##### 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
 For the quarterly period ended June 30, 2007
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from  to
 Commission file number: 1-13277
 CNA SURETY CORPORATION
  DELAWARE
    
    36-4144905(State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification No.)333 S. WABASH AVE., CHICAGO, ILLINOIS
    
    60604(Address of principal executive offices)
    
    (Zip Code)
 
 þ o
  o þ o
 o þ
 
 o o




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##### 



PagePART I. FINANCIAL INFORMATIONItem 1. Condensed Consolidated Financial Statements (Unaudited):
    
    
    3Condensed Consolidated Balance Sheets at June 30, 2007 and at December 31, 2006
    
    
    3Condensed Consolidated Statements of Income for the Three and Six Months Ended June 30, 2007 and 2006
    
    
    4Condensed Consolidated Statements of Stockholders Equity for the Six Months Ended June 30, 2007 and 2006
    
    
    5Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 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
    
    
    31Item 4. Controls and Procedures
    
    
    33PART II. OTHER INFORMATION
    
    
    33Item 1. Legal Proceedings
    
    
    33Item 1A. Risk Factors
    
    
    33Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    33Item 3. Defaults Upon Senior Securities
    
    
    33Item 4. Submission of Matters to a Vote of Security Holders
    
    
    33Item 5. Other Information
    
    
    33Item 6. Exhibits
    
    
    33302 Certification of Chief Executive Officer302 Certification of Chief Financial Officer906 Certification of Chief Executive Officer906 Certification of Chief Financial Officer
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##### Table of Contents



June 30,
    
    
    December 31,2007
    
    
    2006ASSETSInvested assets:Fixed income securities, at fair value (amortized cost: $855,090 and $773,178)
    
    $
    851,049
    
    
    $
    784,791Equity securities, at fair value (cost: $1,664 and $1,508)
    
    
    1,900
    
    
    
    1,668Short-term investments, at cost (approximates fair value)
    
    
    54,276
    
    
    
    103,640Other investments, at cost
    
    
    60
    
    
    
    22Total invested assets
    
    
    907,285
    
    
    
    890,121Cash
    
    
    5,331
    
    
    
    7,164Deferred policy acquisition costs
    
    
    109,012
    
    
    
    102,937Insurance receivables:Premiums, including $16,244 and $6,885 from affiliates, (net of allowance for
doubtful accounts: $1,185 and $1,369)
    
    
    53,491
    
    
    
    37,205Reinsurance, including $49,800 and $55,023 from affiliates
    
    
    114,371
    
    
    
    118,412Deposit with affiliated ceding company
    
    
    33,866
    
    
    
    33,145Intangible assets (net of accumulated amortization: $25,523 and $25,523)
    
    
    138,785
    
    
    
    138,785Current income taxes receivable
    
    
    239
    
    
    
    323Property and
equipment, at cost (less accumulated depreciation and amortization: $27,014 and $24,466)
    
    
    24,918
    
    
    
    24,807Prepaid reinsurance premiums (including $715 and $1,702 from affiliates)
    
    
    1,027
    
    
    
    2,165Accrued investment income
    
    
    11,334
    
    
    
    10,089Other assets
    
    
    1,689
    
    
    
    3,180Total assets
    
    $
    1,401,348
    
    
    $
    1,368,333LIABILITIESReserves:Unpaid losses and loss adjustment expenses
    
    $
    435,569
    
    
    $
    434,224Unearned premiums
    
    
    273,664
    
    
    
    253,803Total reserves
    
    
    709,233
    
    
    
    688,027Debt
    
    
    30,740
    
    
    
    30,690Deferred income taxes, net
    
    
    11,462
    
    
    
    17,298Reinsurance and other payables to affiliates
    
    
    285
    
    
    
    166Accrued expenses
    
    
    13,597
    
    
    
    20,247Liability for postretirement benefits
    
    
    12,781
    
    
    
    12,466Other liabilities
    
    
    22,023
    
    
    
    33,537Total liabilities
    
    
    800,121
    
    
    
    802,431Commitments and contingencies (See Notes 3, 4, & 7)STOCKHOLDERS EQUITYCommon stock, par value $.01 per share, 100,000 shares authorized; 45,379 shares
issued and 43,991 shares outstanding at June 30, 2007 and 45,263 shares issued
and 43,872 shares outstanding at December 31, 2006
    
    
    454
    
    
    
