<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 MARCH 31, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number: 1-13277
CNA SURETY CORPORATION
(Exact name of Registrant as specified in its Charter)
DELAWARE 36-4144905
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
CNA PLAZA, CHICAGO, ILLINOIS 60685
(Address of principal executive offices) (Zip Code)
(312) 822-5000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
42,897,156 shares of Common Stock, $.01 par value as of May 7, 2000.
<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 March 31, 2000 and
at December 31, 1999........................................................................... 4
Condensed Consolidated Statements of Income for the Three Months Ended
March 31, 2000 and 1999........................................................................ 5
Condensed Consolidated Statements of Stockholders' Equity for the Three
Months Ended March 31, 2000 and 1999........................................................... 6
Condensed Consolidated Statements of Cash Flows for the Three Months Ended
March 31, 2000 and 1999........................................................................ 7
Notes to Condensed Consolidated Financial Statements at March 31, 2000 ........................ 8
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.......................................................................... 11
Part II. Other Information:
Item 1. Legal Proceedings.............................................................................. 18
Item 2. Changes in the Rights of the Company's Security Holders........................................ 18
Item 3. Defaults Upon Senior Securities................................................................ 18
Item 4. Submission of Matters to a Vote of Security Holders............................................ 18
Item 5. Other Information.............................................................................. 18
Item 6. Exhibits and Reports on Form 8-K .............................................................. 18
</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 March 31, 2000, and the related
condensed consolidated statements of income, stockholders' equity and cash flows
for the three-month periods ended March 31, 2000 and 1999. These financial
statements are the responsibility of the Corporation's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and of making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with auditing standards generally accepted in the United States of America, the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to such condensed consolidated financial statements for them to be in
conformity with accounting principles generally accepted in the United States of
America.
We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the consolidated balance sheet of CNA
Surety Corporation and subsidiaries as of December 31, 1999, 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 22,
2000, 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, 1999 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
May 8, 2000
3
<PAGE> 4
CNA SURETY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
(Unaudited)
March 31, December 31,
2000 1999
----------------- -----------------
<S> <C> <C>
ASSETS
Invested assets and cash:
Fixed income securities, at fair value (amortized cost: $449,025 and $436,690) $ 433,664 $ 417,956
Equity securities, at fair value (cost: $24,436 and $23,968) 26,471 25,897
Short-term investments, at cost (approximates fair value)...................... 60,869 43,033
Other investments, at fair value............................................... 4,889 5,277
Cash 8,422 7,237
---------- ----------
Total invested assets and cash.............................................. 534,315 499,400
Deferred policy acquisition costs................................................ 88,763 84,924
Insurance receivables:
Premiums....................................................................... 9,557 9,822
Reinsurance, including $49,868 and $57,129 from affiliates..................... 87,463 76,158
Intangible assets, net of accumulated amortization of $14,854 and $13,329
at March 31, 2000 and December 31, 1999, respectively.......................... 154,455 155,980
Property and equipment, at cost (less accumulated
depreciation: $11,723 and $11,094)............................................. 16,240 14,769
Prepaid reinsurance premiums..................................................... 2,099 2,302
Other assets..................................................................... 7,784 8,220
---------- ----------
Total assets.............................................................. $ 900,676 $ 851,575
========== ==========
LIABILITIES
Reserves:
Unpaid losses and loss adjustment expenses..................................... $ 162,948 $ 157,933
Unearned premiums.............................................................. 202,589 199,300
---------- ----------
Total reserves.............................................................. 365,537 357,233
Debt .. 101,900 101,900
Deferred income taxes, net....................................................... 12,213 10,447
Payable for securities purchased................................................. 5,891 7,487
Current income taxes payable..................................................... 12,919 7,076
Reinsurance and other payables to affiliates..................................... 36,566 7,229
