##### Table of Contents



FORM 10-Q
 SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   CNA SURETY CORPORATION
  DELAWARE
(State or other jurisdiction of 
incorporation or organization)
    
    36-4144905
(I.R.S. Employer
Identification No.)333 S. WABASH AVE., CHICAGO, ILLINOIS
(Address of principal executive offices)
    
    60604
(Zip Code)
 
 þ o
  Large accelerated filer  o
    
    Accelerated filer  þ
    
    Non-accelerated filer  o
 o þ
 
 o o




---



##### 



PagePART I. FINANCIAL INFORMATIONItem 1. Condensed Consolidated Financial Statements (Unaudited):
    
    
    3Condensed Consolidated Balance Sheets at March 31, 2007 and at December 31, 2006
    
    
    3Condensed Consolidated Statements of Income for the Three Months Ended March 31, 2007 and 2006
    
    
    4Condensed Consolidated Statements of Stockholders Equity for the Three Months Ended March 31, 2007 and 2006
    
    
    5Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2007 and 2006
    
    
    6Notes to Condensed Consolidated Financial Statements
    
    
    7Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    15Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    29Item 4. Controls and Procedures
    
    
    31PART II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    31Item 1A. Risk Factors
    
    
    31Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    31Item 3. Defaults Upon Senior Securities
    
    
    31Item 4. Submission of Matters to a Vote of Security Holders
    
    
    32Item 5. Other Information
    
    
    32Item 6. Exhibits
    
    
    32Certification Pursuant to Section 302 - Chief Executive OfficerCertification Pursuant to Section 302 - Chief Financial OfficerCertification Pursuant to Section 906 - Chief Executive OfficerCertification Pursuant to Section 906 - Chief Financial Officer
  2




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##### Table of Contents



March 31,
    
    
    December 31,2007
    
    
    2006ASSETSInvested assets:Fixed income securities, at fair value (amortized cost: $828,057 and $773,178)
    
    $
    837,833
    
    
    $
    784,791Equity securities, at fair value (cost: $1,630 and $1,508)
    
    
    1,787
    
    
    
    1,668Short-term investments, at cost (approximates fair value)
    
    
    60,992
    
    
    
    103,640Other investments, at cost
    
    
    60
    
    
    
    22Total invested assets
    
    
    900,672
    
    
    
    890,121Cash
    
    
    9,173
    
    
    
    7,164Deferred policy acquisition costs
    
    
    105,778
    
    
    
    102,937Insurance receivables:Premiums, including $10,377 and $6,885 from affiliates, (net of allowance for
doubtful accounts: $1,117 and $1,369)
    
    
    42,928
    
    
    
    37,205Reinsurance, including $52,771 and $55,023 from affiliates
    
    
    118,132
    
    
    
    118,412Deposit with affiliated ceding company
    
    
    33,450
    
    
    
    33,145Intangible assets (net of accumulated amortization: $25,523 and $25,523)
    
    
    138,785
    
    
    
    138,785Current income taxes receivable
    
    
    
    
    
    
    323Property and equipment, at cost (less accumulated depreciation and
amortization: $25,362 and $24,466)
    
    
    24,986
    
    
    
    24,807Prepaid reinsurance premiums
    
    
    1,551
    
    
    
    2,165Accrued investment income
    
    
    10,189
    
    
    
    10,089Other assets
    
    
    2,655
    
    
    
    3,180Total assets
    
    $
    1,388,299
    
    
    $
    1,368,333LIABILITIESReserves:Unpaid losses and loss adjustment expenses
    
    $
    431,974
    
    
    $
    434,224Unearned premiums
    
    
    263,661
    
    
    
    253,803Total reserves
    
    
    695,635
    
    
    
    688,027Debt
    
    
    30,715
    
    
    
    30,690Deferred income taxes, net
    
    
    17,024
    
    
    
    17,298Current income taxes payable
    
    
    7,438
    
    
    
    Reinsurance and other payables to affiliates
    
    
    295
    
    
    
    166Accrued expenses
    
    
    11,753
    
    
    
    20,247Liability for postretirement benefits
    
    
    12,610
    
    
    
    12,466Other liabilities
    
    
    25,249
    
    
    
    33,537Total liabilities
    
    
    800,719
    
    
    
    802,431Commitments and contingencies (See Notes 3, 4, & 7)STOCKHOLDERS EQUITYCommon stock, par value $.01 per share, 100,000 shares authorized; 45,369
shares issued and 43,981 shares outstanding at March 31, 2007 and 45,263
shares issued and 43,872 shares outstanding at December 31, 2006
    
    
    454
    
    
    
    453Additional paid-in capital
    
    
    270,712
    
    
    
    268,651Retained earnings
    
    
    327,494
    
    
    
    306,745Accumulated other comprehensive income
    
    
    3,823
    
    
    
    4,993Treasury stock, 1,388 and 1,391 shares, at cost
    
    
    (14,903
    )
    
    
    (14,940
    )Total stockholders equity
    
    
    587,580
    
    
    
    565,902Total liabilities and stockholders equity
    
    $
    1,388,299
    
    
    $
    1,368,333
  3




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##### Table of Contents



Three Months EndedMarch 31,2007
    
    
    2006Revenues:Net earned premium
    
    $
    98,303
    
    
    $
    91,888Net investment income
    
    
    10,701
    
    
    