    453Additional paid-in capital
    
    
    271,368
    
    
    
    268,651Retained earnings
    
    
    349,388
    
    
    
    306,745Accumulated other comprehensive income
    
    
    (5,080
    )
    
    
    4,993Treasury stock, 1,388 and 1,391 shares, at cost
    
    
    (14,903
    )
    
    
    (14,940
    )Total stockholders equity
    
    
    601,227
    
    
    
    565,902Total liabilities and stockholders equity
    
    $
    1,401,348
    
    
    $
    1,368,333
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##### Table of Contents



Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Revenues:Net earned premium
    
    $
    105,687
    
    
    $
    97,041
    
    
    $
    203,990
    
    
    $
    188,929Net investment income
    
    
    10,763
    
    
    
    10,017
    
    
    
    21,464
    
    
    
    19,171Net realized investment gains (losses)
    
    
    (830
    )
    
    
    87
    
    
    
    (551
    )
    
    
    105Total revenues
    
    
    115,620
    
    
    
    107,145
    
    
    
    224,903
    
    
    
    208,205Expenses:Net losses and loss adjustment expenses
    
    
    26,854
    
    
    
    24,945
    
    
    
    51,797
    
    
    
    48,541Net commissions, brokerage and other underwriting expenses
    
    
    57,020
    
    
    
    53,514
    
    
    
    110,918
    
    
    
    104,427Interest expense
    
    
    728
    
    
    
    1,012
    
    
    
    1,449
    
    
    
    1,964Total expenses
    
    
    84,602
    
    
    
    79,471
    
    
    
    164,164
    
    
    
    154,932Income before income taxes
    
    
    31,018
    
    
    
    27,674
    
    
    
    60,739
    
    
    
    53,273Income tax expense
    
    
    9,124
    
    
    
    8,185
    
    
    
    18,096
    
    
    
    15,783Net income
    
    $
    21,894
    
    
    $
    19,489
    
    
    $
    42,643
    
    
    $
    37,490Earnings per common share
    
    $
    0.50
    
    
    $
    0.45
    
    
    $
    0.97
    
    
    $
    0.86Earnings per common share, assuming dilution
    
    $
    0.50
    
    
    $
    0.45
    
    
    $
    0.96
    
    
    $
    0.86Weighted average shares outstanding
    
    
    43,938
    
    
    
    43,519
    
    
    
    43,959
    
    
    
    43,545Weighted average shares outstanding, assuming dilution
    
    
    44,217
    
    
    
    43,765
    
    
    
    44,248
    
    
    
    43,788
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Common
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    AccumulatedStock
    
    
    
    
    
    
    Additional
    
    
    
    
    
    
    
    
    
    
    Other
    
    
    Treasury
    
    
    TotalShares
    
    
    Common
    
    
    Paid-In
    
    
    Comprehensive
    
    
    Retained
    
    
    Comprehensive
    
    
    Stock
    
    
    StockholdersOutstanding
    
    
    Stock
    
    
    Capital
    
    
    Income (Loss)
    
    
    Earnings
    
    
    Income (Loss)
    
    
    At Cost
    
    
    EquityBalance, December 31, 2005
    
    
    43,334
    
    
    $
    447
    
    
    $
    259,684
    
    
    
    
    
    
    $
    223,927
    
    
    $
    7,546
    
    
    $
    (15,029
    )
    
    $
    476,575Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    37,490
    
    
    
    37,490
    
    
    
    
    
    
    
    
    
    
    
    37,490Other comprehensive income:Change in unrealized gains on
securities, after income tax
benefit of $6,235 (net of
reclassification adjustment of
$107, after income tax expense
of $58)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (11,580
    )
    
    
    
    
    
    
    (11,580
    )
    
    
    
    
    
    
    (11,580
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    25,910Stock-based compensation
    
    
    
    
    
    
    
    
    
    
    646
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    646Stock options exercised and other
    
    
    342
    
    
    
    4
    
    
    
    4,864
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    44
    
    
    
    4,912Balance, June 30, 2006
    
    
    43,676
    
    
    $
    451
    
    
    $
    265,194
    
    
    
    
    
    
    $
    261,417
    
    
    $
    (4,034
    )
    
    $
    (14,985
    )
    
    $
    508,043Balance, December 31, 2006
    
    
    43,872
    
    
    $
    453
    
    
    $
    268,651
    
    
    
