<PAGE> 1
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended JUNE 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number: 1-13277
CNA SURETY CORPORATION
(Exact name of Registrant as specified in its Charter)
DELAWARE 36-4144905
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
CNA PLAZA, CHICAGO, ILLINOIS 60685
(Address of principal executive offices) (Zip Code)
(312) 822-5000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
-- --
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
44,101,985 shares of Common Stock, $.01 par value as of August 6, 1999.
<PAGE> 2
CNA SURETY CORPORATION AND SUBSIDIARIES
INDEX
<TABLE>
<CAPTION>
Page
<S> <C> <C>
Part I. Financial Information (Unaudited):
Item 1. Condensed Consolidated Financial Statements:
Independent Accountants' Report.................................................. 3
Condensed Consolidated Balance Sheets at June 30, 1999 and
at December 31, 1998............................................................. 4
Condensed Consolidated Statements of Income for the Three- and Six- Months
Ended June 30, 1999 and 1998..................................................... 5
Condensed Consolidated Statements of Stockholders' Equity for the Six
Months Ended June 30, 1999 and 1998.............................................. 6
Condensed Consolidated Statements of Cash Flows for the Six Months Ended
June 30, 1999 and 1998........................................................... 7
Notes to Condensed Consolidated Financial Statements at June 30, 1999 ........... 8
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................................ 11
Part II. Other Information:
Item 1.Legal Proceedings.................................................................. 21
Item 2.Changes in the Rights of the Company's Security Holders............................ 21
Item 3.Defaults Upon Senior Securities.................................................... 21
Item 4.Submission of Matters to a Vote of Security Holders................................ 21
Item 5.Other Information.................................................................. 22
Item 6.Exhibits and Reports on Form 8-K .................................................. 22
</TABLE>
2
<PAGE> 3
INDEPENDENT ACCOUNTANTS' REPORT
To the Board of Directors and Stockholders of
CNA Surety Corporation
Chicago, Illinois
We have reviewed the accompanying condensed consolidated balance sheet of CNA
Surety Corporation and subsidiaries as of June 30, 1999, and the related
condensed consolidated statements of income for the three-month and six-month
periods ended June 30, 1999 and 1998 and related condensed consolidated
statements of stockholders' equity and cash flows for the six-month periods
ended June 30, 1999 and 1998. 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.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of CNA Surety Corporation and
subsidiaries as of December 31, 1998, and the related consolidated statements of
income, stockholders' equity, and cash flows for the year then ended (not
presented herein); and in our report dated February 8, 1999, we expressed an
unqualified opinion on those consolidated financial statements. In our opinion,
the information set forth in the accompanying condensed consolidated balance
sheet as of December 31, 1998 is fairly stated, in all material respects, in
relation to the consolidated balance sheet from which it has been derived.
Deloitte & Touche LLP
Chicago, Illinois
August 6, 1999
3
<PAGE> 4
CNA SURETY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
(Unaudited)
June 30, December 31,
1999 1998
----------------- -----------------
<S> <C> <C>
ASSETS Invested assets and cash:
Fixed income securities, at fair value (amortized cost: $416,181 and $418,866) $ 405,716 $ 423,914
Equity securities, at fair value (cost: $5,984 and $0) 6,117 --
Short-term investments, at cost (approximates fair value)...................... 48,178 57,865
Other investments, at fair value............................................... 5,203 5,830
Cash 9,985 17,746
---------- ----------
Total invested assets and cash.............................................. 475,199 505,355
Deferred policy acquisition costs................................................ 80,831 74,488
Insurance receivables:
Premiums....................................................................... 10,830 8,950
Reinsurance, including $69,872 and $47,175 from affiliates..................... 79,119 55,350
Intangible assets (net of accumulated amortization of $10,297 and $7,347)........ 153,111 156,062
Prepaid reinsurance premiums..................................................... 2,546 2,157
Other assets..................................................................... 20,410 17,008
---------- ----------
Total assets.............................................................. $ 822,046 $ 819,370
========== ==========
LIABILITIES
Reserves:
Unpaid losses and loss adjustment expenses..................................... $ 158,477 $ 150,020
Unearned premiums.............................................................. 192,074 183,708
---------- ----------
Total reserves.............................................................. 350,551 333,728
Long-term debt................................................................... 100,000 113,000
Current income taxes payable..................................................... 9,238 6,726
Deferred income taxes, net....................................................... 6,679 10,649
Payable for securities purchased................................................. 1,453 8,517
Other liabilities................................................................ 35,656 36,853
---------- ----------
Total liabilities........................................................... $ 503,577 $ 509,473
---------- ----------
Commitments and contingencies (See Note 5)
STOCKHOLDERS' EQUITY
Preferred stock, par value $.01 per share, 20,000 shares authorized; none issued
and outstanding................................................................ -- --
Common stock, par value $.01 per share, 100,000 shares authorized; 44,115 shares
issued and 44,102 shares outstanding at June 30, 1999 and 44,093 issued and
outstanding at December 31, 1998 .............................................. 441 441
Treasury stock, at cost.......................................................... (163) --
Additional paid-in capital....................................................... 253,326 253,215
Retained earnings................................................................ 71,808 52,984
Accumulated other comprehensive income........................................... (6,943) 3,257
---------- ----------
Total stockholders' equity.................................................. 318,469 309,897
---------- ----------
Total liabilities and stockholders' equity.................................. $ 822,046 $ 819,370
========== ==========
</TABLE>
The accompanying notes are an integral part of these condensed financial
statements.