Other liabilities................................................................ 27,694 33,899
---------- ----------
Total liabilities........................................................... $ 562,720 $ 525,271
---------- ----------
Commitments and contingencies (See Note 4)
STOCKHOLDERS' EQUITY
Preferred stock, par value $.01 per share, 20,000 shares authorized; none issued
and outstanding................................................................ -- --
Common stock, par value $.01 per share, 100,000 shares authorized; 44,123 shares
issued and 42,896 shares outstanding at March 31, 2000 and 44,123 shares .issued
and 43,006 shares outstanding at December 31, 1999 .............................. 441 441
Additional paid-in capital....................................................... 253,367 253,366
Retained earnings................................................................ 106,100 95,419
Accumulated other comprehensive income (loss).................................... (8,967) (11,150)
Treasury stock, at cost.......................................................... (12,985) (11,772)
--------- ---------
Total stockholders' equity.................................................. 337,956 326,304
---------- ----------
Total liabilities and stockholders' equity.................................. $ 900,676 $ 851,575
========== ==========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
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
March 31,
----------------------------------
2000 1999
----------------- ----------------
<S> <C> <C>
Revenues:
Net earned premium.......................................... $ 75,687 $ 67,870
Net investment income....................................... 7,201 6,341
Net realized investment gains (losses)...................... (4) 396
----------- ----------
82,884 74,607
---------- ----------
Expenses:
Net losses and loss adjustment expenses..................... 13,572 11,914
Net commissions, brokerage and other underwriting........... 44,808 39,978
Interest expense............................................ 1,621 1,489
Amortization of intangible assets........................... 1,525 1,475
---------- ----------
61,526 54,856
---------- ----------
Income before income taxes.................................... 21,358 19,751
Income taxes.................................................. 7,245 6,708
---------- ----------
Net income.................................................... $ 14,113 $ 13,043
========== ==========
Earnings per share............................................ $ 0.33 $ 0.30
========== ==========
Earnings per share, assuming dilution......................... $ 0.33 $ 0.30
========== ==========
Weighted average shares outstanding........................... 42,962 44,100
========== ==========
Weighted average shares outstanding, assuming dilution........ 43,065 44,213
========== ==========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
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 Paid-In Comprehensive Retained
Outstanding Stock Capital Income Earnings
------------------------ --------------------------- ------------
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1998................................... 44,093 $ 441 $ 253,215 $ 52,984
Comprehensive income:
Net income................................................. -- -- -- $13,043 13,043
Other comprehensive income:
Change in unrealized gains (losses) on securities (after
income taxes), net of reclassification adjustment of $361.... -- -- -- (2,781) --
----------
Total comprehensive income.............................. $ 10,262
=========
Issuance of common stock..................................... -- -- -- --
Purchase of treasury stock................................... -- -- -- --
Stock options exercised...................................... 8 -- 40 --
Dividends paid to stockholders............................... -- -- -- (3,528)
------- ------- --------- --------
Balance, March 31, 1999...................................... 44,101 $ 441 $ 253,255 $ 62,499
======= ======= ========= ========
Balance, December 31, 1999................................... 43,006 $ 441 $ 253,366 $ 95,419
Comprehensive income:
Net income................................................. -- -- -- 14,113 14,113
Other comprehensive income:
Change in unrealized gains (losses) on securities (after
income ....taxes), net of reclassification adjustment of $135 -- -- -- 2,183 --
---------
Total comprehensive income.............................. $ 16,296
=========
Purchase of treasury stock................................... (110) -- -- --
Stock options exercised and other............................ -- -- 1 --
Dividends paid to stockholders............................... -- -- -- (3,432)
------- ------- --------- --------
Balance, March 31, 2000...................................... 42,896 $ 441 $ 253,367 $106,100
======= ======= ========= ========
<CAPTION>
Accumulated
Other Total
Comprehensive Treasury Stockholders'
Income Stock Equity
---------------------------------------------
<S> <C> <C> <C>
Balance, December 31, 1998................................... $ 3,257 $ -- $ 309,897
Comprehensive income:
Net income................................................. -- -- 13,043
Other comprehensive income:
Change in unrealized gains (losses) on securities (after
income taxes), net of reclassification adjustment of $361.... (2,781) -- (2,781)
Total comprehensive income..............................