    
    
    
    $
    306,745
    
    
    $
    4,993
    
    
    $
    (14,940
    )
    
    $
    565,902Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    42,643
    
    
    
    42,643
    
    
    
    
    
    
    
    
    
    
    
    42,643Other comprehensive income:Change in unrealized gains on
securities, after income tax
benefit of $5,452 (net of
reclassification adjustment of
($142), after income tax
benefit of $76)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (10,126
    )
    
    
    
    
    
    
    (10,126
    )
    
    
    
    
    
    
    (10,126
    )Adjustment to postretirement
benefit plan net periodic
cost, after income tax expense
of $29
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    53
    
    
    
    
    
    
    
    53
    
    
    
    
    
    
    
    53Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    32,570
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Stock-based compensation
    
    
    
    
    
    
    
    
    
    
    980
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    980Stock options exercised and other
    
    
    119
    
    
    
    1
    
    
    
    1,737
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    37
    
    
    
    1,775Balance, June 30, 2007
    
    
    43,991
    
    
    $
    454
    
    
    $
    271,368
    
    
    
    
    
    
    $
    349,388
    
    
    $
    (5,080
    )
    
    $
    (14,903
    )
    
    $
    601,227
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##### Table of Contents



Six Months EndedJune 30,2007
    
    
    2006CASH FLOWS FROM OPERATING ACTIVITIES:Net income
    
    $
    42,643
    
    
    $
    37,490Adjustments to reconcile net income to net cash provided by operating activities:Provision for doubtful accounts
    
    
    151
    
    
    
    351Depreciation and amortization
    
    
    3,207
    
    
    
    2,557Amortization (accretion) of bond premium (discount), net
    
    
    98
    
    
    
    (74
    )Loss on disposal of property and equipment
    
    
    8
    
    
    
    148Net realized investment (gains) losses
    
    
    551
    
    
    
    (105
    )Stock-based compensation
    
    
    980
    
    
    
    646Changes in:Insurance receivables
    
    
    (12,396
    )
    
    
    (25,292
    )Reserve for unearned premiums
    
    
    19,861
    
    
    
    21,016Reserve for unpaid losses and loss adjustment expenses
    
    
    1,345
    
    
    
    11,276Deposits with affiliated ceding company
    
    
    (721
    )
    
    
    610Deferred policy acquisition costs
    
    
    (6,075
    )
    
    
    (4,161
    )Deferred income taxes, net
    
    
    (486
    )
    
    
    (320
    )Reinsurance and other payables to affiliates
    
    
    119
    
    
    
    (6
    )Prepaid reinsurance premiums
    
    
    1,138
    
    
    
    1,159Accrued expenses
    
    
    (6,650
    )
    
    
    (2,759
    )Other assets and liabilities
    
    
    (10,715
    )
    
    
    (4,901
    )Net cash provided by operating activities
    
    
    33,058
    
    
    
    37,635CASH FLOWS FROM INVESTING ACTIVITIES:Fixed income securities:Purchases
    
    
    (101,829
    )
    
    
    (164,475
    )Maturities
    
    
    12,428
    
    
    
    14,067Sales
    
    
    5,359
    
    
    
    91,577Purchases of equity securities
    
    
    (320
    )
    
    
    (502
    )Proceeds from the sale of equity securities
    
    
    202
    
    
    
    373Changes in short-term investments
    
    
    50,790
    
    
    
    20,832Purchases of property and equipment, net
    
    
    (3,275
    )
    
    
    (5,566
    )Other, net
    
    
    (21
    )
    
    
    (13
    )Net cash used in investing activities
    
    
    (36,666
    )
    
    
    (43,707
    )CASH FLOWS FROM FINANCING ACTIVITIES:Employee stock option exercises and other
    
    
    1,775
    
    
    
    4,911Net cash provided by financing activities
    
    
    1,775
    
    
    
    4,911Decrease in cash
    
    
    (1,833
    )
    
    
    (1,161
    )Cash at beginning of period
    
    
    7,164
    
    
    
    8,323Cash at end of period
    
    $
    5,331
    
    
    $
    7,162Supplemental Disclosure of Cash Flow Information:Cash paid during the period for:Interest
    
    $
    1,399
    
    
    $
    1,984Income taxes
    
    
    18,128
    
    
    
    18,094
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7




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##### Table of Contents



Three Months Ended June 30,
    
    
    Six Months Ended June 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Net income
    
