator or receiver
or statutory successor. The expenses thus incurred by the Reinsurer shall be
chargeable, subject to court approval, against the Company(ies) as part of the
expense of liquidation to the extent of a proportionate share of the benefits
which may accrue to the Company(ies) solely as a result of the defense so
undertaken by the Reinsurer.
Should one or more than one of the Companies go into liquidation of should a
receiver be appointed, the Reinsurer shall be entitled to deduct from any sums
which may be or may become due to the Company(ies) any sums which are due to
the Reinsurer by the Company(ies) and which are payable at a fixed or stated
date under this Contract or under the Surety Quota Share Treaty, the Surety
Excess of Loss Reinsurance Contract and/or the Aggregate Stop Loss Reinsurance
Contract between certain of the parties hereto to the full extent permitted by
the laws of the insolvent party's state of domicile.
Page 6 of 11
<PAGE> 7
It is further understood and agreed that, in the event of the insolvency of one
or more than one of the Companies, the reinsurance under this Contract shall be
payable directly by the Reinsurer to the Company(ies) or to Its liquidator,
receiver or statutory successor, except a) where this Contract specifically
provides another payee of such reinsurance in the event of the insolvency of
the Company(ies) and b) where the Reinsurer with the consent of the direct
insured or insureds has assumed such Bond obligations of the Company(ies) as
direct obligations of the Reinsurer to the payees under such Bonds and in
substitution for the obligations of the Company(ies) to such payees.
In no event shall anyone other than the parties to this Contract or, in the
event of one or more than one of the Company's insolvency, its liquidator
receiver, or statutory successor, have any rights under this Contract.
ARTICLE 19 - AMENDMENTS
This Contract may be altered or amended in any of its terms and conditions by
mutual written consent of the Company and the Reinsurer. Such written mutual
consent will then constitute a part of this Contract.
ARTICLE 20 -ARBITRATION
As a condition precedent to any right of action hereunder, any dispute arising
out of the interpretation, performance or breach of this Contract, including
the formation or validity thereof, shall be submitted for decision to a panel
of three arbitrators. Notice requesting arbitration will be in writing and
sent certified mail, return receipt requested.
One arbitrator shall be chosen by each party and the two arbitrators shall,
before instituting the hearing, choose an impartial third arbitrator who shall
preside at the hearing. If either party falls to appoint its arbitrator within
thirty (30) days after being requested to do so by the other party, the latter,
after ten (10) days notice by certified mail of its intention to do so, may
appoint the second arbitrator.
If the two arbitrators are unable to agree upon the third arbitrator within
thirty (30) days of their appointment, the third arbitrator shall be selected
from a list of six individuals (three named by each arbitrator) by a judge of
the federal district court having jurisdiction over the geographical area in
which the arbitration is to take place, or if the federal court declines to
act, the state court having general jurisdiction in such area.
All arbitrators shall be disinterested active or former executive officers of
insurance or reinsurance companies or Underwriters at Lloyd's London.
Within thirty (30) days after notice of appointment of all arbitrators, the
panel shall meet and determine timely periods for briefs, discovery procedures
and schedules for hearings.
The panel shall be relieved of all judicial formality and shall not be bound by
the strict rules of procedure and evidence. Arbitration shall take place in
Sioux Falls, South Dakota, or a
Page 7 of 11
<PAGE> 8
location mutually agreed to by the panel. Insofar as the arbitration panel
looks to substantive law, it shall consider the law of the State of South
Dakota. The decision of any two arbitrators when rendered in writing shall be
final and binding. The panel is empowered to grant interim relief as it may
deem appropriate.
The panel shall make its decision considering the custom and practice of the
applicable insurance and reinsurance business as promptly as possible following
the termination of the hearings. Judgment upon the award may be entered in any
court having jurisdiction thereof.
Each party shall bear the expense of its own arbitrator and shall jointly and
equally bear with the other party the cost of the third arbitrator. The
remaining costs of the arbitration shall be allocated by the panel. The panel
may, at its discretion, award such further costs and expenses as it considers
appropriate, Including but not limited to attorneys fees, to the extent
permitted by law, The panel is prohibited from awarding punitive, exemplary or
treble damages, of whatever nature, in connection with any arbitration
proceeding concerning this Contact.
ARTICLE 21 - CHOICE OF LAW
This Contract, including all matters relating to formation, validity and
performance thereof, shall be interpreted in accordance with the law of the
State of South Dakota.
ARTICLE 22 - AGENCY
For purposes of sending and receiving notices and payments required by this
Contract, the reinsured Company that is set forth first in the Title section to
this Contract will be deemed the agent for all other reinsured companies
referenced in the Title of this Contract. In no event however, will any
reinsured Company be deemed the agent of the other with respect to the terms of
the Insolvency Article.
ARTICLE 23 - ENTIRE CONTRACT
This Contract, and that certain Services and Indemnity Agreement between the
parties dated September 30, 1997, represent the entire agreement and
understanding among the parties. No other oral or written agreements or
contracts relating to the risks reinsured hereunder currently exist and/or are
contemplated between the parties.
ARTICLE 24 - SEVERABILITY
If any law or regulation of any Federal, State, or Local Government of the
United States of America, or the ruling of officials having supervision over
insurance companies, should render illegal this Contract, or any portion
thereof, as to risks or properties located in the jurisdiction of such
authority, either the Company or the Reinsurer may upon written notice to the
other
Page 8 of 11
<PAGE> 9
suspend, abrogate, or amend this Contract insofar as it relates to risks or
properties located within such jurisdiction to such extent as may be necessary
to comply with such law, regulations, or ruling.
Such illegality, suspension, abrogation, or amendment of a portion of this
Contract shall in no way affect any other portion thereof.
ARTICLE 25 - HONORABLE UNDERTAKING
The purposes of this Contract are not to be defeated by narrow or technical
legal interpretations of its provisions. The Contract shall be construed as an
honorable undertaking and should be interpreted for the purpose of giving
effect to the real intentions of the parties hereto.