4
<PAGE> 5
CNA SURETY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------- --------------------------
1999 1998 1999 1998
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Revenues:
Net earned premium.......................................... $ 69,688 $ 63,278 $ 137,558 $ 122,023
Net investment income....................................... 6,172 6,077 12,513 12,866
Net realized investment gains............................... 24 44 420 44
---------- ---------- ---------- ----------
75,884 69,399 150,491 134,933
---------- ---------- ---------- ----------
Expenses:
Net losses and loss adjustment expenses..................... 11,758 10,558 23,672 21,776
Net commissions, brokerage and other underwriting........... 41,838 37,729 81,816 72,768
Interest expense............................................ 1,331 1,837 2,820 3,658
Amortization of intangible assets........................... 1,475 1,475 2,950 2,950
---------- ---------- ---------- ----------
56,402 51,599 111,258 101,152
---------- ---------- ---------- ----------
Income before income taxes.................................... 19,482 17,800 39,233 33,781
Income taxes.................................................. 6,644 6,643 13,352 12,809
---------- ---------- ---------- ----------
Net income.................................................... $ 12,838 $ 11,157 $ 25,881 $ 20,972
========== ========== ========== ==========
Earnings per share............................................ $ 0.29 $ 0.25 $ 0.59 $ 0.48
========== ========== ========== ==========
Earnings per share, assuming dilution......................... $ 0.29 $ 0.25 $ 0.59 $ 0.48
========== ========== ========== ==========
Weighted average shares outstanding........................... 44,098 43,405 44,099 43,377
========== ========== ========== ==========
Weighted average shares outstanding, assuming dilution........ 44,267 43,566 44,238 43,567
========== ========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these condensed financial
statements.
5
<PAGE> 6
CNA SURETY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(AMOUNTS IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
Common
Stock Additional
Shares Common Treasury Paid-In Comprehensive
Outstanding Stock Stock Capital Income
------------- --------- ----------- ------------ ---------------
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1997......................................... $ 43,320 $ 433 $ -- $ 244,829
Comprehensive income:
Net income....................................................... -- -- -- -- 20,972
Other comprehensive income:
Change in unrealized gains on securities (after income taxes),
net of reclassification adjustment of $29...................... -- -- -- -- 432
---------
Total comprehensive income.................................... $ 21,404
=========
Stock options exercised............................................ 126 1 -- 564
------- ------- -------- ---------
Balance, June 30, 1998............................................. 43,446 $ 434 $ -- $ 245,393
======= ======= ======== =========
Balance, December 31, 1998......................................... 44,093 $ 441 $ -- $ 253,215
Comprehensive income:
Net income....................................................... -- -- -- -- $25,881
Other comprehensive income:
Change in unrealized gains on securities (after income taxes),
net of reclassification adjustment of $775..................... -- -- -- -- (10,200)
---------
Total comprehensive income.................................... $ 15,681
=========
Issuance of common stock........................................... -- -- -- --
Purchase of treasury stock......................................... (13) -- (163) --
Stock options exercised............................................ 22 -- -- 111
Dividends paid to stockholders..................................... -- -- -- --
------- ------- -------- ---------
Balance, June 30, 1999............................................. 44,102 $ 441 $ (163) $ 253,326
======= ======= ======== =========
<CAPTION>
Accumulated
Other Total
Retained Comprehensive Stockholders'
Earnings Income Equity
-------------- -------------- ----------------
<S> <C> <S> <C>
Balance, December 31, 1997......................................... $ 10,996 $ 474 $ 256,732
Comprehensive income:
Net income....................................................... 20,972 -- 20,972
Other comprehensive income:
Change in unrealized gains on securities (after income taxes),
net of reclassification adjustment of $29...................... -- 432 432
Total comprehensive income....................................
Stock options exercised............................................ -- -- 565
-------- --------- ---------
Balance, June 30, 1998............................................. $ 31,968 $ 906 $ 278,701
======== ========= =========
Balance, December 31, 1998......................................... $ 52,984 $ 3,257 $ 309,897
Comprehensive income:
Net income....................................................... 25,881 -- 25,881
Other comprehensive income:
Change in unrealized gains on securities (after income taxes),
net of reclassification adjustment of $775..................... -- (10,200) (10,200)
Total comprehensive income....................................
Issuance of common stock........................................... -- -- --
Purchase of treasury stock......................................... -- -- (163)
Stock options exercised............................................ -- -- 111
Dividends paid to stockholders..................................... (7,057) -- (7,057)
-------- --------- ---------
Balance, June 30, 1999............................................. $ 71,808 $ (6,943) $ 318,469
======== ========== =========
</TABLE>
The accompanying notes are an integral part of these condensed financial
statements.
6
<PAGE> 7
CNA SURETY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
--------------------------------------
1999 1998
----------------- -----------------
<S> <C> <C>
OPERATING ACTIVITIES:
Net income..................................................................... $ 25,881 $ 20,972
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization............................................... 4,032 3,891
Accretion of bond discount, net............................................. 1,117 906
Net realized investment gains............................................... (420) (44)
Changes in:
Insurance receivables....................................................... (25,649) (9,784)
Reserve for unearned premiums............................................... 8,366 14,231
Reserve for unpaid losses and loss adjustment expenses...................... 8,457 4,794
Deferred policy acquisition costs........................................... (6,343) (7,688)
Deferred income taxes, net.................................................. 1,487 4,030
Other assets and liabilities................................................ (923) (7,252)
---------- ----------
Net cash provided by operating activities................................. 16,005 24,056
---------- ----------
INVESTING ACTIVITIES:
Fixed income securities:
Purchases................................................................... (117,535) (180,653)
Maturities.................................................................. 23,207 24,714
Sales....................................................................... 96,317 19,266
Purchase of equity securities.................................................. (6,035) --
Proceeds from sale of equity securities........................................ 51 --
Changes in short-term investments.............................................. 9,687 118,788
Change in payable for securities purchased..................................... (7,064) (3,082)
Other, net..................................................................... (2,238) (1,532)
---------- ----------
Net cash (used in) investing activities................................... (3,610) (22,499)
----------- ----------
FINANCING ACTIVITIES:
Principal payments on long-term debt........................................... (13,000) --
Dividends to stockholders...................................................... (7,057) --
Purchase of treasury stock..................................................... (163) --
Other.......................................................................... 64 418
---------- ----------
Net cash (used in) provided by financing activities....................... (20,156) 418
----------- ----------
(Decrease) Increase in cash...................................................... (7,761) 1,975
Cash at beginning of period...................................................... 17,746 130
---------- ----------
Cash at end of period............................................................ $ 9,985 $ 2,105
========== ==========
Supplemental Disclosure of Cash Flow Information:
Cash paid during the period for:
Interest.................................................................... $ 3,375 $ 3,658
Income taxes................................................................ $ 8,800 $ 10,500
</TABLE>
The accompanying notes are an integral part of these condensed financial
statements.