    $
    21,894
    
    
    $
    19,489
    
    
    $
    42,643
    
    
    $
    37,490Shares:Weighted average shares outstanding
    
    
    43,931
    
    
    
    43,450
    
    
    
    43,872
    
    
    
    43,334Weighted average shares of options
exercised and additional stock
issuance
    
    
    7
    
    
    
    69
    
    
    
    87
    
    
    
    211Total weighted average shares outstanding
    
    
    43,938
    
    
    
    43,519
    
    
    
    43,959
    
    
    
    43,545Effect of dilutive options
    
    
    279
    
    
    
    246
    
    
    
    289
    
    
    
    243Total weighted average shares
outstanding, assuming dilution
    
    
    44,217
    
    
    
    43,765
    
    
    
    44,248
    
    
    
    43,788Earnings per share
    
    $
    0.50
    
    
    $
    0.45
    
    
    $
    0.97
    
    
    $
    0.86Earnings per share, assuming dilution
    
    $
    0.50
    
    
    $
    0.45
    
    
    $
    0.96
    
    
    $
    0.86
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Gross
    
    
    Gross Unrealized LossesAmortized Cost
    
    
    Unrealized
    
    
    Less Than
    
    
    More Than
    
    
    EstimatedJune 30, 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
    
    $
    14,803
    
    
    $
    
    
    
    $
    
    
    
    $
    (392
    )
    
    $
    14,411U.S. Agencies
    
    
    76,837
    
    
    
    35
    
    
    
    (170
    )
    
    
    (182
    )
    
    
    76,520Collateralized mortgage obligations
    
    
    21,192
    
    
    
    232
    
    
    
    (150
    )
    
    
    (449
    )
    
    
    20,825Mortgage pass-through securities
    
    
    35,787
    
    
    
    45
    
    
    
    
    
    
    
    (1,604
    )
    
    
    34,228Obligations of states and political subdivisions
    
    
    566,317
    
    
    
    6,296
    
    
    
    (5,237
    )
    
    
    (47
    )
    
    
    567,329Corporate bonds
    
    
    56,634
    
    
    
    759
    
    
    
    
    
    
    
    (1,626
    )
    
    
    55,767Non-agency collateralized mortgage obligations
    
    
    37,000
    
    
    
    7
    
    
    
    (20
    )
    
    
    (1,301
    )
    
    
    35,686Other asset-backed securities:Second mortgages/home equity loans
    
    
    18,483
    
    
    
    
    
    
    
    
    
    
    
    (101
    )
    
    
    18,382Credit card receivables
    
    
    17,232
    
    
    
    15
    
    
    
    (1
    )
    
    
    
    
    
    
    17,246Other
    
    
    10,805
    
    
    
    63
    
    
    
    
    
    
    
    (213
    )
    
    
    10,655Total fixed income securities
    
    
    855,090
    
    
    
    7,452
    
    
    
    (5,578
    )
    
    
    (5,915
    )
    
    
    851,049Equity securities
    
    
    1,664
    
    
    
    236
    
    
    
    
    
    
    
    
    
    
    
    1,900Total
    
    $
    856,754
    
    
    $
    7,688
    
    
    $
    (5,578
    )
    
    $
    (5,915
    )
    
    $
    852,949
 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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##### Table of Contents



Three Months Ended June 30,2007
    
    
    2006Written
    
    
    Earned
    
    
    Written
    
    
    EarnedDirect
    
    $
    95,192
    
    
    $
    87,950
    
    
    $
    87,594
    
    
    $
    79,836Assumed
    
    
    30,747
    
    
    
    27,985
    
    
    
    31,720
    
    
    
    28,693Ceded
    
    
    (9,724
    )
    
    
    (10,248
    )
    
    
    (10,117
    )
    
    
    (11,488
    )$
    116,215
    
    
    $
    105,687
    
    
    $
    109,197
    
    
    $
    97,041
 Six Months Ended June 30,2007
    
    
    2006Written
    
    
    Earned
    
    
    Written
    
    
    EarnedDirect
    
    $
    187,747
    
    
    $
    168,624
    
    
    $
    173,352
    
    
    $
    155,057Assumed
    
    
    56,606
    
    
    
    55,867
    
    
    
    58,691
    
    
    
    55,970Ceded
    
    
    (19,363
    )
    