ARTICLE 26- NOTICES
Any notice relating to this Contract shall be in writing and shall be
sufficiently given if delivered by certified mail to the Reinsurer at the
following address:
Continental Casualty Company
Chief Financial Officer
Global Operations Department
CNA Plaza
Chicago, IL 60685
and to the Company at the following address:
Western Surety Company
Attention: Chief Executive Officer
Sioux Falls, South Dakota 57117-5077.
Page 9 of 11
<PAGE> 10
IN WITNESS WHEREOF the parties acknowledge that no intermediary is involved in
or brought about this transaction, and the parties hereto, by their authorized
representatives, have executed this Contract:
on this ______________________ day of ____________________________________1997
WESTERN SURETY COMPANY
By: __________________________________________________________________________
Title: _______________________________________________________________________
Attested by: _________________________________________________________________
UNIVERSAL SURETY OF AMERICA
By: __________________________________________________________________________
Title: _______________________________________________________________________
Attested by: _________________________________________________________________
SURETY BONDING COMPANY OF AMERICA
By: __________________________________________________________________________
Title: _______________________________________________________________________
Attested by: _________________________________________________________________
Page 10 of 11
<PAGE> 11
and on this ____________________ day of ___________________________________ 1997
CONTINENTAL CASUALTY COMPANY
By: _______________________________________________________________________
Title: ______________________________________________________________________
Attested by: _________________________________________________________________
SURETY SECOND EXCESS OF LOSS
REINSURANCE CONTRACT
(REFERRED TO AS "CONTRACT")
EFFECTIVE DATE: OCTOBER 1, 1997
(REFERRED TO AS "EFFECTIVE DATE")
ENTERED INTO BY AND BETWEEN
WESTERN SURETY COMPANY
UNIVERSAL SURETY OF AMERICA
SURETY BONDING COMPANY OF AMERICA
(COLLECTIVELY REFERRED TO AS "COMPANY")
AND
CONTINENTAL CASUALTY COMPANY
(REFERRED TO AS "REINSURER")
Page 11 of 11
<PAGE> 1
EXHIBIT 10(15)
CNA SURETY CORPORATION
NON-EMPLOYEE DIRECTORS DEFERRED
COMPENSATION PLAN
<PAGE> 2
CNA SURETY CORPORATION
NON-EMPLOYEE DIRECTORS DEFERRED COMPENSATION PLAN
The CNA Surety Corporation Non-Employee Directors Deferred Compensation
Plan ("Plan"), is hereby established by CNA Surety Corporation, a Delaware
corporation (the "Company"), effective as of January 1, 1998, subject to
approval of the Company's shareholders.
1. PURPOSES
The purposes of the Plan are to enable the Company to attract, retain and
motivate the best-qualified directors and to enhance a long-term mutuality of
interest between the directors and shareholders of the Company by providing
directors with an opportunity to defer the receipt of certain director's fees
and have deemed invested in Stock Units (as defined below).
2. DEFINITIONS
Unless the context requires otherwise, the following words as used in the
Plan shall have the meanings specified below:
(a) "Annual Meeting" means the annual meeting of the shareholders of the
Company.
(b) "Annual Retainer" means the aggregate amount of any annual retainer
fees that are payable from time to time by the Company to a Participant in cash
for any services to be performed by the Participant as a member of the Board or
any committee thereof, but excludes any meeting fees for attending meetings of
the Board or a Board committee.
(c) "Beneficiary" means the person or persons who under the Plan becomes
entitled to receive a Participant's interest in the event of the Participant's
death and who has been designated as such by a Participant in a written notice
received by the Company before such Participant's death.
(d) "Board" means the Board of Directors of the Company.
(e) "Code" means the Internal Revenue Code of 1986, as amended.
(f) "Common Stock" means the common stock of the Company, par value $0.01.
(g) "Company" means CNA Surety Corporation, a Delaware corporation.
(h) "Deferral Notice" -- see Section 5(a).
<PAGE> 3
(i) "Deferred Compensation Account" means the account(s) maintained on the
books of the Company for each Participant.
(j) "Determination Date" means the date on which the amount of a
Participant's Deferred Compensation Account is determined as provided in
Section 5 hereof. Each business day shall be a Determination Date.
(k) "Disability" means a mental or physical condition which, in the
judgment of the Board, renders a Participant unable to carry out his or her
responsibilities as a director of the Company, and which condition is expected
to be permanent or for an indefinite duration exceeding one year.
(l) "Effective Date" means January 1, 1998, subject to the approval of the
shareholders of the Company at the 1998 annual meeting of shareholders.
(m) "Exchange Act" means the Securities Exchange Act of 1934, as amended.
(n) "Fair Market Value" as of any date means the closing price of a Share
on such date (or, if no sale of Shares was reported for such date, on the next
preceding date on which a sale of Shares was reported) as reported in the
principal consolidated transaction reporting system for the New York Stock
Exchange (or, if the Common Stock is not listed on the New York Stock Exchange,
on such other national exchange or the over-the-counter market on which the
Common Stock is principally traded); provided that if such Fair Market Value as
of any date cannot be so determined, such Fair Market Value shall be determined
by the Board by whatever means or method as it, in the good faith exercise of
its discretion, shall at such time deem appropriate.
(o) "including" means including without limitation.
(p) "Participant" means, as of any date, a person who, at the close of
business on such date, is director of the Company, but is not an employee of
the Company or any Subsidiary.
(q) "Plan" means the CNA Surety Corporation Director Deferred Compensation
Plan, as set forth herein and as may be amended from time to time.
(r) "Securities Act" means the Securities Act of 1933, as amended.
(s) "Share" means a share of Common Stock.
(t) "Stock Units" -- see Section 5(c).
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<PAGE> 4
3. ADMINISTRATION
(a) Rules; Interpretation; Determinations. Subject to the provisions of
the Plan, the Board has full authority to interpret and administer the Plan, to
establish, amend and rescind rules for carrying out the Plan, to construe
agreements and to make all other determinations and to take all other actions
that it deems necessary or desirable for administering the Plan; provided,
however, that no such interpretation, rule or determination shall change
criteria for the determination of Participants in the Plan, the amount of
deferrals permitted or the amount or frequency of any award that may be granted
under the Plan (except for changes that result solely from changes in the
amount of the Annual Retainer). Each determination, interpretation or other
action made or taken by the Board shall be final and binding for all purposes
and upon all persons. The Board may delegate any or all of its powers and
functions under the Plan (other than the power to amend the Plan pursuant to
Section 7(b)) to a committee of the Board.