7
<PAGE> 8
CNA SURETY CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1999
(UNAUDITED)
1. SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
These condensed consolidated financial statements include the accounts of
CNA Surety Corporation and all majority-owned subsidiaries.
Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Basis of Presentation
These unaudited Condensed Consolidated Financial Statements should be read
in conjunction with the Consolidated Financial Statements and Notes thereto
included in the Company's 1998 Annual Report to Shareholders. 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 1998
Financial Statements to conform with the presentation in the 1999 Condensed
Consolidated Financial Statements.
Accounting Changes
In March 1998, the American Institute of Certified Public Accountants'
Accounting Standards Executive Committee ("AcSEC") issued Statement of Position
("SOP") 98-1, "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use," which provides guidance on accounting for costs of
computer software developed or obtained for internal use and for determining
whether computer software is for internal use. For the purposes of the SOP,
internal-use software is software acquired, internally developed or modified
solely to meet the entity's internal needs for which no substantive plan exists
or is being developed to market the software externally during the software's
development or modification. Accounting treatment for costs associated with
software developed or obtained for internal use, as defined by this SOP, is
based upon a number of factors, including the point in time during the project
that costs are incurred as well as the types of costs incurred. The Company has
adopted this standard effective January 1, 1999; such adoption did not have a
material impact on the Company's financial position and results of operations.
In April 1998, AcSEC issued SOP 98-5, "Reporting on the Costs of Start-Up
Activities," which provides guidance on the financial reporting of start-up
costs and organization costs. It requires that costs of start-up activities and
organization costs, as defined, be expensed as incurred. The Company has adopted
this standard effective January 1, 1999; such adoption did not have a material
impact on the
8
<PAGE> 9
Company's financial position and results of operations.
In October 1998, AcSEC issued SOP 98-7, "Deposit Accounting: Accounting for
Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk," which
provides accounting guidance for insurance and reinsurance contracts that do not
transfer insurance risk, excluding long-duration life and health insurance
contracts. The Company has adopted this standard effective January 1, 1999; such
adoption did not have a material impact on the Company's financial position and
results of operations.
3. INVESTMENTS
The amortized cost and estimated fair value of fixed income and equity
securities held by CNA Surety at June 30, 1999 and December 31, 1998, by
investment category, were as follows (dollars in thousands):
<TABLE>
<CAPTION>
Gross Gross
Amortized Cost or Unrealized Unrealized Estimated Fair
June 30, 1999 Cost Gains Losses Value
--------------------------------------------------- -------------------------------------- ------------------ -------------------
<S> <C> <C> <C> <C>
Fixed income securities:
U.S. Treasury securities and obligations of U.S.
Government and agencies:
U.S. Treasury............................. $ 15,591 $ 95 $ -- $ 15,686
U.S. Agencies............................. 42,934 -- (830) 42,104
Collateralized mortgage obligations....... 3,462 27 (4) 3,485
Mortgage pass-through securities.......... 49,466 3 (771) 48,698
Obligations of states and political subdivisions 215,608 -- (7,155) 208,453
Corporate bonds................................ 38,164 -- (1,749) 36,415
Non-agency collateralized mortgage obligations. 13,825 1 (191) 13,635
Other asset-backed securities:
Second mortgages/home equity loans........... 24,976 120 (8) 25,088
Credit card receivables...................... 3,506 20 -- 3,526
Other........................................ 8,649 20 (43) 8,626
---------- ---------- ----------- ----------
Total fixed income securities............. 416,181 286 (10,751) 405,716
Equity securities.............................. 5,984 269 (136) 6,117
---------- ---------- ----------- ----------
Total..................................... $ 422,165 $ 555 $ (10,887) $ 411,833
========== ========== ========== ==========
<CAPTION>
Gross Gross
Amortized Cost or Unrealized Unrealized Estimated Fair
December 31, 1998 Cost Gains Losses Value
--------------------------------------------------- -------------------------------------- ------------------ -------------------
<S> <C> <C> <C> <C>
Fixed income securities:
U.S. Treasury securities and obligations of U.S.