    
    (20,501
    )
    
    
    (20,940
    )
    
    
    (22,098
    )$
    224,990
    
    
    $
    203,990
    
    
    $
    211,103
    
    
    $
    188,929
  10




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Three Months Ended June 30,2007
    
    
    2006$
    
    
    Ratio
    
    
    $
    
    
    RatioGross losses and loss adjustment expenses
    
    $
    30,280
    
    
    
    26.1
    %
    
    $
    28,328
    
    
    
    26.1
    %Ceded amounts
    
    
    (3,426
    )
    
    
    33.4
    %
    
    
    (3,383
    )
    
    
    29.4
    %Net losses and loss adjustment expenses
    
    $
    26,854
    
    
    
    25.4
    %
    
    $
    24,945
    
    
    
    25.7
    %
 Six Months Ended June 30,2007
    
    
    2006$
    
    
    Ratio
    
    
    $
    
    
    RatioGross losses and loss adjustment expenses
    
    $
    58,573
    
    
    
    26.1
    %
    
    $
    55,182
    
    
    
    26.1
    %Ceded amounts
    
    
    (6,776
    )
    
    
    33.1
    %
    
    
    (6,641
    )
    
    
    30.1
    %Net losses and loss adjustment expenses
    
    $
    51,797
    
    
    
    25.4
    %
    
    $
    48,541
    
    
    
    25.7
    %
         11




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Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Reserves at beginning of period:Gross
    
    $
    431,974
    
    
    $
    426,181
    
    
    $
    434,224
    
    
    $
    424,449Ceded reinsurance
    
    
    143,676
    
    
    
    150,003
    
    
    
    144,858
    
    
    
    147,435Net reserves at beginning of period
    
    
    288,298
    
    
    
    276,178
    
    
    
    289,366
    
    
    
    277,014Net incurred loss and loss adjustment expenses:Provision for insured events of current period
    
    
    26,878
    
    
    
    25,071
    
    
    
    51,847
    
    
    
    48,708Decrease in provision for insured events of prior periods
    
    
    (24
    )
    
    
    (126
    )
    
    
    (50
    )
    
    
    (167
    )Total net incurred
    
    
    26,854
    
    
    
    24,945
    
    
    
    51,797
    
    
    
    48,541Net payments attributable to:Current period events
    
    
    3,299
    
    
    
    1,141
    
    
    
    5,574
    
    
    
    1,551Prior period events
    
    
    19,260
    
    
    
    19,494
    
    
    
    42,996
    
    
    
    43,516Total net payments
    
    
    22,559
    
    
    
    20,635
    
    
    
    48,570
    
    
    
    45,067Net reserves at end of period
    
    
    292,593
    
    
    
    280,488
    
    
    
    292,593
    
    
    
    280,488Ceded reinsurance at end of period
    
    
    142,976
    
    
    
    155,237
    
    
    
    142,976
    
    
    
    155,237Gross reserves at end of period
    
    $
    435,569
    
    
    $
    435,725
    
    
    $
    435,569
    
    
    $
    435,725
    12




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Three Months Ended June 30,
    
    
    Six Months Ended June 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Net periodic benefit cost:Service cost
    
    $
    77
    
    
    $
    74
    
    
    $
    153
    
    
    $
    148Interest cost
    
    
    173
    
    
    
    143
    
    
    
    346
    
    
    
    286Prior service cost
    
    
    (40
    )
    
    
    (39
    )
    
    
    (81
    )
    
    
    (80
    )Recognized net actuarial loss
    
    
    81
    
    
    
    62
    
    
    
    163
    
    
    
    125Net periodic benefit cost
    
    $
    291
    
    
    $
    240
    
    
    $
    581
    
    
    $
    479
     13




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WeightedAverageShares
    
    
    ExerciseSubject
    
    
    Price PerTo Option
    
    
    ShareOutstanding options at January 1, 2006
    
    
    1,587,909
    
    
    $
    12.41Options granted
    
    
    
    
    
    $
    Options forfeited
    
    
    (9,500
    )
    
    $
    12.00Options expired
    
    
    (20,875
    )
    
    $
    14.07Options exercised
    
    
    (337,034
    )
    
    $
    13.09Outstanding options at June 30, 2006
    
    
    1,220,500
    
    
    $
    12.19Outstanding options at January 1, 2007
    
    
    1,008,525
    
    
    $
    12.02Options granted
    
    
    334,100
    
    
    $
    20.70Options forfeited
    
    
    (19,175
    )
    