(b) Agents; Expenses. The Board may appoint agents (who may be employees
of the Company) to assist in the administration of the Plan, and may authorize
such persons to execute agreements or other documents on its behalf. The Board
may employ such legal counsel, consultants and agents as it may deem desirable
for the administration of the Plan, and may rely upon any opinion received from
any such counsel or consultant and any computation received from any such
consultant or agent. All expenses incurred in the administration of the Plan,
including for the engagement of any counsel, consultant or agent, shall be paid
by the Company.
(c) No Liability. No director or former director or any agent designated
pursuant to Section 3(b) shall be liable for any action or determination made
in good faith with respect to the Plan or any Award.
4. SHARES; ADJUSTMENT UPON CERTAIN EVENTS
(a) Shares. Shares to be issued or delivered under the Plan may consist,
in whole or in part, of treasury shares or authorized but unissued Shares not
reserved for any other purpose. The aggregate number of Shares that may be
delivered under the Plan shall not exceed ____________, except as provided in
this Section.
(b) Certain Adjustments. In the event of any stock dividend or stock
split, recapitalization, merger, consolidation, combination, spin-off,
distribution of assets to shareholders (other than ordinary cash dividends),
exchange of shares, or other similar corporate change, the Board shall
appropriately adjust the aggregate number of Shares available under the Plan.
The Board's determination shall be conclusive.
-3-
<PAGE> 5
5. DEFERRED COMPENSATION PROGRAM
(a) Deferral Election. On or before December 31 of any calendar year
ending on or before December 31, 2007, a Participant may elect to defer receipt
of all or any specified portion, in multiples of 10%, of the cash portion of
any Annual Retainer payable in respect of the calendar year following the year
in which such election is made, and to have such amounts credited to such
Participant's Deferred Compensation Account. Any person who shall become a
Participant during any calendar year may elect, not later than the 30th day
after his or her term as a director begins, to defer payment of all or any
portion of his or her Annual Retainer payable for the portion of such calendar
year following such election. Also, Deferral Elections as to the 1998 Annual
Retainer may be made in any event up to the 30th day following adoption of the
Plan by the Board.
(b) Form and Duration of Deferral Election. A deferral election shall be
made by written notice (a "Deferral Notice") filed with the Secretary of the
Company. Such Deferral Notice (including the Distribution Election thereunder)
shall continue in effect (including with respect to the Annual Retainer, if
any, payable for subsequent calendar years ending no later than December 31,
2007) unless and until the Participant revokes or modifies such election by
filing a new Deferral Notice with the Secretary of the Company. Any such
revocation or modification of a Deferral Notice shall become effective as of
the end of the calendar year in which such notice is given and only with
respect to the Annual Retainer, if any, payable for services rendered after
such effectiveness. Amounts credited to the Participant's Deferred
Compensation Account prior to the effective date of any such revocation or
modification of a Deferral Notice shall not be affected by such revocation or
modification and shall be distributed only in accordance with the otherwise
applicable terms of the Plan. A Participant who has revoked an election to
participate in the Plan may file a new election to defer the Annual Retainer,
if any, payable for services to be rendered in the calendar year following the
year in which such new election is filed.
(c) Determination of Value of Account. The value of a Participant's
Deferred Compensation Account as of any date shall consist of the value of the
Participant's Deferred Compensation Account as of the immediately preceding
Determination Date, plus the Participant's deferrals pursuant to Section 5(a)
since the immediately preceding Determination Date, reduced by the amount of
all distributions, if any, made from such Deferred Compensation Account since
the preceding Determination Date, and adjusted for the appropriate investment
earnings and gains and/or losses and expenses pursuant to this Section 5(c)
since the preceding Determination Date. Adjustments for earnings and gains
and/or losses and expenses shall be made after the Deferred Compensation
Account has been adjusted for any additions or distributions to be credited or
deducted since the preceding Determination Date.
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<PAGE> 6
(d) Deferred Compensation Account Adjustments. Deferred Compensation
Accounts shall be deemed invested in Company Common Stock Units. The amount
deferred pursuant to a Participant's Deferral Election shall initially be
deemed invested in a number of notional Shares (the "Stock Units") equal to the
quotient of (i) the amount deemed invested divided by (ii) the Fair Market
Value on the date the amount is deemed so invested. Fractional Stock Units
shall be credited, but shall be rounded to the nearest one-hundredth, with
amounts equal to or greater than .005 rounded up and amounts less than .005
rounded down. Whenever a dividend (other than a dividend payable in the form
of Shares) is declared with respect to the outstanding Shares, the number of
Stock Units credited to the Participant's Deferred Compensation Account shall
be increased by the number of Stock Units determined by dividing (i) the
product of (A) the number of Stock Units credited to the Participant's Deferred
Compensation Account on the related dividend record date and (B) the amount of
any cash dividend declared by the Company on a Share (or, in the case of any
dividend distributable in property other than Shares, the per share value of
such dividend, as determined by the Company for purposes of income tax
reporting) by (ii) the Fair Market Value on the related dividend payment date.
In the case of any dividend declared on Shares which is payable in Shares, the
amount credited to a Participant's Deferred Compensation Account shall be
increased by the number of Stock Units equal to the product of (i) the number
of Stock Units credited to the Participant's Deferred Compensation Account on
the related dividend record date and (ii) the number of Shares (including any
fraction thereof) distributable as a dividend on a Share. In the event
of any change in the number or kind of outstanding Shares by reason of any
recapitalization, reorganization, merger, consolidation, stock split or any
similar change affecting the Shares, other than a stock dividend as provided
above, the Company shall make an appropriate adjustment in the number of Stock
Units credited to the Participant's Deferred Compensation Account.
The Company may, but is under no obligation to acquire any investment or
otherwise set aside assets for the deemed investment of Deferred Compensation
Accounts hereunder. The Company shall determine the amount and rate of
investment gains or losses with respect to any such investment option for any
period, and may take into account deemed expenses which would be incurred if
actual investments were made.