    9,154Net realized investment gains
    
    
    279
    
    
    
    18Total revenues
    
    
    109,283
    
    
    
    101,060Expenses:Net losses and loss adjustment expenses
    
    
    24,943
    
    
    
    23,596Net commissions, brokerage and other underwriting expenses
    
    
    53,898
    
    
    
    50,913Interest expense
    
    
    721
    
    
    
    952Total expenses
    
    
    79,562
    
    
    
    75,461Income before income taxes
    
    
    29,721
    
    
    
    25,599Income tax expense
    
    
    8,972
    
    
    
    7,598Net income
    
    $
    20,749
    
    
    $
    18,001Earnings per common share
    
    $
    0.47
    
    
    $
    0.41Earnings per common share, assuming dilution
    
    $
    0.47
    
    
    $
    0.41Weighted average shares outstanding
    
    
    43,931
    
    
    
    43,450Weighted average shares outstanding, assuming dilution
    
    
    44,217
    
    
    
    43,692
  4




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##### Table of Contents



Common
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    AccumulatedStock
    
    
    
    
    
    
    Additional
    
    
    
    
    
    
    
    
    
    
    Other
    
    
    Treasury
    
    
    TotalShares
    
    
    Common
    
    
    Paid-In
    
    
    Comprehensive
    
    
    Retained
    
    
    Comprehensive
    
    
    Stock
    
    
    Stockholders'Outstanding
    
    
    Stock
    
    
    Capital
    
    
    Income (Loss)
    
    
    Earnings
    
    
    Income
    
    
    At Cost
    
    
    EquityBalance, December 31, 2005
    
    
    43,334
    
    
    $
    447
    
    
    $
    259,684
    
    
    
    
    
    
    $
    223,927
    
    
    $
    7,546
    
    
    $
    (15,029
    )
    
    $
    476,575Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    18,001
    
    
    
    18,001
    
    
    
    
    
    
    
    
    
    
    
    18,001Other comprehensive income:Change in unrealized gains on
securities, after income tax
benefit of $3,293 (net of
reclassification adjustment of
$8, after income tax expense of
$4)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (6,115
    )
    
    
    
    
    
    
    (6,115
    )
    
    
    
    
    
    
    (6,115
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    11,886Stock-based compensation
    
    
    
    
    
    
    
    
    
    
    259
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    259Stock options exercised and other
    
    
    235
    
    
    
    2
    
    
    
    3,245
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    44
    
    
    
    3,291Balance, March 31, 2006
    
    
    43,569
    
    
    $
    449
    
    
    $
    263,188
    
    
    
    
    
    
    $
    241,928
    
    
    $
    1,431
    
    
    $
    (14,985
    )
    
    $
    492,011Balance, December 31, 2006
    
    
    43,872
    
    
    $
    453
    
    
    $
    268,651
    
    
    
    
    
    
    $
    306,745
    
    
    $
    4,993
    
    
    $
    (14,940
    )
    
    $
    565,902Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    20,749
    
    
    
    20,749
    
    
    
    
    
    
    
    
    
    
    
    20,749Other comprehensive income:Change in unrealized gains on
securities, after income tax
benefit of $644 (net of
reclassification adjustment of
($161), after income tax
benefit of $87)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,196
    )
    
    
    
    
    
    
    (1,196
    )
    
    
    
    
    
    
    (1,196
    )Adjustment to postretirement
benefit plan net periodic cost,
after income tax expense of $15
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    26
    
    
    
    
    
    
    
    26
    
    
    
    
    
    
    
    26Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    19,579
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Stock-based compensation
    
    
    
    
    
    
    
    
    
    
    490
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    490Stock options exercised and other
    
    
    109
    
    
    
    1
    
    
    
    1,571
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    37
    
    
    
    1,609Balance, March 31, 2007
    
    
    43,981
    
    
    $
    454
    
    
    $
    270,712
    
    
    
    
    
    
    $
    327,494
    
    
    $
    3,823
    
    
    $
    (14,903
    )
    
    $
    587,580
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Three Months EndedMarch 31,2007
    
    
    2006CASH FLOWS FROM OPERATING ACTIVITIES:Net income
    
    $
    20,749
    
    
    $
    18,001Adjustments to reconcile net income to net cash provided by operating activities:Provision for doubtful accounts
    
    
    (148
    )
    
    
    (542
    )Depreciation and amortization
    
    
    1,426
    
    
    
    1,298Amortization (accretion) of bond premium (discount), net
    
    
    (155
    )
    
    
    244Loss (gain) on disposal of property and equipment
    
    
    (31
    )
    
    
    144Net realized investment gains
    
    
    (279
    )
    
    
    (18
    )Stock-based compensation
    
    
    490
    
    
    
    259Changes in:Insurance receivables
    
    
    (5,295
    )
    
    
    (10,185
    )Reserve for unearned premiums
    
    
    9,858
    
    
    
    10,230Reserve for unpaid losses and loss adjustment expenses
    
    
    (2,250
    )
    