    $
    13.32Options expired
    
    
    (590
    )
    
    $
    14.97Options exercised
    
    
    (114,010
    )
    
    $
    12.18Outstanding options at June 30, 2007
    
    
    1,208,850
    
    
    $
    14.38
 14




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WeightedShares
    
    
    AverageSubject
    
    
    Grant DateTo Option
    
    
    Fair ValueNon-vested options at January 1, 2006
    
    
    785,845
    
    
    $
    4.40Options granted
    
    
    
    
    
    
    Options vested
    
    
    (12,875
    )
    
    $
    3.72Options forfeited
    
    
    (9,500
    )
    
    $
    4.48Non-vested options at June 30, 2006
    
    
    763,470
    
    
    $
    4.41Non-vested options at January 1, 2007
    
    
    481,613
    
    
    $
    4.51Options granted
    
    
    334,100
    
    
    $
    9.04Options vested
    
    
    (12,875
    )
    
    $
    3.72Options forfeited
    
    
    (19,175
    )
    
    $
    5.13Non-vested options at June 30, 2007
    
    
    783,663
    
    
    $
    6.44
  Options Vested or Expected to VestWeighted
    
    
    
    
    
    Weighted AverageAverage
    
    Aggregate
    
    RemainingNumber
    
    Exercise Price
    
    Intrinsic Value
    
    Contractual LifeJune 30, 2007
    
    
    1,125,505
    
    
    $
    14.01
    
    
    $
    5,999,178
    
    
    7.3 years
 Options ExercisableWeighted
    
    
    
    
    
    Weighted AverageAverage
    
    Aggregate
    
    RemainingNumber
    
    Exercise Price
    
    Intrinsic Value
    
    Contractual LifeJune 30, 2007
    
    
    425,187
    
    
    $
    11.67
    
    
    $
    3,079,849
    
    
    5.4 years
    
      15




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Gross Case Loss
    
    
    Gross IBNR Loss
    
    
    Total Grossand LAE Reserves
    
    
    and LAE Reserves
    
    
    ReservesContract
    
    $
    121,482
    
    
    $
    147,511
    
    
    $
    268,993Commercial
    
    
    102,136
    
    
    
    53,042
    
    
    
    155,178Fidelity and other
    
    
    3,565
    
    
    
    7,833
    
    
    
    11,398Total
    
    $
    227,183
    
    
    $
    208,386
    
    
    $
    435,569
    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.
   17




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18




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19




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20




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Three Months Ended June 30,
    
    
    Six Months Ended June 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Gross written premiums
    
    $
    125,939
    
    
    $
    119,314
    
    
    $
    244,353
    
    
    $
    232,043Net written premiums
    
    $
    116,215
    
    
    $
    109,197
    
    
    $
    224,990
    
    
    $
    211,103Net earned premiums
    
    $
    105,687
    
    
    $
    97,041
    
    
    $
    203,990
    
    
    $
    188,929Net losses and loss adjustment expenses
    
    $
    26,854
    
    
    $
    24,945
    
    
    $
    51,797
    
    
    $
    48,541Net commissions, brokerage and other expenses
    
    $
    57,020
    
    
    $
    53,514
    
    
    $
    110,918
    
    
    $
    104,427Loss ratio
    
    
    25.4
    %
    
    
    25.7
    %
    
    
    25.4
    %
    
    
    25.7
    %Expense ratio
    
    
    54.0
    
    
    
    55.1
    
    
    
    54.4
    
    
    
    55.3Combined ratio
    
    
    79.4
    %
    
    
    80.8
    %
    
    
    79.8
    %
    
    
    81.0
    %
     Three Months Ended June 30,
    
    
    Six Months Ended June 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Contract
    
    $
    84,873
    
    
    $
    78,758
    
    
    $
    158,016
    
    
    $
    146,202Commercial
    
    
    33,457
    
    
    
    33,017
    
    
    
    69,687
    
    
    
    68,872Fidelity and other
    
    
    7,609
    
    
    
    7,539
    
    
    
    16,650
    
    
    
    16,969$
    125,939
    
    
    $
    119,314
    
    
    $
    244,353
    
    
    $
    232,043
   21




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Three Months Ended June 30,
    
    
    Six Months Ended June 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Contract
    