(e) Vesting of Deferred Compensation Accounts. A Participant shall be
100% vested in the value of his or her Deferred Compensation Account at all
times.
(f) Distribution Elections. At the time a Participant makes a deferral
election pursuant to Section 5(a), the Participant shall also include in the
Deferral Notice a written election (a "Distribution Election") with respect to
the following:
(i) whether the distribution to such Participant shall commence (A)
on the first business day of any calendar year specified by the Participant that
is more than 24 months after the month in which the Participant's last deferral
under the applicable Deferral Notice
-5-
<PAGE> 7
was made, or (B) immediately following the date the Participant ceases
to be a director; provided that in no event shall distribution of any deferred
amount be made until at least six months have elapsed after such deferral is
credited to the Participant's Deferred Compensation Account; and
(ii) whether such distribution shall be in one lump sum payment or
in such number of annual installments (not to exceed ten) as the Participant may
designate.
The Distribution Election may be modified in accordance with the procedures set
forth in Section 5(b); provided that any such modification shall be effective
with respect to only distributions relating to deferrals of Annual
Retainer for services rendered in the year or years after the year in which the
Distribution Election is modified.
(g) Manner of Plan Distributions. Each distribution to or for the account
of a Participant from the Deferred Compensation Account shall be made in
accordance with the Distribution Election made by such Participant in
accordance with Section 5(f) and shall be paid in whole shares of Common Stock,
with the value of any fractional share of Common Stock (rounded to the next
lowest one-hundredth of a dollar) payable in cash; provided, however, that if a
Participant elected a distribution in accordance with Section 5(f)(i)(A) and
the year of such Participant's termination of service on the Board occurs prior
to the year designated pursuant to Section 5(f)(i)(A), the entire value of the
Participant's Deferred Compensation Account shall be distributed in a lump sum
in the year of such termination of service, but at least six months following
the last date an amount of deferred fees is credited to such Participant's
Deferred Compensation Account. If a Participant has failed to specify a
commencement date for a distribution in accordance with Section 5(f), such
distribution shall be made immediately following the date the Participant
ceases to be a director, or, if later, the first business day occurring more
than six months following the last date an amount of deferred fees is credited
to such Participant's Deferred Compensation Account. If a Participant has
failed to specify in accordance with Section 5(f) that a distribution shall be
made in a lump-sum payment or a number of installments, such distribution shall
be made in a lump-sum payment. In the case of any distribution being made in
annual installments, each installment after the first installment shall be paid
on the first business day of each subsequent calendar year until the entire
amount subject to such installment Distribution Election shall have been paid.
6. NONTRANSFERABILITY OF DEFERRED COMPENSATION ACCOUNTS
A Participant's Deferred Compensation Account shall not be transferable by
the Participant otherwise than by will or under the applicable laws of descent
and distribution. In addition, no portion of a Participant's Deferred
Compensation Account shall be assigned, negotiated, or pledged in any way
(whether by operation of law or otherwise),
-6-
<PAGE> 8
and no portion of a Participant's Deferred Compensation Account shall be
subject to execution, attachment or similar process.
7. EFFECTIVENESS, TERMINATION AND AMENDMENT
(a) The Plan shall become effective on the Effective Date and shall
terminate at the close of business of December 31, 2007, unless sooner
terminated pursuant to paragraph (b) below; provided that amounts deferred
prior to December 31, 2007 to be deferred shall continue to be deferred in
accordance with the terms of the Plan.
(b) The Board at any time or from time to time may amend or terminate the
Plan without the approval of the shareholders of the Company; provided that (i)
any amendment of the Plan shall be subject to the approval of the shareholders
of the Company to the extent that such approval is then required under the
listing requirements of any securities exchange on which the Common Stock
is then listed and (ii) no termination, amendment or modification of the
Plan may, without the consent of a Participant, impair the rights and
obligations of such Participant arising under any then-outstanding Deferred
Compensation Account.
8. GENERAL PROVISIONS
(a) No Right to Remain as a Director. The existence of Plan shall not
obligate the Company or its shareholders to retain any Participant as a
director nor shall it obligate any Participant to remain as a director of the
Company; provided that, by accepting any Award, a Participant shall represent
to the Company that it is the Participant's good faith intention to continue to
serve as a director of the Company until the next Annual Meeting.
(b) Investment Representation; Registration. If the Board determines that
the law so requires, a Participant (or his or her Beneficiary) shall, upon any
distribution of Common Stock from a Participant's Deferred Compensation
Account, execute and deliver to the Company a written statement, in form
satisfactory to the Company, representing and warranting that he or she is
accepting the Shares then acquired for his or her own account and not with a
view to the resale or distribution thereof, that any subsequent offer for sale
or sale of any such Shares shall be made either pursuant to (i) an effective
registration statement under the Securities Act, or (ii) an exemption from the
registration requirements of such Act, as provided in a favorable written
opinion from counsel approved by the Company as to the availability of such
exemption.
(c) No Right to Specific Assets. Nothing contained in the Plan and no
action taken pursuant to the Plan shall create a trust of any kind or any
fiduciary relationship between the Company and any Participant, the executor,
administrator or other personal
-7-
<PAGE> 9
representative or Beneficiary of such Participant, or any other
persons; provided, however, that the Company may at any time establish one or
more trusts to pay benefits under the Plan; provided, further, that to the
extent that payments are made from such trust, such payments will satisfy the
Company's obligations under the Plan. To the extent that any Participant or
his or her Beneficiary executor, administrator, or other personal
representative, as the case may be, acquires a right to receive any payment
from the Company pursuant to the Plan, such right shall be no greater than the
right of an unsecured general creditor of the Company.
(d) Rights as a Shareholder. A Participant shall have no rights as a
shareholder of the Company with respect to any Share Units credited to his or
her Deferred Compensation Account until he or she shall have received Shares on
distribution of his or her Deferred Compensation Account.
(e) Non-Exclusivity. The adoption of the Plan shall not limit the power
of the Board to adopt any other incentive arrangements it may deem desirable
otherwise than under the Plan.