Issuance of common stock..................................... -- -- --
Purchase of treasury stock................................... -- -- --
Stock options exercised...................................... -- -- 40
Dividends paid to stockholders............................... -- -- (3,528)
--------- -------- ---------
Balance, March 31, 1999...................................... $ 476 $ -- $ 316,671
========= ======== =========
Balance, December 31, 1999................................... $ (11,150) $(11,772) $326,304
Comprehensive income:
Net income................................................. -- -- 14,113
Other comprehensive income:
Change in unrealized gains (losses) on securities (after
income ....taxes), net of reclassification adjustment of $135 2,183 -- 2,183
Total comprehensive income..............................
Purchase of treasury stock................................... -- (1,213) (1,213)
Stock options exercised and other............................ -- -- 1
Dividends paid to stockholders............................... -- -- (3,432)
--------- -------- ---------
Balance, March 31, 2000...................................... $ (8,967) $(12,985) $ 337,956
========== ========= =========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
6
<PAGE> 7
CNA SURETY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
--------------------------------------
2000 1999
----------------- -----------------
<S> <C> <C>
OPERATING ACTIVITIES:
Net income..................................................................... $ 14,113 $ 13,043
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization............................................... 2,284 2,045
Accretion of bond discount, net............................................. 319 566
Net realized investment (gains) losses...................................... 4 (396)
Changes in:
Insurance receivables....................................................... (11,040) (6,852)
Reserve for unearned premiums............................................... 3,289 1,915
Reserve for unpaid losses and loss adjustment expenses...................... 5,015 8,097
Deferred policy acquisition costs........................................... (3,839) (2,802)
Deferred income taxes, net.................................................. 591 1,303
Reinsurance and other payables to affiliates................................ 29,337 3,961
Other assets and liabilities................................................ 346 498
---------- ----------
Net cash provided by operating activities................................. 40,419 21,378
---------- ----------
INVESTING ACTIVITIES:
Fixed income securities:
Purchases................................................................... (29,302) (60,731)
Maturities.................................................................. 12,864 25,670
Sales....................................................................... 3,119 41,346
Purchases of equity securities................................................. (868) --
Proceeds from the sale of equity securities.................................... 967 --
Changes in short-term investments.............................................. (17,742) 5,773
Purchases of property and equipment............................................ (2,300) (543)
Other, net..................................................................... (1,327) (5,115)
---------- ----------
Net cash provided by (used in) investing activities....................... (34,589) 6,400
----------- ----------
FINANCING ACTIVITIES:
Principal payments on long-term debt........................................... -- (13,000)
Dividends to stockholders...................................................... (3,432) (3,528)
Purchase of treasury stock..................................................... (1,213) --
Other.......................................................................... -- 23
---------- ----------
Net cash used in financing activities..................................... (4,645) (16,505)
----------- -----------
Increase in cash................................................................. 1,185 11,273
Cash at beginning of period...................................................... 7,237 17,746
---------- ----------
Cash at end of period............................................................ $ 8,422 $ 29,019
========== ==========
Supplemental Disclosure of Cash Flow Information:
Cash paid during the period for:
Interest.................................................................... $ 2,127 $ 2,013
Income taxes................................................................ $ 750 $ 1,300
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
7
<PAGE> 8
CNA SURETY CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2000
(UNAUDITED)
1. SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of CNA Surety
Corporation and all majority-owned subsidiaries.
Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Basis of Presentation
These unaudited Condensed Consolidated Financial Statements should be read
in conjunction with the Consolidated Financial Statements and Notes thereto
included in the Company's 1999 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 1999
Financial Statements to conform with the presentation in the 2000 Condensed
Consolidated Financial Statements.