Government and agencies:
U.S. Treasury............................. $ 19,009 $ 412 $ -- $ 19,421
U.S. Agencies............................. 68,922 2,189 -- 71,111
Collateralized mortgage obligations....... 17,741 78 (76) 17,743
Mortgage pass-through securities.......... 24,834 172 (1) 25,005
Obligations of states and political subdivisions 206,264 2,329 (355) 208,238
Corporate bonds................................ 36,538 686 (465) 36,759
Non-agency collateralized mortgage obligations. 18,811 32 (149) 18,694
Other asset-backed securities:
Second mortgages/home equity loans........... 12,169 219 (1) 12,387
Credit card receivables...................... 4,896 5 (3) 4,898
Other........................................ 9,682 24 (48) 9,658
---------- ---------- ----------- ----------
Total fixed income securities............. 418,866 6,146 (1,098) 423,914
Equity securities.............................. -- -- -- --
---------- ---------- ---------- ----------
Total..................................... $ 418,866 $ 6,146 $ (1,098) $ 423,914
========== ========== ========== ==========
</TABLE>
9
<PAGE> 10
4. REINSURANCE
The effect of reinsurance on the Company's written and earned premium was
as follows (dollars in thousands):
<TABLE>
<CAPTION>
Six Months Ended June 30,
1999 1998
------------------------- --------------------------
Written Earned Written Earned
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Direct........................................................ $ 56,127 $ 50,548 $ 55,184 $ 49,734
Assumed from affiliates....................................... 93,578 90,103 83,809 78,828
Ceded......................................................... (4,170) (3,093) (4,048) (6,539)
----------- ----------- ----------- -----------
$ 145,535 $ 137,558 $ 134,945 $ 122,023
=========== =========== =========== ===========
</TABLE>
The effect of reinsurance on the Company's provision for loss and loss
adjustment expenses was as follows (dollars in thousands):
<TABLE>
<CAPTION>
Six Months Ended
June 30,
--------------------------
1999 1998
----------- -----------
<S> <C> <C>
Gross loss and loss adjustment expense.................................................. $ 27,406 $ 25,091
Ceded amounts........................................................................... (3,734) (3,315)
----------- -----------
Net loss and loss adjustment expense.................................................... $ 23,672 $ 21,776
=========== ===========
</TABLE>
5. LEGAL PROCEEDINGS
The Company and its subsidiaries are parties to various lawsuits arising in
the normal course of business, some seeking material damages. The Company
believes the resolution of these lawsuits will not have a material adverse
effect on its financial condition or its results of operations.
10
<PAGE> 11
CNA SURETY CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
GENERAL
The following is a discussion and analysis of CNA Surety Corporation ("CNA
Surety" or the "Company") and its insurance subsidiaries' operating results,
liquidity and capital resources, and financial condition. This discussion should
be read in conjunction with the Consolidated Financial Statements of CNA Surety
and notes thereto.
FORMATION OF CNA SURETY AND MERGER
In December 1996, CNA Financial Corporation ("CNAF") and Capsure agreed to
merge (the "Merger") the surety business of CNAF with Capsure's insurance
subsidiaries, Western Surety Company ("Western Surety") and Universal Surety of
America ("USA"), into a newly-formed holding company, CNA Surety Corporation.
CNAF, through its operating subsidiaries, writes multiple lines of property and
casualty insurance, including surety business that is reinsured by Western
Surety. CNAF owns approximately 61% of the outstanding common stock of CNA
Surety. Loews Corporation owns approximately 86% 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.
BUSINESS
CNA Surety's insurance subsidiaries write surety and fidelity bonds in all
50 states through a combined network of approximately 37,000 independent
agencies. CNA Surety's principal insurance subsidiaries are Western Surety and
USA. Western Surety writes, on a direct basis or as business assumed from CCC
and CIC, small fidelity and non-contract surety bonds, referred to as commercial
bonds; small, medium and large contract bonds; international surety and credit
insurance; and errors and omissions ("E&O") liability insurance, 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
11
<PAGE> 12
business and is licensed in 23 states. USA specializes in the underwriting of
small contract and commercial surety bonds. USA is licensed in 43 states and the
District of Columbia with most of its business generated in Texas.
The Company'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 its customers and independent agents
and brokers.
"SAFE HARBOR" STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995
The statements which are not historical facts contained in this Form 10-Q are
forward-looking statements that involve risks and uncertainties, including, but
not limited to, product and policy demand and market response risks, the effect
of economic conditions, the impact of competitive products, policies and
pricing, product and policy development, regulatory changes and conditions,
rating agency policies and practices, development of claims and the effect on
loss reserves, the performance of reinsurance companies under reinsurance
contracts with the Company, investment portfolio developments and reaction to
market conditions, the results of financing efforts, the actual closing of
contemplated transactions and agreements, the effect of the Company's accounting
policies, and other risks detailed in the Company's Securities and Exchange
Commission filings. No assurance can be given that the actual results of
operations and financial condition will conform to the forward-looking
statements contained herein.
RESULTS OF OPERATIONS
CNA SURETY RESULTS FOR THREE- AND SIX-MONTHS ENDED JUNE 30, 1999 AND 1998
The components of net income for the Company for the three and six months
ended June 30, 1999 and 1998 are summarized as follows (dollars in thousands,
except per share amounts):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------ -------------------------------
1999 1998 1999 1998
------------------------------ --------------- ---------------
<S> <C> <C> <C> <C>
Total revenues................................ $ 75,884 $ 69,399 $ 150,491 $ 134,933
========== ========== ========== ==========
Underwriting income........................... $ 16,092 $ 14,991 $ 32,070 $ 27,479
Net investment income......................... 6,172 6,077 12,513 12,866
Net investment gains.......................... 24 44 420 44
Interest expense.............................. 1,331 1,837 2,820 3,658
Amortization of intangible assets............. 1,475 1,475 2,950 2,950
---------- ---------- ---------- ----------
Income before income taxes.................... 19,482 17,800 39,233 33,781
Income taxes.................................. 6,644 6,643 13,352 12,809
---------- ---------- ---------- ----------
Net income.................................... $ 12,838 $ 11,157 $ 25,881 $ 20,972
========== ========== ========== ==========
Net income per share.......................... $ 0.29 $ 0.25 $ 0.59 $ 0.48
========== ========== ========== ==========
</TABLE>
12
<PAGE> 13
Insurance Underwriting
Underwriting results for the Company for the three and six months ended
June 30, 1999 and 1998 are summarized in the following table (dollars in
thousands):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------ -------------------------------
1999 1998 1999 1998
-------------- -------------- -------------- ---------------
<S> <C> <C> <C> <C>
Gross written premiums........................ $ 78,181 $ 75,145 $ 149,705 $ 138,993
========= ========= ========= =========
Net written premium........................... $ 76,173 $ 73,109 $ 145,535 $ 134,945
========= ========= ========= =========
Net earned premium............................ $ 69,688 $ 63,278 $ 137,558 $ 122,023
Net losses and loss adjustment expenses....... 11,758 10,558 23,672 21,776
Net commissions, brokerage and other.......... 41,838 37,729 81,816 72,768
--------- --------- --------- ---------
Underwriting income........................... $ 16,092 $ 14,991 $ 32,070 $ 27,479
========= ========= ========= =========
Loss ratio.................................... 16.9% 16.7% 17.2% 17.9%
Expense ratio................................. 60.0 59.6 59.5 59.6
--------- --------- --------- ---------
Combined ratio................................ 76.9% 76.3% 76.7% 77.5%
========= ========= ========= =========
</TABLE>
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 which cover losses arising from employee dishonesty and errors
and omissions ("E&O") liability insurance.