(f) Legends. Certificates for Shares issued upon pursuant to the Plan
shall bear such legend or legends as the Company, in its discretion, determines
to be necessary or appropriate to prevent a violation of, or to perfect an
exemption from, the registration requirements of the Securities Act.
(g) Necessary Approvals. If at any time the Board shall determine in its
discretion that the listing, registration or qualification of the Shares
covered by the Plan upon any national securities exchange or under any state or
federal law, or the consent or approval of any governmental regulatory body, is
necessary or desirable as a condition of, or in connection with, the sale of
Shares under the Plan, no Shares will be delivered unless and until such
listing, registration, qualification, consent or approval shall have been
effected or obtained, or otherwise provided for, free of any conditions not
acceptable to the Board.
(h) Withholding Taxes. The Company shall have the right to make such
provisions as it deems necessary or appropriate to satisfy any obligations it
may have to withhold federal, state or local income or other taxes in
connection with any distribution from a Deferred Compensation Account. In lieu
thereof, the Company shall have the right to withhold the amount of such taxes
from any other sums due or to become due from the Company to the Participant
upon such terms and conditions as the Board may prescribe.
(i) Severability. If any part of the Plan is declared by any court or
governmental authority to be unlawful or invalid, such unlawfulness or
invalidity shall not invalidate any other part of the Plan. Any Section or
part of a Section so declared to be unlawful or invalid shall, if possible, be
construed in a manner which will give effect to the terms of such Section or
part of a Section to the fullest extent possible while remaining lawful and
valid.
-8-
<PAGE> 10
(j) Headings and Captions. The headings and captions herein are provided
for reference and convenience only, shall not be considered part of the Plan,
and shall not be employed in the construction of the Plan.
(k) Controlling Law. The Plan shall be construed and enforced according
to the laws of the State of Illinois, excluding the conflict of laws principles
thereof.
CNA SURETY CORPORATION
By:
------------------------
------------------------
------------------------
-9-
<PAGE> 1
EXHIBIT 15
June 3, 1998
CNA Surety Corporation
CNA Plaza
Chicago, Illinois
We have made a review, in accordance with standards established by the American
Institute of Certified Public Accountants, of the unaudited interim financial
information of CNA Surety Corporation and subsidiaries for the period ended
March 31, 1998 and CCC Surety Operations (the Predecessor), a unit of CNA
Financial Corporation, for the period ended March 31, 1997, as indicated in our
report dated May 12, 1998; because we did not perform an audit, we expressed no
opinion on that information.
We are aware that our report referred to above, which was included in the
Quarterly Report of CNA Surety Corporation on Form 10-Q for the quarter ended
March 31, 1998, is being used in this Registration Statement.
We also are aware that the aforementioned report, pursuant to Rule 436(c) under
the Securities Act of 1933, is not considered a part of the Registration
Statement prepared or certified by an accountant or a report prepared or
certified by an accountant within the meaning of Sections 7 and 11 of that Act.
DELOITTE & TOUCHE LLP
Chicago, Illinois
<PAGE> 1
EXHIBIT 21
CNA SURETY CORPORATION AND SUBSIDIARIES
AS OF DECEMBER 31, 1997
<TABLE>
<CAPTION>
INCORPORATED
COMPANY IN
- - ------- ------------
<S> <C>
CNA Surety Corporation ........................................ Delaware
Capsure Holdings Corp. (f/k/a Nucorp, Inc.) ................... Delaware
Capsure Financial Group, Inc. ............................... Oklahoma
(f/k/a/ Nucorp Energy of Oklahoma, Inc.)
NI Acquisition Corp. .................................... Texas
SI Acquisition Corp. .................................... Texas
Surewest Financial Corp. ............................ Delaware
Surety Bonding Company of America ................. South Dakota
Western Surety Company ............................ South Dakota
Troy Fain Insurance, Inc. ....................... Florida
Universal Surety Holding Corp. .......................... Texas
Universal Surety of America ......................... Texas
</TABLE>
<PAGE> 1
EXHIBIT 23 (1)
INDEPENDENT AUDITORS' CONSENT
We consent to the use in this Registration Statement of CNA Surety Corporation
on Form S-1 of our report dated February 27, 1998, appearing in the Prospectus,
which is part of this Registration Statement, on our audit of the consolidated
balance sheet of CNA Surety Corporation and subsidiaries as of December 31, 1997
and the related consolidated statements of income, changes in stockholders'
equity, and cash flows for the period from September 30, 1997 (date of
inception) through December 31, 1997, and the related financial statement
schedules, as well as the special-purpose statement of certain assets and
liabilities of CCC Surety Operations, a business unit of CNA Financial
Corporation, as of December 31, 1996 and the special-purpose statements of
certain revenues and direct operating expenses for each of the two years in the
period ended December 31, 1996 and for the nine month period ended September 30,
1997. Our report on the foregoing special-purpose financial statements expresses
an unqualified opinion and includes an explanatory paragraph relating to the
basis of presentation.
We also consent to the reference to us under the heading "Experts" in such
Prospectus.
DELOITTE & TOUCHE LLP
Chicago, Illinois
June 3, 1998
<PAGE> 1
Exhibit 23(3)
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the inclusion in this registration statement of CNA Surety
Corporation on Form S-1 (File No. 333- ) of our report dated February 20,
1997, on our audits of the consolidated financial statements and financial
statement schedules of Capsure Holdings Corp. and Subsidiaries as of December
31, 1996 and 1995, and for the years ended December 31, 1996, 1995, and 1994.
We also consent to the reference to our firm under the caption "Experts."
Coopers & Lybrand L.L.P.
Chicago, Illinois
June 4, 1998
<PAGE> 1
State of Illinois )
) SS
County of Cook )
KNOW ALL MEN BY THESE PRESENTS that Giorgio Balzer, having an address
at Business Mens Assurance Co. of America, BMA Tower, Kansas City, MO, 64141,
has made, constituted and appointed and BY THESE PRESENTS, does make, constitute
and appoint Sandra D. Wagman, having an address at CNA, 333 South Wabash,
Chicago, IL, 60685, his true and lawful Attorney-in-fact for him and in his
name, place and stead to sign and execute in any and all capacities the Form S-1
and any or all amendments to the Form S-1, and to file the same with all
exhibits thereto, and other documents in connections therewith, with the
Securities and Exchange Commission, giving and granting unto Sandra D. Wagman,
said attorney-in-fact, full power and authority to do and perform each and every
act and thing, requisite and necessary to be done in and about the premises, as
fully, to all intents and purposes as he might or could do if personally present
at the doing thereof, with full power of substitution and revocation, hereby
ratifying and confirming all that said Attorney-in-fact or her substitutes shall
lawfully do or cause to be done by virtue hereof.