8
<PAGE> 9
2. INVESTMENTS
The estimated amortized cost and fair value of fixed income securities held
by CNA Surety at March 31, 2000 and December 31, 1999, by investment category,
were as follows (dollars in thousands):
<TABLE>
<CAPTION>
Gross Gross
Amortized Cost or Unrealized Unrealized Estimated Fair
March 31, 2000 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............................. $ 19,808 $ 46 $ (165) $ 19,689
U.S. Agencies............................. 51,564 -- (2,177) 49,387
Collateralized mortgage obligations....... 1,796 1 (15) 1,782
Mortgage pass-through securities.......... 45,168 -- (1,899) 43,269
Obligations of states and political subdivisions 234,827 738 (8,429) 227,136
Corporate bonds................................ 43,383 69 (2,536) 40,916
Non-agency collateralized mortgage obligations 12,326 -- (286) 12,040
Other asset-backed securities:
Second mortgages/home equity loans........... 16,126 12 (267) 15,871
Credit card receivables...................... 10,592 1 (309) 10,284
Manufactured housing......................... 8,186 82 (232) 8,036
Other........................................ 1,249 2 (17) 1,234
Redeemable preferred stock..................... 4,000 20 -- 4,020
---------- ---------- ---------- ----------
Total fixed income securities............. 449,025 971 (16,332) 433,664
Equity securities.............................. 24,436 4,226 (2,191) 26,471
---------- ---------- ---------- ----------
Total..................................... $ 473,461 $ 5,197 $ (18,523) $ 460,135
========== ========== =========== ==========
<CAPTION>
Gross Gross
Amortized Cost or Unrealized Unrealized Estimated Fair
December 31, 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............................ $ 17,575 $ 6 $ (129) $ 17,452
U.S. Agencies............................. 49,786 58 (1,764) 48,080
Collateralized mortgage obligations....... 2,123 3 (10) 2,116
Mortgage pass-through securities.......... 46,701 -- (1,610) 45,091
Obligations of states and political subdivisions 229,499 56 (11,402) 218,153
Corporate bonds................................ 43,395 3 (2,934) 40,464
Non-agency collateralized mortgage obligations 12,845 -- (278) 12,567
Other asset-backed securities:
Second mortgages/home equity loans........... 19,041 16 (237) 18,820
Credit card receivables...................... 8,101 1 (323) 7,779
Other........................................ 7,624 2 (192) 7,434
---------- ---------- ----------- ----------
Total fixed income securities............. 436,690 145 (18,879) 417,956
Equity securities.............................. 23,968 3,274 (1,345) 25,897
---------- ---------- ---------- ----------
Total..................................... $ 460,658 $ 3,419 $ (20,224) $ 443,853
========== ========== =========== ==========
</TABLE>
9
<PAGE> 10
3. REINSURANCE
The effect of reinsurance on the Company's written and earned premium was
as follows (dollars in thousands):
<TABLE>
<CAPTION>
Three Months Ended March 31,
-------------------------------------------------------
2000 1999
------------------------- --------------------------
Written Earned Written Earned
<S> <C> <C> <C> <C>
Direct........................................................ $ 30,297 $ 25,880 $ 28,757 $ 25,109
Assumed from affiliates....................................... 50,358 52,994 42,767 44,509
Ceded......................................................... (1,476) (3,187) (2,162) (1,748)
----------- ----------- ----------- -----------
$ 79,179 $ 75,687 $ 69,362 $ 67,870
=========== =========== =========== ===========
</TABLE>
The effect of reinsurance on the Company's provision for loss and loss
adjustment expenses was as follows (dollars in thousands):
<TABLE>
<CAPTION>
Three Months Ended
March 31,
--------------------------
2000 1999
----------- -----------
<S> <C> <C>
Gross losses and loss adjustment expenses............................................... $ 36,704 $ 13,847
Ceded amounts........................................................................... (23,132) (1,933)
----------- -----------
Net losses and loss adjustment expenses................................................. $ 13,572 $ 11,914
=========== ===========
</TABLE>
4. LEGAL PROCEEDINGS
The Company and its subsidiaries are parties to various lawsuits arising in
the normal course of business, some seeking material damages. The Company
believes the resolution of these lawsuits will not have a material adverse
effect on its financial condition or its results of operations.
5. PROPOSED TENDER OFFER
On March 20, 2000, Continental Casualty Company ("CCC") proposed a cash
tender offer to purchase the remaining common stock of CNA Surety that it and
its affiliates do not own for $13.00 per share. On March 21, 2000, the Company's
Board of Directors appointed a special committee of independent directors to
review the proposed tender offer. The special committee has engaged independent
financial advisors and legal counsel to advise the special committee in its
review of the proposed tender offer. As of May 12, 2000, the special committee
was reviewing the proposal and had not yet made any recommendation to
shareholders concerning the proposed tender offer.