Gross written premiums are shown in the table below (dollars in thousands):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------ -------------------------------
1999 1998 1999 1998
------------- --------------- -------------- ---------------
<S> <C> <C> <C> <C>
Contract...................................... $ 39,004 $ 36,886 $ 69,717 $ 63,086
Commercial.................................... 32,902 32,273 66,267 62,677
Fidelity...................................... 4,494 4,279 9,408 8,998
E&O and other................................. 1,781 1,707 4,313 4,232
---------- ---------- ---------- ----------
$ 78,181 $ 75,145 $ 149,705 $ 138,993
========== ========== ========== ==========
</TABLE>
Gross written premiums increased 4.0%, or $3.0 million, for the three
months ended June 30, 1999 over the comparable period in 1998. Contract surety
accounted for most of this increase with growth of 5.7%, or $2.1 million, in
gross written premiums as compared to 1998. This increase reflects increased
volume from new accounts added during 1998 and generally healthy economic
conditions for public construction nationwide. The highway/bridge sector has
shown particular strength since the United States Congressional passage of The
Transportation Equity Act for the 21st Century (TEA-21). TEA-21 authorizes a 40%
increase in total Federal funding for highway and transit systems to over $200
billion in the six year period from 1998 to 2004. Commercial surety increased
1.9%, or $0.6 million, for the three months ended June 30, 1999 primarily
reflecting increased premiums from the Company's international surety and credit
reinsurance contract. CNA Surety assumed $3.0 million and $2.5 million of
international surety and credit business for the three months ended June 30,
1999 and 1998, respectively, through a
13
<PAGE> 14
quota share reinsurance treaty with an affiliate of CCC, CNA Reinsurance Company
Limited (London) ("CNA Re"). Commercial surety, exclusive of international
surety and credit business, increased 0.4% for the three months ended June 30,
1999 as compared to the same period in 1998. This slower quarterly growth rate
for core direct commercial surety was primarily due to a $1.5 million decline in
quarterly premiums for renewal business and increased competitive conditions in
the large commercial account segment. The decline in renewal premiums primarily
relates to quarterly fluctuations in processing. The growth in renewal premiums
for the first half was consistent with the 5.8% growth for the entire core
domestic commercial book on a year to date basis. The fidelity, E&O and other
book of business increased 4.8%, or $0.3 million, to $6.3 million for the three
months ended June 30, 1999 as compared to the same period in 1998.
Gross written premiums for the first half of 1999 increased 7.7%, or $10.7
million, compared to the same period in 1998. Contract surety and commercial
surety gross written premiums increased 10.5% and 5.7%, respectively, for the
first half of 1999. CNA Surety assumed $5.3 million and $5.0 million of
international surety and credit business for the six months ended June 30, 1999
and 1998, respectively, through a quota share reinsurance treaty with an
affiliate of CCC, CNA Re.
Net written premiums are shown in the table below (dollars in thousands):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------ -------------------------------
1999 1998 1999 1998
-------------- -------------- -------------- ---------------
<S> <C> <C> <C> <C>
Contract...................................... $ 37,838 $ 35,092 $ 67,497 $ 60,332
Commercial.................................... 32,511 32,489 65,395 62,461
Fidelity...................................... 4,494 4,272 9,408 8,968
E&O and other................................. 1,330 1,256 3,235 3,184
---------- ---------- ---------- ----------
$ 76,173 $ 73,109 $ 145,535 $ 134,945
========== ========== ========== ==========
</TABLE>
For the three months ended June 30, 1999, net written premiums increased
4.2%, or $3.1 million, over the comparable period in 1998, consistent with the
changes in gross written premiums described above. Net written premiums
increased 7.8%, or $2.7, million for the contract surety business. Commercial
surety net written premiums remained flat at $32.5 million for the three months
ended June 30, 1999 compared to the same period in 1998, with domestic
commercial surety down 1.6% offset by the increased assumed international surety
and credit business from CNA Re. The fidelity, E&O and other book of business
increased 5.4%, or $0.3 million, for the three months ended June 30, 1999 as
compared to the same period in 1998.
For the first half of 1999, net written premiums increased 7.8%, or $10.6
million, over the comparable period in 1998 with contract surety and commercial
surety up 11.9% and 4.7%, respectively. The increase in commercial surety for
the first half of 1999 is primarily attributable to increased business with key
national and regional distribution partners. The fidelity, E&O and other book of
business increased 4.0%, or $0.5 million, for the six months ended June 30, 1999
as compared to the same period in 1998.
Underwriting Income
Underwriting income increased 7.3% to $16.1 million for the three months
ended June 30, 1999 compared to the same period in 1998 primarily reflecting a
10.1% period to period increase in earned premiums. Underwriting income
increased 16.7% to $32.1 million for the six months ended June 30, 1999 compared
to the same period in 1998. The six month period to period change in
underwriting income
14
<PAGE> 15
primarily reflects the 12.7% increase in earned premiums along with the changes
in loss experience discussed below.