    
    1,733Deposits with affiliated ceding company
    
    
    (305
    )
    
    
    491Deferred policy acquisition costs
    
    
    (2,841
    )
    
    
    (2,850
    )Deferred income taxes, net
    
    
    289
    
    
    
    300Reinsurance and other payables to affiliates
    
    
    129
    
    
    
    (174
    )Prepaid reinsurance premiums
    
    
    614
    
    
    
    (212
    )Accrued expenses
    
    
    (8,494
    )
    
    
    (5,641
    )Other assets and liabilities
    
    
    149
    
    
    
    1,127Net cash provided by operating activities
    
    
    13,906
    
    
    
    14,205CASH FLOWS FROM INVESTING ACTIVITIES:Fixed income securities:Purchases
    
    
    (66,628
    )
    
    
    (45,000
    )Maturities
    
    
    8,008
    
    
    
    4,945Sales
    
    
    3,214
    
    
    
    45,000Purchases of equity securities
    
    
    (298
    )
    
    
    (292
    )Proceeds from the sale of equity securities
    
    
    202
    
    
    
    194Changes in short-term investments
    
    
    43,554
    
    
    
    (18,737
    )Purchases of property and equipment, net
    
    
    (1,549
    )
    
    
    (2,055
    )Other, net
    
    
    (9
    )
    
    
    (5
    )Net cash used in investing activities
    
    
    (13,506
    )
    
    
    (15,950
    )CASH FLOWS FROM FINANCING ACTIVITIES:Employee stock option exercises and other
    
    
    1,609
    
    
    
    3,291Net cash provided by financing activities
    
    
    1,609
    
    
    
    3,291Increase in cash
    
    
    2,009
    
    
    
    1,546Cash at beginning of period
    
    
    7,164
    
    
    
    8,323Cash at end of period
    
    $
    9,173
    
    
    $
    9,869Supplemental Disclosure of Cash Flow Information:Cash paid during the period for:Interest
    
    $
    711
    
    
    $
    1,021Income taxes
    
    
    584
    
    
    
    3,371
  6




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7




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##### Table of Contents



Three Months EndedMarch 31,2007
    
    
    2006Net income
    
    $
    20,749
    
    
    $
    18,001Shares:Weighted average shares outstanding
    
    
    43,872
    
    
    
    43,334Weighted average shares of options exercised and additional stock issuance
    
    
    59
    
    
    
    116Total weighted average shares outstanding
    
    
    43,931
    
    
    
    43,450Effect of dilutive options
    
    
    286
    
    
    
    242Total weighted average shares outstanding, assuming dilution
    
    
    44,217
    
    
    
    43,692Earnings per share
    
    $
    0.47
    
    
    $
    0.41Earnings per share, assuming dilution
    
    $
    0.47
    
    
    $
    0.41
      8




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##### Table of Contents



Gross
    
    
    Gross Unrealized LossesAmortized Cost
    
    
    Unrealized
    
    
    Less Than
    
    
    More Than
    
    
    EstimatedMarch 31, 2007
    
    or Cost
    
    
    Gains
    
    
    12 Months
    
    
    12 Months
    
    
    Fair ValueFixed income securities:U.S. Treasury securities and obligations of
U.S. Government and agencies:U.S. Treasury
    
    $
    14,817
    
    
    $
    
    
    
    $
    
    
    
    $
    (219
    )
    
    $
    14,598U.S. Agencies
    
    
    72,072
    
    
    
    15
    
    
    
    (30
    )
    
    
    (161
    )
    
    
    71,896Collateralized mortgage obligations
    
    
    21,671
    
    
    
    339
    
    
    
    (24
    )
    
    
    (270
    )
    
    
    21,716Mortgage pass-through securities
    
    
    37,493
    
    
    
    85
    
    
    
    
    
    
    
    (1,015
    )
    
    
    36,563Obligations of states and political subdivisions
    
    
    543,139
    
    
    
    11,866
    
    
    
    (587
    )
    
    
    (13
    )
    
    
    554,405Corporate bonds
    
    
    58,857
    
    
    
    1,147
    
    
    
    
    
    
    
    (914
    )
    
    
    59,090Non-agency collateralized mortgage obligations
    
    
    37,071
    
    
    
    254
    
    
    
    
    
    
    
    (766
    )
    
    
    36,559Other asset-backed securities:Second mortgages/home equity loans
    
    
    20,093
    
    
    
    
    
    
    
    
    
    
    
    (138
    )
    
    
    19,955Credit card receivables
    
    
    17,231
    
    
    
    266
    
    
    
    
    
    
    
    
    
    
    
    17,497Other
    
    
    5,613
    
    
    
    60
    
    
    
    
    
    
    
    (119
    )
    
    
    5,554Total fixed income securities
    
    
    828,057
    
    
    
    14,032
    
    
    
    (641
    )
    
    
    (3,615
    )
    
    
    837,833Equity securities
    
    
    1,630
    
    
    
    157
    
    
    
    
    
    
    
    
    
    
    
    1,787Total
    
    $
    829,687
    
    
    $
    14,189
    
    
    $
    (641
    )
    
    $
    (3,615
    )
    