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 63% of the outstanding common stock of CNA
Surety. Loews Corporation owns approximately 87% of the outstanding common stock
of CNAF. The principal operating subsidiaries of CNAF that wrote the surety line
of business for their own account prior to the Merger were Continental Casualty
Company and its property and casualty affiliates (collectively, "CCC") and The
Continental Insurance Company and its property and casualty affiliates
(collectively, "CIC"). CIC was acquired by CNAF on May 10, 1995. The combined
surety operations of CCC and CIC are referred to herein as CCC Surety Operations
("CCC Surety Operations" or "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.
PROPOSED TENDER OFFER
On March 20, 2000, CCC proposed a cash tender offer to purchase the
remaining common stock of CNA Surety that it and its affiliates do not own for
$13.00 per share. On March 21, 2000, the Company's Board of Directors appointed
a special committee of independent directors to review the proposed tender
offer. The special committee has engaged independent financial advisors and
legal counsel to advise the special committee in its review of the proposed
tender offer. As of May 12, 2000, the special committee was reviewing the
proposal and had not yet made any recommendation to shareholders concerning the
proposed tender offer.
11
<PAGE> 12
BUSINESS
CNA Surety's insurance subsidiaries write surety and fidelity bonds in all
50 states through a combined network of approximately 37,000 independent
agencies. CNA Surety's principal insurance subsidiaries are Western Surety and
USA. The insurance subsidiaries write, on a direct basis or as business assumed
from CCC and CIC, small fidelity and non-contract surety bonds, referred to as
commercial bonds; small, medium and large contract bonds; international surety
and credit insurance; and errors and omissions ("E&O") liability insurance.
Western Surety is a licensed insurer in all 50 states and the District of
Columbia. USA is licensed in 44 states and the District of Columbia. Western
Surety's affiliated company, Surety Bonding Company of America ("SBCA"), is
licensed in 24 states.
"SAFE HARBOR" STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995
The statements which are not historical facts contained in this Form 10-Q are
forward-looking statements that involve risks and uncertainties, including, but
not limited to, product and policy demand and market response risks, the effect
of economic conditions, the impact of competitive products, policies and
pricing, product and policy development, regulatory changes and conditions,
rating agency policies and practices, development of claims and the effect on
loss reserves, the performance of reinsurance companies under reinsurance
contracts with the Company, investment portfolio developments and reaction to
market conditions, the results of financing efforts, the actual closing of
contemplated transactions and agreements, the effect of the Company's accounting
policies, and other risks detailed in the Company's Securities and Exchange
Commission filings. No assurance can be given that the actual results of
operations and financial condition will conform to the forward-looking
statements contained herein.
RESULTS OF OPERATIONS
CNA SURETY RESULTS FOR THREE MONTHS ENDED MARCH 31, 2000 AND 1999
The components of income for the Company for the three months ended March
31, 2000 and 1999 are summarized as follows (dollars in thousands):
<TABLE>
<CAPTION>
Three Months Ended March 31,
2000 1999
----------------- -----------------
<S> <C> <C>
Total revenues................................ $ 82,884 $ 74,607
========== ==========
Underwriting income........................... $ 17,307 $ 15,978
Net investment income......................... 7,201 6,341
Net realized investment gains (losses)........ (4) 396
Interest expense.............................. 1,621 1,489
Amortization of intangible assets............. 1,525 1,475
---------- ----------
Income before income taxes.................... 21,358 19,751
Income taxes.................................. 7,245 6,708
---------- ----------
Net income.................................... $ 14,113 $ 13,043
========== ==========
Net income per share.......................... $ 0.33 $ 0.30
========== ==========
</TABLE>
12
<PAGE> 13
Insurance Underwriting
Underwriting results for the Company for the three months ended March 31,
2000 and 1999 are summarized in the following table (dollars in thousands):
<TABLE>
<CAPTION>
Three Months Ended March 31,
2000 1999
----------------- -----------------
<S> <C> <C>
Gross written premiums........................ $ 80,655 $ 71,524
========== ==========
Net written premium........................... $ 79,179 $ 69,362
========== ==========
Net earned premium............................ $ 75,687 $ 67,870
Net losses and loss adjustment expenses....... 13,572 11,914
Net commissions, brokerage and other.......... 44,808 39,978
---------- ----------
Underwriting income........................... $ 17,307 $ 15,978
========== ==========
Loss ratio.................................... 17.9% 17.6%
Expense ratio................................. 59.2 58.9
---------- ----------
Combined ratio................................ 77.1% 76.5%
========== ==========
</TABLE>
Premiums Written
CNA Surety primarily markets contract and commercial surety bonds. Contract
surety bonds secure a contractor's performance and/or payment obligation
generally with respect to a construction project. Contract surety bonds are
generally required by federal, state and local governments for public works
projects. The most common types include bid, performance and payment bonds.