This Power of Attorney shall remain in full force and effect until
terminated by the undersigned through the instrumentality of a signed writing.
IN WITNESS THEREOF, Giorgio Balzer has hereunto set his hand this 19th
day of May, 1998.
/s/ Giorgio Balzer
-------------------------------------
Giorgio Balzer
I, Patricia Pochron, a Notary Public in and for said county in the
state aforesaid, do hereby certify that Giorgio Balzer, personally known to me
to be the same person whose name is subscribed to the foregoing instrument
appeared before me this day in person and acknowledged that he signed and
delivered said instrument as his own free and voluntary act for the uses and
purposes therein set forth.
Given under my hand and notarial seal this 19th day of May, 1998.
/s/ Patricia Pochron
-------------------------------------
Notary Public
My Commission Expires: 3-7-2001
------------
<PAGE> 2
State of Illinois )
) SS
County of Cook )
KNOW ALL MEN BY THESE PRESENTS that Philip H. Britt, having an address
at First Chicago NBD, One First National Plaza, Suite 0085, Chicago, IL, 60670,
has made, constituted and appointed and BY THESE PRESENTS, does make, constitute
and appoint Sandra D. Wagman, having an address at CNA, 333 South Wabash,
Chicago, IL, 60685, his true and lawful Attorney-in-fact for him and in his
name, place and stead to sign and execute in any and all capacities the Form S-1
and any or all amendments to the Form S-1, and to file the same with all
exhibits thereto, and other documents in connections therewith, with the
Securities and Exchange Commission, giving and granting unto Sandra D. Wagman,
said attorney-in-fact, full power and authority to do and perform each and every
act and thing, requisite and necessary to be done in and about the premises, as
fully, to all intents and purposes as he might or could do if personally present
at the doing thereof, with full power of substitution and revocation, hereby
ratifying and confirming all that said Attorney-in-fact or her substitutes shall
lawfully do or cause to be done by virtue hereof.
This Power of Attorney shall remain in full force and effect until
terminated by the undersigned through the instrumentality of a signed writing.
IN WITNESS THEREOF, Philip H. Britt has hereunto set his hand this 19th
day of May, 1998.
/s/ Philip H. Britt
-------------------------------------
Philip H. Britt
I, Patricia Pochron, a Notary Public in and for said county in the
state aforesaid, do hereby certify that Philip H. Britt, personally known to me
to be the same person whose name is subscribed to the foregoing instrument
appeared before me this day in person and acknowledged that he signed and
delivered said instrument as his own free and voluntary act for the uses and
purposes therein set forth.
Given under my hand and notarial seal this 19th day of May, 1998.
/s/ Patricia Pochron
-------------------------------------
Notary Public
My Commission Expires: 3-7-2001
-------------
<PAGE> 3
State of Illinois )
) SS
County of Cook )
KNOW ALL MEN BY THESE PRESENTS that Rod F. Dammeyer, having an address
at Equity Group Investments, Inc., Two North Riverside Plaza, Suite 600,
Chicago, IL, 60606, has made, constituted and appointed and BY THESE PRESENTS,
does make, constitute and appoint Sandra D. Wagman, having an address at CNA,
333 South Wabash, Chicago, IL, 60685, his true and lawful Attorney-in-fact for
him and in his name, place and stead to sign and execute in any and all
capacities the Form S-1 and any or all amendments to the Form S-1, and to file
the same with all exhibits thereto, and other documents in connections
therewith, with the Securities and Exchange Commission, giving and granting unto
Sandra D. Wagman, said attorney-in-fact, full power and authority to do and
perform each and every act and thing, requisite and necessary to be done in and
about the premises, as fully, to all intents and purposes as he might or could
do if personally present at the doing thereof, with full power of substitution
and revocation, hereby ratifying and confirming all that said Attorney-in-fact
or her substitutes shall lawfully do or cause to be done by virtue hereof.
This Power of Attorney shall remain in full force and effect until
terminated by the undersigned through the instrumentality of a signed writing.
IN WITNESS THEREOF, Rod F. Dammeyer has hereunto set his hand this 19th
day of May, 1998.
/s/ Rod F. Dammeyer
-------------------------------------
Rod F. Dammeyer
I, Patricia Pochron, a Notary Public in and for said county in the
state aforesaid, do hereby certify that Rod F. Dammeyer, personally known to me
to be the same person whose name is subscribed to the foregoing instrument
appeared before me this day in person and acknowledged that he signed and
delivered said instrument as his own free and voluntary act for the uses and
purposes therein set forth.
Given under my hand and notarial seal this 19th day of May, 1998.
/s/ Patricia Pochron
-------------------------------------
Notary Public
My Commission Expires: 3-7-2001
--------------
<PAGE> 4
State of Illinois )
) SS
County of Cook )
KNOW ALL MEN BY THESE PRESENTS that Melvin Gray, having an address at
Graycor, Inc., 1 Graycor Drive, Homewood, IL, 60430, has made, constituted and
appointed and BY THESE PRESENTS, does make, constitute and appoint appoint
Sandra D. Wagman, having an address at CNA, 333 South Wabash, Chicago, IL,
60685, his true and lawful Attorney-in-fact for him and in his name, place and
stead to sign and execute in any and all capacities the Form S-1 and any or all
amendments to the Form S-1, and to file the same with all exhibits thereto, and
other documents in connections therewith, with the Securities and Exchange
Commission, giving and granting unto Sandra D. Wagman, said attorney-in-fact,
full power and authority to do and perform each and every act and thing,
requisite and necessary to be done in and about the premises, as fully, to all
intents and purposes as he might or could do if personally present at the doing
thereof, with full power of substitution and revocation, hereby ratifying and
confirming all that said Attorney-in-fact or her substitutes shall lawfully do
or cause to be done by virtue hereof.