    $
    839,620
 Gross
    
    
    Gross Unrealized LossesAmortized Cost
    
    
    Unrealized
    
    
    Less Than
    
    
    More Than
    
    
    EstimatedDecember 31, 2006
    
    or Cost
    
    
    Gains
    
    
    12 Months
    
    
    12 Months
    
    
    Fair ValueFixed income securities:U.S. Treasury securities and obligations of
U.S. Government and agencies:U.S. Treasury
    
    $
    14,832
    
    
    $
    
    
    
    $
    
    
    
    $
    (327
    )
    
    $
    14,505U.S. Agencies
    
    
    62,106
    
    
    
    14
    
    
    
    (96
    )
    
    
    (260
    )
    
    
    61,764Collateralized mortgage obligations
    
    
    16,969
    
    
    
    294
    
    
    
    
    
    
    
    (326
    )
    
    
    16,937Mortgage pass-through securities
    
    
    38,851
    
    
    
    77
    
    
    
    
    
    
    
    (1,129
    )
    
    
    37,799Obligations of states and political subdivisions
    
    
    492,640
    
    
    
    13,833
    
    
    
    (118
    )
    
    
    (10
    )
    
    
    506,345Corporate bonds
    
    
    66,943
    
    
    
    1,375
    
    
    
    (5
    )
    
    
    (1,059
    )
    
    
    67,254Non-agency collateralized mortgage obligations
    
    
    37,069
    
    
    
    210
    
    
    
    
    
    
    
    (817
    )
    
    
    36,462Other asset-backed securities:Second mortgages/home equity loans
    
    
    20,925
    
    
    
    
    
    
    
    (26
    )
    
    
    (150
    )
    
    
    20,749Credit card receivables
    
    
    17,230
    
    
    
    211
    
    
    
    
    
    
    
    
    
    
    
    17,441Other
    
    
    5,613
    
    
    
    62
    
    
    
    
    
    
    
    (140
    )
    
    
    5,535Total fixed income securities
    
    
    773,178
    
    
    
    16,076
    
    
    
    (245
    )
    
    
    (4,218
    )
    
    
    784,791Equity securities
    
    
    1,508
    
    
    
    160
    
    
    
    
    
    
    
    
    
    
    
    1,668Total
    
    $
    774,686
    
    
    $
    16,236
    
    
    $
    (245
    )
    
    $
    (4,218
    )
    
    $
    786,459
   9




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Three Months Ended March 31,2007
    
    
    2006Written
    
    
    Earned
    
    
    Written
    
    
    EarnedDirect
    
    $
    92,555
    
    
    $
    80,674
    
    
    $
    85,758
    
    
    $
    75,221Assumed
    
    
    25,859
    
    
    
    27,882
    
    
    
    26,971
    
    
    
    27,277Ceded
    
    
    (9,639
    )
    
    
    (10,253
    )
    
    
    (10,823
    )
    
    
    (10,610
    )Net premiums
    
    $
    108,775
    
    
    $
    98,303
    
    
    $
    101,906
    
    
    $
    91,888
   Three Months Ended March 31,2007
    
    
    2006$
    
    
    Ratio
    
    
    $
    
    
    RatioGross losses and loss adjustment expenses
    
    $
    28,293
    
    
    
    26.1
    %
    
    $
    26,854
    
    
    
    26.2
    %Ceded amounts
    
    
    (3,350
    )
    
    
    32.7
    %
    
    
    (3,258
    )
    
    
    30.7
    %Net losses and loss adjustment expenses
    
    $
    24,943
    
    
    
    25.4
    %
    
    $
    23,596
    
    
    
    25.7
    %
   10




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Three Months EndedMarch 31,2007
    
    
    2006Reserves at beginning of period:Gross
    
    $
    434,224
    
    
    $
    424,449Ceded reinsurance
    
    
    144,858
    
    
    
    147,435Net reserves at beginning of period
    
    
    289,366
    
    
    
    277,014Net incurred loss and loss adjustment expenses:Provision for insured events of current period
    
    
    24,969
    
    
    
    23,637Decrease in provision for insured events of prior periods
    
    
    (26
    )
    
    
    (41
    )Total net incurred
    
    
    24,943
    
    
    
    23,596Net payments attributable to:Current period events
    
    
    2,275
    
    
    
    410Prior period events
    
    
    23,736
    
    
    
    24,022Total net payments
    
    
    26,011
    
    
    
    24,432Net reserves at end of period
    
    
    288,298
    
    
    
    276,178Ceded reinsurance at end of period
    
    
    143,676
    
    
    
    150,003Gross reserves at end of period
    
    $
    431,974
    
    
    $
    426,181
       12




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##### Table of Contents



Three Months EndedMarch 31,2007
    
    
    2006Net periodic benefit cost:Service cost
    
    $
    76
    
    
    $
    74Interest cost
    
    
    173
    
    
    
    143Prior service cost
    
    
    (41
    )
    
    
    (41
    )Recognized net actuarial loss
    
    
    82
    
    
    
    63Net periodic benefit cost
    
    $
    290
    
    
    $
    239
           13




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WeightedAverageShares
    
    
    ExerciseSubject
    
    
    Price PerTo Option
    
    
    ShareOutstanding options at January 1, 2006
    
    
    1,587,909
    
    
    $
    12.41Options granted
    
    
    