Commercial surety bonds include all surety bonds other than contract and cover
obligations typically required by law or regulation. The commercial surety
market includes numerous types of bonds categorized as court judicial, court
fiduciary, public official, license and permit and many miscellaneous bonds that
include guarantees of financial performance. The Company also writes fidelity
bonds which cover losses arising from employee dishonesty and other insurance
products.
Gross written premiums are shown in the table below (dollars in thousands):
<TABLE>
<CAPTION>
Three Months Ended March 31,
2000 1999
----------------- -----------------
<S> <C> <C>
Contract...................................... $ 37,415 $ 30,713
Commercial.................................... 35,747 33,365
Fidelity and other............................ 7,493 7,446
---------- ----------
$ 80,655 $ 71,524
========== ==========
</TABLE>
Gross written premiums increased 12.8%, or $9.1 million, for the three
months ended March 31, 2000 over the comparable period in 1999. Contract surety
accounted for most of this increase with growth of 21.8%, or $6.7 million, in
gross written premiums as compared to 1999. This increase reflects generally
favorable economic conditions for public construction nationwide and an increase
of $3.0 million of direct international premium. The highway/bridge sector has
shown particular strength in new account and bid activity 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, excluding international reinsurance business
assumed from CNA Reinsurance Company, Limited (London) ("CNA Re"), increased
5.2%, or $1.6 million, for the three months ended March 31, 2000. In the first
quarter of 2000, the Company experienced increased volume with local and
regional distribution partners with
13
<PAGE> 14
respect to small commercial products. CNA Surety assumed $3.0 million and $2.3
million of international surety and credit business for the three months ended
March 31, 2000 and 1999, respectively, through a quota share reinsurance treaty
with CNA Re, an affiliate of CCC. Fidelity and other products increased 0.6% to
$7.5 million for the three months ended March 31, 2000 as compared to the same
period in 1999.
Net written premiums are shown in the table below (dollars in thousands):
<TABLE>
<CAPTION>
Three Months Ended March 31,
2000 1999
----------------- -----------------
<S> <C> <C>
Contract...................................... $ 35,930 $ 29,659
Commercial.................................... 35,315 32,884
Fidelity and other............................ 7,934 6,819
---------- ----------
$ 79,179 $ 69,362
========== ==========
</TABLE>
For the three months ended March 31, 2000, net written premiums increased
14.2%, or $9.8 million, over the comparable period in 1999, consistent with the
changes in gross written premiums described above. Net written premiums
increased 21.1%, or $6.3 million, for the contract surety business. Commercial
surety net written premiums increased 7.4%, or $2.4, million for the first three
months in 2000 with direct commercial surety up 5.5%. The fidelity and other
products increased 16.4%, or $1.1 million, for the first three months in 2000 as
compared to the same period in 1999. This increase is primarily due to the
cancellation of reinsurance for other products as of September 30, 1999 that
increased our retention rate on this business from 20% to 100%.