This Power of Attorney shall remain in full force and effect until
terminated by the undersigned through the instrumentality of a signed writing.
IN WITNESS THEREOF, Melvin Gray has hereunto set his hand this 19th day
of May, 1998.
/s/ Melvin Gray
-------------------------------------
Melvin Gray
I, Patricia Pochron, a Notary Public in and for said county in the
state aforesaid, do hereby certify that Melvin Gray, personally known to me to
be the same person whose name is subscribed to the foregoing instrument appeared
before me this day in person and acknowledged that he signed and delivered said
instrument as his own free and voluntary act for the uses and purposes therein
set forth.
Given under my hand and notarial seal this 19th day of May, 1998.
/s/ Patricia Pochron
-------------------------------------
Notary Public
My Commission Expires: 3-7-2001
--------------
<PAGE> 5
State of Illinois )
) SS
County of Cook )
KNOW ALL MEN BY THESE PRESENTS that Joe P. Kirby, having an address at
Western Surety Company, 101 South Phillips Avenue, Sioux Falls, South Dakota,
57102, has made, constituted and appointed and BY THESE PRESENTS, does make,
constitute and appoint Sandra D. Wagman, having an address at CNA, 333 South
Wabash, Chicago, IL, 60685, his true and lawful Attorney-in-fact for him and in
his name, place and stead to sign and execute in any and all capacities the Form
S-1 and any or all amendments to the Form S-1, and to file the same with all
exhibits thereto, and other documents in connections therewith, with the
Securities and Exchange Commission, giving and granting unto Sandra D. Wagman,
said attorney-in-fact, full power and authority to do and perform each and every
act and thing, requisite and necessary to be done in and about the premises, as
fully, to all intents and purposes as he might or could do if personally present
at the doing thereof, with full power of substitution and revocation, hereby
ratifying and confirming all that said Attorney-in-fact or her substitutes shall
lawfully do or cause to be done by virtue hereof.
This Power of Attorney shall remain in full force and effect until
terminated by the undersigned through the instrumentality of a signed writing.
IN WITNESS THEREOF, Joe P. Kirby has hereunto set his hand this 19th
day of May, 1998.
/s/ Joe P. Kirby
-------------------------------------
Joe P. Kirby
I, Patricia Pochron, a Notary Public in and for said county in the
state aforesaid, do hereby certify that Joe P. Kirby, personally known to me to
be the same person whose name is subscribed to the foregoing instrument appeared
before me this day in person and acknowledged that he signed and delivered said
instrument as his own free and voluntary act for the uses and purposes therein
set forth.
Given under my hand and notarial seal this 19th day of May, 1998.
/s/ Patricia Pochron
-------------------------------------
Notary Public
My Commission Expires: 3-7-2001
----------------
<PAGE> 6
State of Illinois )
) SS
County of Cook )
KNOW ALL MEN BY THESE PRESENTS that Roy E. Posner, having an address at
273 Whitman Street, Haworth, NJ, 07641,, has made, constituted and appointed and
BY THESE PRESENTS, does make, constitute and appoint Sandra D. Wagman, having an
address at CNA, 333 South Wabash, Chicago, IL, 60685, his true and lawful
Attorney-in-fact for him and in his name, place and stead to sign and execute in
any and all capacities the Form S-1 and any or all amendments to the Form S-1,
and to file the same with all exhibits thereto, and other documents in
connections therewith, with the Securities and Exchange Commission, giving and
granting unto Sandra D. Wagman, said attorney-in-fact, full power and authority
to do and perform each and every act and thing, requisite and necessary to be
done in and about the premises, as fully, to all intents and purposes as he
might or could do if personally present at the doing thereof, with full power of
substitution and revocation, hereby ratifying and confirming all that said
Attorney-in-fact or her substitutes shall lawfully do or cause to be done by
virtue hereof.
This Power of Attorney shall remain in full force and effect until
terminated by the undersigned through the instrumentality of a signed writing.
IN WITNESS THEREOF, Roy E. Posner has hereunto set his hand this 19th
day of May, 1998.
/s/ Roy E. Posner
-------------------------------------
Roy E. Posner
I, Patricia Pochron, a Notary Public in and for said county in the
state aforesaid, do hereby certify that Roy E. Posner, personally known to me to
be the same person whose name is subscribed to the foregoing instrument appeared
before me this day in person and acknowledged that he signed and delivered said
instrument as his own free and voluntary act for the uses and purposes therein
set forth.
Given under my hand and notarial seal this 19th day of May, 1998.
/s/ Patricia Pochron
-------------------------------------
Notary Public
My Commission Expires: 3-7-2001
---------------
<PAGE> 7
State of Illinois )
) SS
County of Cook )
KNOW ALL MEN BY THESE PRESENTS that Adrian M. Tocklin, having an
address at 801 Islamorada-Bacopa Bay, 4961 Bacopa Bay South, St. Petersburg, FL,
33715, has made, constituted and appointed and BY THESE PRESENTS, does make,
constitute and appoint Sandra D. Wagman, having an address at CNA, 333 South
Wabash, Chicago, IL, 60685, her true and lawful Attorney-in-fact for her and in
her name, place and stead to sign and execute in any and all capacities the Form
S-1 and any or all amendments to the Form S-1, and to file the same with all
exhibits thereto, and other documents in connections therewith, with the
Securities and Exchange Commission, giving and granting unto Sandra D. Wagman,
said attorney-in-fact, full power and authority to do and perform each and every
act and thing, requisite and necessary to be done in and about the premises, as
fully, to all intents and purposes as she might or could do if personally
present at the doing thereof, with full power of substitution and revocation,
hereby ratifying and confirming all that said Attorney-in-fact or her
substitutes shall lawfully do or cause to be done by virtue hereof.
This Power of Attorney shall remain in full force and effect until
terminated by the undersigned through the instrumentality of a signed writing.
IN WITNESS THEREOF, Adrian M. Tocklin has hereunto set her hand this
19th day of May, 1998.