    
    
    $
    Options forfeited/expired
    
    
    (23,775
    )
    
    $
    13.54Options exercised
    
    
    (230,200
    )
    
    $
    12.78Outstanding options at March 31, 2006
    
    
    1,333,934
    
    
    $
    12.32Outstanding options at January 1, 2007
    
    
    1,008,525
    
    
    $
    12.02Options granted
    
    
    334,100
    
    
    $
    20.70Options forfeited/expired
    
    
    (15,850
    )
    
    $
    12.79Options exercised
    
    
    (103,485
    )
    
    $
    12.06Outstanding options at March 31, 2007
    
    
    1,223,290
    
    
    $
    14.37
  WeightedShares
    
    
    AverageSubject
    
    
    Grant DateTo Option
    
    

Fair
ValueNon-vested options at January 1, 2006
    
    
    785,845
    
    
    $
    4.40Options granted
    
    
    
    
    
    
    Options vested
    
    
    
    
    
    
    Options forfeited
    
    
    (4,100
    )
    
    $
    4.47Non-vested options at March 31, 2006
    
    
    781,745
    
    
    $
    4.40Non-vested options at January 1, 2007
    
    
    481,613
    
    
    $
    4.51Options granted
    
    
    334,100
    
    
    $
    9.04Options vested
    
    
    
    
    
    
    Options forfeited
    
    
    (15,650
    )
    
    $
    4.82Non-vested options at March 31, 2007
    
    
    800,063
    
    
    $
    6.40
 14




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Options Vested or Expected to VestWeighted
    
    
    
    
    
    Weighted AverageAverage
    
    Aggregate
    
    RemainingNumber
    
    Exercise Price
    
    Intrinsic Value
    
    Contractual LifeMarch 31, 2007
    
    
    1,123,841
    
    
    $
    14.05
    
    
    $
    7,928,306
    
    
    7.5 years
 Options ExercisableWeighted
    
    
    
    
    
    Weighted AverageAverage
    
    Aggregate
    
    RemainingNumber
    
    Exercise Price
    
    Intrinsic Value
    
    Contractual LifeMarch 31, 2007
    
    
    423,227
    
    
    $
    11.77
    
    
    $
    3,950,231
    
    
    5.6 years
    
         15




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##### Table of Contents



Gross Case Loss
    
    
    Gross IBNR Loss
    
    
    Total Grossand LAE Reserves
    
    
    and LAE Reserves
    
    
    ReservesContract
    
    $
    126,165
    
    
    $
    139,431
    
    
    $
    265,596Commercial
    
    
    100,586
    
    
    
    53,944
    
    
    
    154,530Fidelity and other
    
    
    3,920
    
    
    
    7,928
    
    
    
    11,848Total
    
    $
    230,671
    
    
    $
    201,303
    
    
    $
    431,974
      16




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##### Table of Contents



-
    
    Current claim activity, including the frequency and severity of current claims;-
    
    Changes in underwriting standards and business mix such as the Companys efforts to
reduce exposures to large commercial bonds;-
    
    Changes in the claims handling process; and-
    
    Current economic conditions, especially corporate default rates and the condition of
the construction economy.
   Gross Basis:Recorded loss reserves at December 31, 2006
    
    $
    434,224Actuarial point estimate at December 31, 2006
    
    
    438,313Difference at December 31, 2006
    
    $
    (4,089
    )Difference as a % of actuarial point estimate
    
    
    (0.9
    )%Recorded loss reserves at March 31, 2007
    
    $
    431,974Net Basis:Recorded loss reserves at December 31, 2006
    
    $
    289,366Actuarial point estimate at December 31, 2006
    
    
    292,703Difference at December 31, 2006
    
    $
    (3,337
    )Difference as a % of actuarial point estimate
    
    
    (1.1
    )%Recorded loss reserves at March 31, 2007
    
    $
    288,298
     17




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18




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19




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##### Table of Contents



Three MonthsEndedMarch 31,2007
    
    
    2006Gross written premiums
    
    $
    118,414
    
    
    $
    112,729Net written premiums
    
    $
    108,775
    
    
    $
    101,906Net earned premiums
    
    $
    98,303
    
    
    $
    91,888Net losses and loss adjustment expenses
    
    $
    24,943
    
    
    $
    23,596Net commissions, brokerage and other expenses
    
    $
    53,898
    
    
    $
    50,913Loss ratio
    
    
    25.4
    %
    
    
    25.7
    %Expense ratio
    
    
    54.8
    
    
    
    55.4Combined ratio
    
    
    80.2
    %
    
    
    81.1
    %
    20




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##### Table of Contents



Three MonthsEndedMarch 31,2007
    
    
    2006Contract
    
    $
    73,143
    
    
    $
    67,444Commercial
    
    
    36,230
    
    
    
    35,855Fidelity and other
    
    
    9,041
    
    
    
    9,430Total
    
    $
    118,414
    
    
    $
    112,729
   Three MonthsEndedMarch 31,2007
    
    
    2006Contract
    
    $
    64,447
    
    
    $
    57,712Commercial
    
    
    35,287
    
    
    