In the second half of calendar year 1999, the Company experienced an
increase in claim severity in the most recent accident years, primarily with
respect to large commercial risks. As a result of this increase in large loss
activity where the Company cedes loss amounts in excess of $5 million per
principal under its excess of loss reinsurance program, CNA Surety anticipates
paying higher costs for reinsurance beginning in the second quarter of 2000.
Based upon management's expectations regarding revenue growth in 2000,
management does not believe that the expected increase in reinsurance costs will
have a materially adverse impact on the Company's results of operations for the
year ending December 31, 2000.
Underwriting Income
Underwriting income increased 8.3% to $17.3 million for the three months
ended March 31, 2000 compared to $16.0 million for the same period in 1999. The
period to period changes in underwriting income primarily reflect an 11.5%
increase in earned premiums.
Loss Ratio
The loss ratios for the three months ended March 31, 2000 and 1999 were
17.9% and 17.6%, respectively. The loss ratios included $2.1 million and $1.7
million of favorable reserve development for the three months ended March 31,
2000 and 1999, respectively. Excluding the impact of the favorable reserve
development, the loss ratios would have been 20.7% and 20.1% for the period
ended March 31, 2000 and March 31,1999, respectively. The increase in the
adjusted loss ratio in 2000 relates primarily to changes in business mix to a
higher proportion of contract surety business which carries a higher accident
year loss ratio.
14
<PAGE> 15
Expense Ratio
The expense ratio increased to 59.2% for the three months ended March 31,
2000 compared to 58.9% for the same period in 1999. Net earned premiums
increased 11.5% and operating expenses increased at a slightly higher rate of
12.1%, primarily due to increased contingent compensation to agents.
Investment Income
For the three months ended March 31, 2000, net investment income was $7.2
million compared to net investment income for the three months ended March 31,
1999 of $6.3 million. The increase in investment income reflects higher average
invested assets and general interest rate increases since January 1, 1999. The
average pretax yields for the Company's equity and fixed income portfolio were
5.5% and 5.4% for the three months ended March 31, 2000 and 1999, respectively.
Net realized investment losses were minimal for the three months ended
March 31, 2000 compared to $0.4 million of net realized investment gains for the
same period in 1999.
Analysis of Other Operations
Amortization expense was $1.5 million for the three months ended March 31,
2000 and March 31, 1999. Intangible assets represent goodwill and identified
intangibles primarily 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 three months ended March 31, 2000 increased $0.1
million, or 8.9%, for the first quarter of 2000 as compared to the first quarter
in 1999, primarily due to higher interest rates. Average debt outstanding was
$101.9 million for the first quarter in 2000 compared to $111.7 million in the
first quarter of 1999. The weighted average interest rate for the three months
ended March 31, 2000 was 6.2% compared to 5.3% for the same period in 1999.
Income Taxes
Income tax expense was $7.2 million and $6.7 million and the effective
income tax rates were 33.9% and 34.0% for the three months ended March 31, 2000
and 1999, respectively.
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 March 31, 2000, the carrying value of the Company's insurance
subsidiaries' invested assets was comprised of
15
<PAGE> 16
$433.7 million of fixed income securities, $26.5 million of equity securities,
$28.1 million of short-term investments, $4.9 million of other investments and
$5.1 million of cash. At December 31, 1999, the carrying value of the Company's
insurance subsidiaries' invested assets was comprised of $418.0 million of fixed
income securities, $25.9 million of equity securities, $31.4 million of
short-term investments, $5.3 million of other investments and $5.8 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 March 31, 2000, the parent
company's invested assets consisted of $32.8 million of short-term investments
and $3.3 million of cash. At December 31, 1999, the parent company's invested
assets consisted of $11.6 million of short-term investments and $1.4 million of
cash.
The Company's consolidated net cash flow provided by operating activities
was $40.4 million for the three months ended March 31, 2000 and $21.4 million
for the comparable period in 1999. The increase in net cash flow provided by
operating activities primarily relates to increases in reinsurance and other
payables to 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
March 31, 2000, CNA Surety has repaid $18 million of this debt and has unused
capacity under the revolver of approximately $30 million.