Loss Ratio
The loss ratios for the three months ended June 30, 1999 and 1998 were
16.9% and 16.7%, respectively. The loss ratios included $2.4 million and $1.1
million of favorable reserve development for the three months ended June 30,
1999 and 1998, respectively. Excluding the impact of the favorable reserve
development, the loss ratios would have been 20.4% and 18.4% for the three month
periods ended June 30, 1999 and June 30, 1998, respectively. For the six months
ended June 30, 1999 and 1998, the loss ratios were 17.2% and 17.9%,
respectively. The loss ratios included $4.1 million and $1.7 million of
favorable reserve development for the six months ended June 30, 1999 and 1998,
respectively. Excluding the impact of the favorable reserve development, the
loss ratios would have been 20.2% and 19.2% for the six month periods ended June
30, 1999 and June 30, 1998, respectively. The increase in the adjusted loss
ratios reflects the change in business mix to a higher proportion of standard
contract surety.
Expense Ratio
The expense ratio increased to 60.0% for the three months ended June 30,
1999 compared to 59.6% for the same period in 1998. The 1999 increase is
primarily due to planned information technology related expenditures and other
costs related to back office consolidation efforts. For the six months ended
June 30, 1999, the expense ratio decreased to 59.5% from 59.6% for the same
period in 1998 due to the increased scale of the Company as net earned premiums
increased 12.7% and operating expenses increased at a slightly lower rate of
12.4%.
Investment Income
For the three months ended June 30, 1999, net investment income was $6.2
million compared to net investment income for the three months ended June 30,
1998 of $6.1 million. The average pretax yields were 5.4% and 5.7% for the three
months ended June 30, 1999 and 1998, respectively. The increase in investment
income for the three months ended June 30, 1999 is attributable to higher
average invested assets offset by the effects of a higher proportion of the
portfolio being invested in tax exempt securities and lower nominal interest
rates. Net investment income for the six months ended June 30, 1999 and 1998 was
$12.5 million and $12.9 million, respectively. The average pretax yields were
5.3% and 6.1% for the six months ended June 30, 1999 and 1998, respectively. The
decrease in investment income for the six months ended June 30, 1999 is a result
of a higher proportion of the portfolio being invested in tax exempt securities
during the latter half of 1998 and continuing into 1999 and a general decline in
interest rates since January 1, 1997.
Net realized investment gains were $24 thousand for the three months ended
June 30, 1999 compared to $44 thousand net realized investment gains for the
same period in 1998. For the six months ended June 30, 1999, net realized
investment gains were $0.4 million compared to $44 thousand net realized
investment gains for the same period in 1998.
Analysis of Other Operations
Amortization expense was $1.5 million for the three months ended June 30,
1999 compared to $1.5 million for the three months ended June 30, 1998. For six
months ended June 30, 1999 and 1998,
15
<PAGE> 16
amortization of intangibles was $3.0 million. 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 decreased 27.6% for the second quarter of 1999 as compared
to the second quarter in 1998, primarily due to lower debt levels. Average debt
outstanding was $100.0 million for the second quarter in 1999 compared to $118.0
million in the second quarter of 1998. The weighted average interest rate for
the three months ended June 30, 1999 was 5.1% compared to 5.9% for the same
period in 1998. Interest expense decreased 22.9% for the first six months of
1999 as compared to the same period in 1998, primarily due to lower debt levels.
Average debt outstanding was $107.8 million for the first six months in 1999
compared to $118.0 million in the first six months of 1998. The weighted average
interest rate for the six months ended June 30, 1999 was 5.2% compared to 5.9%
for the same period in 1998.
Income Taxes
Income tax expense was $6.6 million and $6.6 million and the effective
income tax rates were 34.1% and 37.3% for the three months ended June 30, 1999
and 1998, respectively. For the six months ended June 30, 1999 and 1998, income
tax expense was $13.4 million and $12.8 million and the effective income tax
rates were 34.0% and 37.9%, respectively. The decline in the effective income
tax rate primarily relates to the aforementioned increased investments in tax
exempt securities.
LIQUIDITY AND CAPITAL RESOURCES
It is anticipated that the liquidity requirements of CNA Surety will be met
primarily by funds generated from operations. The principal operating 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 described below. The primary cash flow uses are payments for
claims, operating expenses, federal income taxes, debt service on the credit
facility and dividends to CNA Surety stockholders. In general, surety operations
generate premium collections from customers in advance of cash outlays for
claims. Premiums are invested until such time as funds are required to pay
claims and claims adjusting expenses.
The Company believes that total invested assets, including cash and
short-term investments, are sufficient in the aggregate and have suitably
scheduled maturities to satisfy all policy claims and other operating
liabilities, including income tax sharing payments of its insurance
subsidiaries. At June 30, 1999, the carrying value of the Company's insurance
subsidiaries' invested assets was comprised of $405.7 million of fixed income
securities, $6.1 million of equity securities, $39.6 million of short-term
investments, $5.2 million of other investments and $3.4 million of cash. At
December 31, 1998, the carrying value of the Company's insurance subsidiaries'
invested assets was comprised of $423.9 million of fixed income securities,
$43.4 million of short-term investments, $5.8 million of other investments and
$1.8 million of cash.
Cash flow at the parent company level is derived principally from dividend
and tax sharing payments from its insurance subsidiaries. The principal
obligations at the parent company level are to service debt, pay operating
expenses and pay dividends to stockholders. At June 30, 1999, the parent
company's invested assets consisted of $8.6 million of short-term investments
and $6.6 million of cash. At December 31, 1998, the parent company's invested
assets consisted of $14.5 million of short-term investments and $15.9 million of
cash.
16
<PAGE> 17
The Company's consolidated net cash flow provided by operating activities
was $16.0 million for the six months ended June 30, 1999 and $24.1 million for
the comparable period in 1998. The decrease in net cash flow provided by
operating activities primarily relates to increased reinsurance receivables from
affiliates.
CNA Surety's bank borrowings are under a five-year unsecured revolving
credit facility (the "Credit Facility") that provides for borrowings of up to
$130 million. 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. As of
June 30, 1999, CNA Surety has repaid $18 million of this debt.