    34,764Fidelity and other
    
    
    9,041
    
    
    
    9,430Total
    
    $
    108,775
    
    
    $
    101,906
   Three MonthsEndedMarch 31,2007
    
    
    2006Contract
    
    $
    58,496
    
    
    $
    52,015Commercial
    
    
    32,003
    
    
    
    31,345Fidelity and other
    
    
    7,804
    
    
    
    8,528Total
    
    $
    98,303
    
    
    $
    91,888
      21




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22




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Three Months EndedMarch 31,2007
    
    
    2006Gross realized investment gains
    
    $
    279
    
    
    $
    19Gross realized investment losses
    
    
    
    
    
    
    (1
    )Net realized investment gains
    
    $
    279
    
    
    $
    18
   23




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24




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Contractual Obligations as ofMarch 31, 2007
    
    2007
    
    
    2008
    
    
    2009
    
    
    2010
    
    
    2011
    
    
    Thereafter
    
    
    TotalDebt (a)
    
    $
    2.1
    
    
    $
    2.7
    
    
    $
    2.7
    
    
    $
    2.7
    
    
    $
    2.7
    
    
    $
    91.5
    
    
    $
    104.4Operating leases
    
    
    1.5
    
    
    
    1.9
    
    
    
    1.9
    
    
    
    1.9
    
    
    
    1.8
    
    
    
    0.9
    
    
    
    9.9Loss and loss adjustment expense reserves
    
    
    178.9
    
    
    
    112.7
    
    
    
    74.7
    
    
    
    18.6
    
    
    
    12.9
    
    
    
    34.2
    
    
    
    432.0Other long-term liabilities (b)
    
    
    0.3
    
    
    
    1.1
    
    
    
    1.0
    
    
    
    0.6
    
    
    
    0.6
    
    
    
    11.5
    
    
    
    15.1Total
    
    $
    182.8
    
    
    $
    118.4
    
    
    $
    80.3
    
    
    $
    23.8
    
    
    $
    18.0
    
    
    $
    138.1
    
    
    $
    561.4
 
 (a)
    
    Reflects expected principal and interest payments.(b)
    
    Reflects unfunded postretirement benefit plans and long-term incentive plan payments to
certain executives.   25




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Gross
    
    
    Gross Unrealized LossesAmortized Cost
    
    
    Unrealized
    
    
    Less Than
    
    
    More Than
    
    
    Estimated FairMarch 31, 2007
    
    or Cost
    
    
    Gains
    
    
    12 Months
    
    
    12 Months
    
    
    ValueFixed income securities:U.S. Treasury securities and obligations of
U.S. Government and agencies:U.S. Treasury
    
    $
    14,817
    
    
    $
    
    
    
    $
    
    
    
    $
    (219
    )
    
    $
    14,598U.S. Agencies
    
    
    72,072
    
    
    
    15
    
    
    
    (30
    )
    
    
    (161
    )
    
    
    71,896Collateralized mortgage obligations
    
    
    21,671
    
    
    
    339
    
    
    
    (24
    )
    
    
    (270
    )
    
    
    21,716Mortgage pass-through securities
    
    
    37,493
    
    
    
    85
    
    
    
    
    
    
    
    (1,015
    )
    
    
    36,563Obligations of states and political subdivisions
    
    
    543,139
    
    
    
    11,866
    
    
    
    (587
    )
    
    
    (13
    )
    
    
    554,405Corporate bonds
    
    
    58,857
    
    
    
    1,147
    
    
    
    
    
    
    
    (914
    )
    
    
    59,090Non-agency collateralized mortgage obligations
    
    
    37,071
    
    
    
    254
    
    
    
    
    
    
    
    (766
    )
    
    
    36,559Other asset-backed securities:Second mortgages/home equity loans
    
    
    20,093
    
    
    
    
    
    
    
    
    
    
    
    (138
    )
    
    
    19,955Credit card receivables
    
    
    17,231
    
    
    
    266
    
    
    
    
    
    
    
    
    
    
    
    17,497Other
    
    
    5,613
    
    
    
    60
    
    
    
    
    
    
    
    (119
    )
    
    
    5,554Total fixed income securities
    
    
    828,057
    
    
    
    14,032
    
    
    
    (641
    )
    
    
    (3,615
    )
    
    
    837,833Equity securities
    
    
    1,630
    
    
    
    157
    
    
    
    
    
    
    
    
    
    
    
    1,787Total
    
    $
    829,687
    
    
    $
    14,189
    
    
    $
    (641
    )
    
    $
    (3,615
    )
    
    $
    839,620
 26




---



##### Table of Contents



Gross
    
    
    Gross Unrealized LossesAmortized Cost
    
    
    Unrealized
    
    
    Less Than
    
    
    More Than
    
    
    Estimated FairDecember 31, 2006
    
    or Cost
    
    
    Gains
    
    
    12 Months
    
    
    12 Months
    
    
    ValueFixed income securities:U.S. Treasury securities and obligations of
U.S. Government and agencies:U.S. Treasury
    
    $
    14,832
    
    
    $
    
    
    
    $
    
    
    
    $
    (327
    )
    