The interest rate on borrowings under the Credit Facility may be fixed, at
CNA Surety's option, for a period of one, two, three, or six months and is based
on, among other rates, the London Interbank Offered Rate ("LIBOR"), plus the
applicable margin. The margin, including the facility fee, varies based on CNA
Surety's leverage ratio (debt to total capitalization) and ranges from 0.25% to
0.40%. As of March 31, 2000, the weighted average interest rate was 6.4% on the
$100.0 million of outstanding borrowings. As of December 31, 1999, the weighted
average interest rate was 6.3% on the $100.0 million of outstanding borrowings.
The Credit Facility contains, among other conditions, limitations on CNA
Surety with respect to the incurrence of additional indebtedness and requires
the maintenance of certain financial ratios. As of March 31, 2000, 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.
During 1999, CNA Surety acquired certain assets of Clark Bonding Company,
Inc., a Charlotte, North Carolina, insurance agency and brokerage doing business
as The Bond Exchange for $5.9 million. As part of this acquisition, the Company
incurred an additional $1.9 million of debt in the form of a promissory note.
The promissory note matures on July 27, 2004 and has an interest rate of 5.0%.
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
16
<PAGE> 17
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 2000 is based on
statutory surplus and income at and for the year ended December 31, 1999.
Without prior regulatory approval in 2000, CNA Surety's insurance subsidiaries
may pay stockholder dividends of $60.5 million in the aggregate. CNA Surety
received $20.0 million in dividends from its insurance subsidiaries during the
first three months of 2000 and $15.0 million in the first three months of 1999.
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 $0.8 million for the three months
ended March 31, 2000 and $0.5 million for the same period in 1999.
CNA Surety management believes that it will have sufficient available
resources to meet its present capital needs.
17
<PAGE> 18
CNA SURETY CORPORATION AND SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings:
The Company, its directors and majority stockholders have been named as
defendants in several lawsuits seeking class action status in connection with
the proposed cash tender offer by Continental Casualty Company, a subsidiary of
CNA Financial Corporation, to purchase the shares of CNA Surety common stock
that it or its affiliates do not currently own. These lawsuits were filed within
the Delaware Chancery Court and request unspecified damages. The Company cannot
reasonably predict any resolution to these lawsuits at this time.
ITEM 2. Changes in the Rights of the Company's Security Holders - None.
ITEM 3. Defaults Upon Senior Securities - None.
ITEM 4. Submission of Matters to a Vote of Security Holders - None.
ITEM 5. Other Information - None.
ITEM 6. Exhibits and Reports on Form 8-K:
(a) Exhibits:
27. Financial Data Schedule.
(b) Reports on Form 8-K:
March 10, 2000; CNA Surety Corporation Press Release issued on
March 3, 2000.
18
<PAGE> 19
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the Registrant has duly caused this Report to be signed on its behalf by the
undersigned thereunto duly authorized.
CNA SURETY CORPORATION
(Registrant)
/s/ John S. Heneghan
John S. Heneghan
Vice President and Chief Financial Officer
Date: May 15, 2000
19
<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>
<MULTIPLIER>1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-2000
<PERIOD-START> JAN-01-2000
<PERIOD-END> MAR-31-2000
<DEBT-HELD-FOR-SALE> 433,664
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 26,471
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 525,893
<CASH> 8,422
<RECOVER-REINSURE> 87,463
<DEFERRED-ACQUISITION> 88,763
<TOTAL-ASSETS> 900,676
<POLICY-LOSSES> 162,948
<UNEARNED-PREMIUMS> 202,589
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 101,900
0
0
<COMMON> 441
<OTHER-SE> 337,515
<TOTAL-LIABILITY-AND-EQUITY> 900,676
75,687
<INVESTMENT-INCOME> 7,201
<INVESTMENT-GAINS> (4)
<OTHER-INCOME> 0
<BENEFITS> 13,572
<UNDERWRITING-AMORTIZATION> 32,544
<UNDERWRITING-OTHER> 12,264
<INCOME-PRETAX> 21,358
<INCOME-TAX> 7,245
<INCOME-CONTINUING> 14,113
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 14,113
<EPS-BASIC> 0.33
<EPS-DILUTED> 0.33
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