/s/ Adrian M. Tocklin
-------------------------------------
Adrian M. Tocklin
I, Patricia Pochron, a Notary Public in and for said county in the
state aforesaid, do hereby certify that Adrian M. Tocklin, personally known to
me to be the same person whose name is subscribed to the foregoing instrument
appeared before me this day in person and acknowledged that she signed and
delivered said instrument as her own free and voluntary act for the uses and
purposes therein set forth.
Given under my hand and notarial seal this 19th day of May, 1998.
/s/ Adrian Tocklin
-------------------------------------
Notary Public
My Commission Expires: 3-7-2001
---------------
<PAGE> 8
State of Illinois )
) SS
County of Cook )
KNOW ALL MEN BY THESE PRESENTS that Robert T. Van Gieson, having an
address at CNA, 333 South Wabash, Chicago, IL, 60685, has made, constituted and
appointed and BY THESE PRESENTS, does make, constitute and appoint Sandra D.
Wagman, having an address at CNA, 333 South Wabash, Chicago, IL, 60685, his true
and lawful Attorney-in-fact for him and in his name, place and stead to sign and
execute in any and all capacities the Form S-1 and any or all amendments to the
Form S-1, and to file the same with all exhibits thereto, and other documents in
connections therewith, with the Securities and Exchange Commission, giving and
granting unto Sandra D. Wagman, said attorney-in-fact, full power and authority
to do and perform each and every act and thing, requisite and necessary to be
done in and about the premises, as fully, to all intents and purposes as he
might or could do if personally present at the doing thereof, with full power of
substitution and revocation, hereby ratifying and confirming all that said
Attorney-in-fact or her substitutes shall lawfully do or cause to be done by
virtue hereof.
This Power of Attorney shall remain in full force and effect until
terminated by the undersigned through the instrumentality of a signed writing.
IN WITNESS THEREOF, Robert T. Van Gieson has hereunto set his hand this
19th day of May, 1998.
/s/ Robert T. Van Gieson
-------------------------------------
Robert T. Van Gieson
I, Patricia Pochron, a Notary Public in and for said county in the
state aforesaid, do hereby certify that Robert T. Van Gieson, personally known
to me to be the same person whose name is subscribed to the foregoing instrument
appeared before me this day in person and acknowledged that he signed and
delivered said instrument as his own free and voluntary act for the uses and
purposes therein set forth.
Given under my hand and notarial seal this 19th day of May, 1998.
/s/ Patricia Pochron
-------------------------------------
Notary Public
My Commission Expires: 3-7-2001
----------------
<PAGE> 9
State of Illinois )
) SS
County of Cook )
KNOW ALL MEN BY THESE PRESENTS that Mark C. Vonnahme, having an address
at CNA Surety Corporation, 333 South Wabash, Chicago, IL, 60685, has made,
constituted and appointed and BY THESE PRESENTS, does make, constitute and
appoint Sandra D. Wagman, having an address at CNA, 333 South Wabash, Chicago,
IL, 60685, his true and lawful Attorney-in-fact for him and in his name, place
and stead to sign and execute in any and all capacities the Form S-1 and any or
all amendments to the Form S-1, and to file the same with all exhibits thereto,
and other documents in connections therewith, with the Securities and Exchange
Commission, giving and granting unto Sandra D. Wagman, said attorney-in-fact,
full power and authority to do and perform each and every act and thing,
requisite and necessary to be done in and about the premises, as fully, to all
intents and purposes as he might or could do if personally present at the doing
thereof, with full power of substitution and revocation, hereby ratifying and
confirming all that said Attorney-in-fact or her substitutes shall lawfully do
or cause to be done by virtue hereof.
This Power of Attorney shall remain in full force and effect until
terminated by the undersigned through the instrumentality of a signed writing.
IN WITNESS THEREOF, Mark C. Vonnahme has hereunto set his hand this
19th day of May, 1998.
/s/ Mark C. Vonnahme
-------------------------------------
Mark C. Vonnahme
I, Patricia Pochron, a Notary Public in and for said county in the
state aforesaid, do hereby certify that Mark C. Vonnahme, personally known to me
to be the same person whose name is subscribed to the foregoing instrument
appeared before me this day in person and acknowledged that he signed and
delivered said instrument as his own free and voluntary act for the uses and
purposes therein set forth.
Given under my hand and notarial seal this 19th day of May, 1998.
/s/ Patricia Pochron
-------------------------------------
Notary Public
My Commission Expires: 3-7-2001
---------------
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION OF CNA SURETY CORPORATION
AND THE PREDECESSOR OPERATIONS EXTRACTED FROM FINANCIAL STATEMENTS AND RELATED
NOTES AND SCHEDULES THERETO INCLUDED IN THE QUARTERLY REPORT ON FORM 10-Q AND
IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-31-1998
<DEBT-HELD-FOR-SALE> 389,396
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 0
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 424,175
<CASH> 3,424
<RECOVER-REINSURE> 55,008
<DEFERRED-ACQUISITION> 67,520
<TOTAL-ASSETS> 740,871
<POLICY-LOSSES> 132,100
<UNEARNED-PREMIUMS> 177,520
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 118,000
434
0
<COMMON> 0
<OTHER-SE> 266,089
<TOTAL-LIABILITY-AND-EQUITY> 740,871
58,745
<INVESTMENT-INCOME> 6,789
<INVESTMENT-GAINS> 0
<OTHER-INCOME> 0
<BENEFITS> 11,218
<UNDERWRITING-AMORTIZATION> 24,464
<UNDERWRITING-OTHER> 10,575
<INCOME-PRETAX> 15,981
<INCOME-TAX> 6,166
<INCOME-CONTINUING> 9,815
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 9,815
<EPS-PRIMARY> 0.23
<EPS-DILUTED> 0.23
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
<PAGE> 1
Exhibit 99(1)
CONSENT
I, William Pate, hereby consent to serve as a director on the Board of
Directors of CNA Surety Corporation, effective following the effectiveness of
the Offering, as such term is defined in the Registration Statement of CNA
Surety Corporation on Form S-1.
Dates as of June 3, 1998.
/s/ William Pate
---------------------------------
William Pate