    $
    14,505U.S. Agencies
    
    
    62,106
    
    
    
    14
    
    
    
    (96
    )
    
    
    (260
    )
    
    
    61,764Collateralized mortgage obligations
    
    
    16,969
    
    
    
    294
    
    
    
    
    
    
    
    (326
    )
    
    
    16,937Mortgage pass-through securities
    
    
    38,851
    
    
    
    77
    
    
    
    
    
    
    
    (1,129
    )
    
    
    37,799Obligations of states and political subdivisions
    
    
    492,640
    
    
    
    13,833
    
    
    
    (118
    )
    
    
    (10
    )
    
    
    506,345Corporate bonds
    
    
    66,943
    
    
    
    1,375
    
    
    
    (5
    )
    
    
    (1,059
    )
    
    
    67,254Non-agency collateralized mortgage obligations
    
    
    37,069
    
    
    
    210
    
    
    
    
    
    
    
    (817
    )
    
    
    36,462Other asset-backed securities:Second mortgages/home equity loans
    
    
    20,925
    
    
    
    
    
    
    
    (26
    )
    
    
    (150
    )
    
    
    20,749Credit card receivables
    
    
    17,230
    
    
    
    211
    
    
    
    
    
    
    
    
    
    
    
    17,441Other
    
    
    5,613
    
    
    
    62
    
    
    
    
    
    
    
    (140
    )
    
    
    5,535Total fixed income securities
    
    
    773,178
    
    
    
    16,076
    
    
    
    (245
    )
    
    
    (4,218
    )
    
    
    784,791Equity securities
    
    
    1,508
    
    
    
    160
    
    
    
    
    
    
    
    
    
    
    
    1,668Total
    
    $
    774,686
    
    
    $
    16,236
    
    
    $
    (245
    )
    
    $
    (4,218
    )
    
    $
    786,459
  March 31, 2007
    
    
    December 31, 2006Estimated
    
    
    Gross
    
    
    Estimated
    
    
    GrossUnrealized Loss Aging
    
    Fair Value
    
    
    Unrealized Loss
    
    
    Fair Value
    
    
    Unrealized LossFixed income securities:Investment grade:0-6 months
    
    $
    152,825
    
    
    $
    636
    
    
    $
    75,215
    
    
    $
    2057-12 months
    
    
    3,119
    
    
    
    5
    
    
    
    10,104
    
    
    
    4013-24 months
    
    
    132,880
    
    
    
    2,708
    
    
    
    137,954
    
    
    
    3,457Greater than 24 months
    
    
    26,757
    
    
    
    807
    
    
    
    16,206
    
    
    
    684Total investment grade
    
    
    315,581
    
    
    
    4,156
    
    
    
    239,479
    
    
    
    4,386Non-investment grade
    
    
    3,934
    
    
    
    100
    
    
    
    3,960
    
    
    
    77Total
    
    $
    319,515
    
    
    $
    4,256
    
    
    $
    243,439
    
    
    $
    4,463
      27




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28




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##### Table of Contents




    
    general economic and business conditions;
 
    
    changes in financial markets such as fluctuations in interest rates, long-term periods of
low interest rates, credit conditions and currency, commodity and stock prices;
 
    
    the ability of the Companys contract principals to fulfill their bonded obligations;
 
    
    the effects of corporate bankruptcies on surety bond claims, as well as on capital
markets;
 
    
    changes in foreign or domestic political, social and economic conditions;
 
    
    regulatory initiatives and compliance with governmental regulations, judicial decisions,
including interpretation of policy provisions, decisions regarding coverage, trends in
litigation and the outcome of any litigation involving the Company, and rulings and changes in
tax laws and regulations;
 
    
    regulatory limitations, impositions and restrictions upon the Company, including the
effects of assessments and other surcharges for guaranty funds and other mandatory pooling
arrangements;
 
    
    the impact of competitive products, policies and pricing and the competitive environment in
which the Company operates, including changes in the Companys books of business;
 
    
    product and policy availability and demand and market responses, including the level of
ability to obtain rate increases and decline or non-renew underpriced accounts, to achieve
premium targets and profitability and to realize growth and retention estimates;
 
    
    development of claims and the impact on loss reserves, including changes in claim
settlement practices;
 
    
    the performance of reinsurance companies under reinsurance contracts with the Company;
 
    
    results of financing efforts, including the availability of bank credit facilities;
 
    
    changes in the Companys composition of operating segments;
 
    
    the sufficiency of the Companys loss reserves and the possibility of future increases in
reserves;
 
    
    the risks and uncertainties associated with the Companys loss reserves; and,
 
    
    the possibility of further changes in the Companys ratings by ratings agencies, including
the inability to access certain markets or distribution channels and the required
collateralization of future payment obligations as a result of such changes, and changes in
rating agency policies and practices.
  