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%. As of June 30, 1999, the weighted average interest rate was 5.4% on the
$100.0 million of outstanding borrowings. As of December 31, 1998, the weighted
average interest rate was 5.9% on the $113.0 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 June 30, 1999, 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 and SBCA are domiciled,
insurance companies may only pay dividends from earned surplus excluding surplus
arising from unrealized capital gains or revaluation of assets. In Texas, where
USA is domiciled, an insurance company may only declare or pay dividends to
stockholders from the insurer's earned surplus. The insurance subsidiaries may
pay dividends without obtaining prior regulatory approval only if such dividend
or distribution (together with dividends or distributions made within the
preceding 12-month period) is less than, as of the end of the immediately
preceding year, the greater of (i) 10% of the insurer's surplus to policyholders
or (ii) statutory net income. In South Dakota, net income includes net realized
capital gains in an amount not to exceed 20% of net unrealized capital gains.
All dividends must be reported to the appropriate insurance department prior to
payment.
The dividends that may be paid without prior regulatory approval are
determined by formulas established by the applicable insurance regulations, as
described above. The formulas that determine dividend capacity in the current
year are dependent on, among other items, the prior year's ending statutory
surplus and statutory net income. Dividend capacity for 1999 is based on
statutory surplus and income at and for the year ended December 31, 1998.
Without prior regulatory approval in 1999, CNA Surety's insurance subsidiaries
may pay stockholder dividends of $32.7 million in the aggregate. CNA Surety
received $15.0 million in dividends from its insurance subsidiaries during the
first six months of 1999 and $4.4 million in the first six months of 1998.
17
<PAGE> 18
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 (the "Code") as amended.
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 $12.9 million for the six months
ended June 30, 1999 and $13.4 million for the same period in 1998.
CNA Surety management believes that it will have sufficient available
resources to meet its present capital needs.
On July 28, 1999, CNA Surety acquired certain assets of Clark Bonding
Company, Inc., a Charlotte, North Carolina, insurance agency and brokerage doing
business as The Bond Exchange. The Bond Exchange specializes in the distribution
of surety and fidelity bonds with 1998 premium production of approximately $4
million. This purchase was primarily funded with working capital.
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 date fields to perform computations and
decision making functions may cause computer systems to malfunction when
processing information involving dates beginning after 1999. Such malfunctions
could lead to business delays and disruptions.
For several years prior to the Merger, CNAF and Western Surety had each, as
a matter of normal maintenance and system development practices, begun to
address Year 2000 considerations. The Company has continued to participate in
CNAF's Year 2000 activities following the Merger. The Company's internal target
for achieving Year 2000 internal substantial readiness generally coincided with
CNAF's December 1, 1998 target substantial readiness date. Based upon internal
certification achieved as part of the CNAF Year 2000 activities, the Company's
management believes that the Company has accomplished the December 1, 1998
target date for its internal systems identified prior to that date for
anticipated renovation.
Independent Assessment of Year 2000 Readiness
In December 1997, the Company engaged an independent information consulting
firm of national standing to perform a limited review and assessment of the
Company's Year 2000 plans. This engagement included collecting and reviewing
existing enterprise-wide and business unit Year 2000 plans and supporting
documentation, reviewing the process for managing critical external agents and
business partners, and determining if timing and coordination efforts appear
reasonable with respect to program testing and enterprise certification. Based
upon the Company's internal examination and the foregoing review and assessment,
the Company has been and is currently in the process of implementing various
resulting recommendations, including the designation of a Year 2000 project
manager with broad authority for the management and coordination of all Year
2000 efforts and the establishment of regular Year 2000 status reporting by the
project manager to senior management and the board of directors of CNA Surety.
Non-IT Systems Remediation Status
The Company considers its non-information technology ("non-IT") systems to
consist of essentially two elements: office facilities and communication
systems, including telephone and facsimile systems.
The Company leases space for home office and branch locations from various
parties, including the Company's Chicago home office and various branch
locations from CNAF pursuant to the Administrative
18
<PAGE> 19
Services Agreement ("ASA"). The Company has confirmed with CNAF and building
management for each building location that reasonable efforts are being
undertaken to ensure timely Year 2000 readiness for such facilities and
continues to monitor the progress of third party landlords.
Communication systems, i.e., telephone switching equipment and facsimile
server systems, are essential to the business operations of CNA Surety. CNAF has
informed the Company that all communications systems provided by CNAF pursuant
to the ASA are anticipated to be Year 2000 ready, and management believes that
USA and Western Surety's separate communication systems will also be Year 2000
ready on a timely basis.
IT Systems Remediation Status
The Company has confirmed that information technology ("IT") systems
provided by CNAF pursuant to the ASA have been certified by CNAF as Year 2000
ready.
With respect to its internal systems, the Company has created plans to
monitor the Year 2000 renovation or replacement of the Company's IT systems.
Several of these systems are deemed to be obsolete and will not be used in a
Year 2000 ready business environment. As a result of a post-Merger Company
initiative to consolidate and centralize disparate technology systems at Western
Surety, Company management decided to combine any needed Year 2000 renovation
effort with Western Surety's modification efforts.
Year 2000 Readiness
All existing IT systems undergoing renovation prior to December 1, 1998, have
been internally certified as Year 2000 ready during the fourth quarter of 1998.
In addition to having accomplished the December 1, 1998 target date for its
internal systems previously scheduled for renovation, the Company is currently
developing and will be implementing several new IT systems that it anticipates
will become operational before January 1, 2000. Also, due to delays in the
development and testing of a new enterprise wide claims system it had originally
intended for implementation prior to January 1, 2000, the Company has decided to
renovate a remaining non-compliant component of its existing claim system. The
development and implementation of these new systems and the renovation of the
one existing claim system component will involve design and testing to confirm
their Year 2000 readiness on a timely basis. However, if such renovation cannot
be completed on a timely basis, the Company does not anticipate any material
adverse impact on the Company's results of operations, financial condition or
liquidity.