   29




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HypotheticalEstimated Fair
    
    
    PercentageHypothetical
    
    
    Value After
    
    
    IncreaseFair Value at
    
    
    Change in
    
    
    Hypothetical
    
    
    (Decrease) inMarch 31,
    
    
    Interest Rate
    
    
    Change in
    
    
    Stockholders2007
    
    
    (bp=basis points)
    
    
    Interest Rate
    
    
    Equity(Dollars in thousands)U.S. Government and government agencies and authorities
    
    $
    144,773
    
    
    200 bp increase
    
    $
    133,511
    
    
    
    (1.2
    )%100 bp increase
    
    
    139,672
    
    
    
    (0.6
    )100 bp decrease
    
    
    148,033
    
    
    
    0.4200 bp decrease
    
    
    149,690
    
    
    
    0.5States, municipalities and political subdivisions
    
    
    554,405
    
    
    200 bp increase
    
    
    487,542
    
    
    
    (7.4
    )100 bp increase
    
    
    520,676
    
    
    
    (3.7
    )100 bp decrease
    
    
    589,981
    
    
    
    3.9200 bp decrease
    
    
    628,628
    
    
    
    8.2Corporate bonds and all other
    
    
    138,655
    
    
    200 bp increase
    
    
    128,325
    
    
    
    (1.1
    )100 bp increase
    
    
    133,354
    
    
    
    (0.6
    )100 bp decrease
    
    
    144,258
    
    
    
    0.6200 bp decrease
    
    
    150,085
    
    
    
    1.3Total fixed income securities available-for-sale
    
    $
    837,833
    
    
    200 bp increase
    
    
    749,378
    
    
    
    (9.7
    )100 bp increase
    
    
    793,702
    
    
    
    (4.9
    )100 bp decrease
    
    
    882,272
    
    
    
    4.9200 bp decrease
    
    
    928,403
    
    
    
    10.0
 30




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##### Table of Contents



HypotheticalEstimated Fair
    
    
    PercentageHypothetical
    
    
    Value After
    
    
    IncreaseFair Value at
    
    
    Change in
    
    
    Hypothetical
    
    
    (Decrease) inDecember 31,
    
    
    Interest Rate
    
    
    Change in
    
    
    Stockholders2006
    
    
    (bp=basis points)
    
    
    Interest Rate
    
    
    Equity(Dollars in thousands)U.S. Government and government agencies and authorities
    
    $
    131,005
    
    
    200 bp increase
    
    $
    120,310
    
    
    
    (1.2
    )%100 bp increase
    
    
    126,070
    
    
    
    (0.6
    )100 bp decrease
    
    
    134,299
    
    
    
    0.4200 bp decrease
    
    
    136,143
    
    
    
    0.6States, municipalities and political subdivisions
    
    
    506,345
    
    
    200 bp increase
    
    
    447,610
    
    
    
    (6.7
    )100 bp increase
    
    
    476,768
    
    
    
    (3.4
    )100 bp decrease
    
    
    537,633
    
    
    
    3.6200 bp decrease
    
    
    571,614
    
    
    
    7.5Corporate bonds and all other
    
    
    147,441
    
    
    200 bp increase
    
    
    136,456
    
    
    
    (1.3
    )100 bp increase
    
    
    141,804
    
    
    
    (0.6
    )100 bp decrease
    
    
    153,399
    
    
    
    0.7200 bp decrease
    
    
    159,611
    
    
    
    1.4Total fixed income securities available-for-sale
    
    $
    784,791
    
    
    200 bp increase
    
    
    704,376
    
    
    
    (9.2
    )100 bp increase
    
    
    744,642
    
    
    
    (4.6
    )100 bp decrease
    
    
    825,331
    
    
    
    4.7200 bp decrease
    
    
    867,368
    
    
    
    9.5
 
     
  
  
  
  
  31




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##### Table of Contents



Number Of Shares/VotesFor
    
    
    Authority WithheldPhilip H. Britt
    
    
    42,262,051
    
    
    
    741,461Anthony S. Cleberg
    
    
    42,455,076
    
    
    
    548,436David B. Edelson
    
    
    37,502,165
    
    
    
    5,501,347James R. Lewis
    
    
    37,696,030
    
    
    
    5,307,482D. Craig Mense
    
    
    37,421,507
    
    
    
    5,582,005Robert Tinstman
    
    
    42,262,311
    
    
    
    741,201John F. Welch
    
    
    37,729,906
    
    
    
    5,273,606
   For
    
    
    42,703,881Against
    
    
    79,175Abstain
    
    
    193,456
 
     
  Exhibit NumberCertification of Chief Executive Officer pursuant
to 18 U.S.C. 1350, as adopted pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
    
    
    31.1Certification of Chief Financial Officer pursuant to 18
U.S.C. 1350, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
    
    
    31.2Certification of Chief Executive Officer pursuant to 18
U.S.C. 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
    
    
    32.1Certification of Chief Financial Officer pursuant to 18
U.S.C. 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
    
    
    32.2
 
 *
    
    Exhibits 32.1 and 32.2 are being furnished and shall not be deemed filed for the purpose
of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the
liabilities of that Section. These Exhibits shall not be incorporated by reference into any
registration statement or other document pursuant to the Securities Act of 1933, as amended. 32




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31(1)
    
    Certification pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002  Chief Executive Officer.31(2)
    
    Certification pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002  Chief Financial Officer.32(1)
    
    Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002  Chief Executive Officer.32(2)
    
    Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002  Chief Financial Officer.
 34