Year 2000 and IT Expenditures
The Company's enterprise-wide Year 2000 readiness efforts are currently
estimated to cost approximately $655,000 in excess of the cost of ordinary
software upgrades and replacements and will be funded through working capital.
As of June 30, 1999, approximately $407,000 had been incurred in Year
2000-related expenditures. The estimated amount includes expenses incurred or
anticipated to be incurred for third party remediation and testing and
additional equipment hardware purchases to facilitate further testing. The Year
2000 estimated readiness costs comprised approximately five percent of the
Company's total 1998 IT budget, and the remaining Year 2000 estimated readiness
costs anticipated to be expended in 1999 comprise approximately $110,000, or
approximately one percent of the Company's total 1999 IT budget.
19
<PAGE> 20
Business Partner Identification and Communication
The Company believes that it has identified and established communication
regarding Year 2000 issues with substantially all of the business partners
management considers to be significant to its operations. Management has not yet
identified any one business partner whose expected failure to achieve timely
Year 2000 readiness will materially and adversely impact the Company's ability
to continue its business operations. 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 other
business partners) address Year 2000 issues successfully.
Year 2000-related Risks
Management believes that the most reasonably likely worst case Year 2000
scenarios involve either failure of all or part of either or both the nation's
telephonic and/or electrical power distribution systems. Due to the general
uncertainty inherent in the Year 2000 problem, resulting in part from the Year
2000 compliance of third parties, the Company is unable to determine with any
degree of certainty the specific potential consequences of the Year 2000
problem. The failure of a third party to correct a material Year 2000 problem,
which affects the Company's business operations, however, could have a material
adverse effect on the Company's results of operations, financial condition and
liquidity.
Contingency Plan
The Company has been and continues to be in the process of revising its
overall enterprise contingency plan to address the continuation of key business
processes. This planning considers disruptions in addition to Year 2000-related
failures, such as fire, vandalism, and other perils.
Company management has concluded that it is not reasonably possible to
continue the Company's business operations without the use of automation and
information technology, such as computers and telephones. Management, for
contingency planning, is considering using, as a back up for its main frame
computer capability, an existing and/or new computer application(s) that can be
operated at stand-alone computer stations. Management believes that such
particular application(s) may provide a short-term solution that will enable the
Company to process, record, and invoice for transactions, and to store such
transactional data until main frame processing capability is restored. Through
Western Surety, the Company also subscribes to a third party disaster recovery
site, although access is subject to certain conditions and potential allocation
among other subscribers. The Company is taking steps to assure itself of a
greater likelihood of efficient access to the site in the event of a Year
2000-related disruption of its main frame computer capability. The Company has
also entered into a contract for the purchase and installation of a back up
emergency power generator for its Sioux Falls facility that it believes will
become operational prior to January 1, 2000.
Company Products and Services' Year 2000 Exposures
Although the Company has not received any claims based on alleged 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 upon the facts and circumstances of the claims
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's results of operations,
financial condition and liquidity.
20
<PAGE> 21
CNA SURETY CORPORATION AND SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings - None.
ITEM 2. Changes in the Rights of the Company's Security Holders - None.
ITEM 3. Defaults Upon Senior Securities - None.
ITEM 4. Submission of Matters to a Vote of Security Holders -
At the Annual Meeting of Shareholders of CNA Surety Corporation
held on May 11, 1999, the Company's shareholders voted on the
following proposals. The number of shares issued, outstanding and
eligible to vote as of the record date of March 15, 1999 were
44,101,463. Proxies representing 40,041,045 shares or 90.79
percent of the eligible voting shares were tabulated.
PROPOSAL 1
Election of Directors.
Number of Shares/Votes
For Authority Withheld
Giorgio Balzer 39,997,957 43,088
Philip H. Britt 39,998,811 42,234
Rod F. Dammeyer 39,998,422 42,623
Edward Dunlop 39,997,961 43,084
Melvin Gray 39,998,661 42,384
Joe P. Kirby 39,998,811 42,234
William C. Pate 39,998,461 42,584
Roy E. Posner 39,998,811 42,234
Adrian M. Tocklin 39,997,961 43,084
Robert T. Van Gieson 39,998,461 42,584
Mark C. Vonnahme 39,998,811 42,234
PROPOSAL II
To ratify the Board of Directors' appointment of the Company's
independent auditors, Deloitte & Touche LLP for fiscal year 1999.
For 40,035,277
Against 1,738
Abstain 4,030
21
<PAGE> 22
ITEM 5. Other Information - None.
ITEM 6. Exhibits and Reports on Form 8-K:
(a) Exhibits:
27. Financial Data Schedule.
(b) Reports on Form 8-K:
May 12, 1999; CNA Surety Corporation Press Release
issued on May 3, 1999.
May 19, 1999; CNA Surety Corporation Press Release
issued on May 11, 1999.
June 18, 1999; CNA Surety Corporation Press Release
issued on June 17, 1999.
22
<PAGE> 23
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the Registrant has duly caused this Report to be signed on its behalf by the
undersigned thereunto duly authorized.
CNA SURETY CORPORATION
(Registrant)
/s/ John S. Heneghan
------------------------------------------
John S. Heneghan
Vice President and Chief Financial Officer
Date: August 11, 1999
23
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION OF CNA SURETY CORPORATION
AND CCC SURETY OPERATIONS EXTRACTED FROM FINANCIAL STATEMENTS AND RELATED NOTES
AND SCHEDULES THERETO INCLUDED IN THIS QUARTERLY REPORT ON FORM 10-Q AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
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<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<DEBT-HELD-FOR-SALE> 405,716
<DEBT-CARRYING-VALUE> 0
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<EQUITIES> 6,117
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<TOTAL-INVEST> 465,214
<CASH> 9,985
<RECOVER-REINSURE> 79,119
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<TOTAL-ASSETS> 822,046
<POLICY-LOSSES> 158,477
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0
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</TABLE>