    $
    76,073
    
    
    $
    69,691
    
    
    $
    140,520
    
    
    $
    127,403Commercial
    
    
    32,533
    
    
    
    31,967
    
    
    
    67,820
    
    
    
    66,731Fidelity and other
    
    
    7,609
    
    
    
    7,539
    
    
    
    16,650
    
    
    
    16,969$
    116,215
    
    
    $
    109,197
    
    
    $
    224,990
    
    
    $
    211,103
    Three Months Ended June 30,
    
    
    Six Months Ended June 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Contract
    
    $
    65,446
    
    
    $
    56,478
    
    
    $
    123,942
    
    
    $
    108,493Commercial
    
    
    32,380
    
    
    
    32,068
    
    
    
    64,383
    
    
    
    63,413Fidelity and other
    
    
    7,861
    
    
    
    8,495
    
    
    
    15,665
    
    
    
    17,023$
    105,687
    
    
    $
    97,041
    
    
    $
    203,990
    
    
    $
    188,929
          22




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23




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Three Months Ended June 30,
    
    
    Six Months Ended June 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Gross realized investment gains
    
    $
    112
    
    
    $
    95
    
    
    $
    391
    
    
    $
    114Gross realized investment losses
    
    
    (942
    )
    
    
    (8
    )
    
    
    (942
    )
    
    
    (9
    )Net realized investment gains
    
    $
    (830
    )
    
    $
    87
    
    
    $
    (551
    )
    
    $
    105
      24




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25




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Contractual Obligations as of June 30, 2007
    
    2007
    
    
    2008
    
    
    2009
    
    
    2010
    
    
    2011
    
    
    Thereafter
    
    
    TotalDebt (a)
    
    $
    1.4
    
    
    $
    2.7
    
    
    $
    2.7
    
    
    $
    2.7
    
    
    $
    2.7
    
    
    $
    91.5
    
    
    $
    103.7Operating leases
    
    
    1.1
    
    
    
    1.9
    
    
    
    1.9
    
    
    
    1.9
    
    
    
    1.8
    
    
    
    0.9
    
    
    
    9.5Loss and loss adjustment expense reserves
    
    
    131.2
    
    
    
    132.6
    
    
    
    87.0
    
    
    
    26.5
    
    
    
    18.1
    
    
    
    40.2
    
    
    
    435.6Other long-term liabilities (b)
    
    
    0.2
    
    
    
    1.1
    
    
    
    1.0
    
    
    
    0.6
    
    
    
    0.6
    
    
    
    11.9
    
    
    
    15.4Total
    
    $
    133.9
    
    
    $
    138.3
    
    
    $
    92.6
    
    
    $
    31.7
    
    
    $
    23.2
    
    
    $
    144.5
    
    
    $
    564.2
 
 (a)
    
    Reflects expected principal and interest payments.(b)
    
    Reflects unfunded postretirement benefit plans and long-term incentive plan payments to
certain executives.   26




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Gross
    
    
    Gross Unrealized LossesAmortized Cost
    
    
    Unrealized
    
    
    Less Than
    
    
    More Than
    
    
    EstimatedJune 30, 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
    
    $
    14,803
    
    
    $
    
    
    
    $
    
    
    
    $
    (392
    )
    
    $
    14,411U.S. Agencies
    
    
    76,837
    
    
    
    35
    
    
    
    (170
    )
    
    
    (182
    )
    
    
    76,520Collateralized mortgage obligations
    
    
    21,192
    
    
    
    232
    
    
    
    (150
    )
    
    
    (449
    )
    
    
    20,825Mortgage pass-through securities
    
    
    35,787
    
    
    
    45
    
    
    
    
    
    
    
    (1,604
    )
    
    
    34,228Obligations of states and political subdivisions
    
    
    566,317
    
    
    
    6,296
    
    
    
    (5,237
    )
    
    
    (47
    )
    
    
    567,329Corporate bonds
    
    
    56,634
    
    
    
    759
    
    
    
    
    
    
    
    (1,626
    )
    
    
    55,767Non-agency collateralized mortgage obligations
    
    
    37,000
    
    
    
    7
    
    
    
    (20
    )
    
    
    (1,301
    )
    
    
    35,686Other asset-backed securities:Second mortgages/home equity loans
    
    
    18,483
    
    
    
    
    
    
    
    
    
    
    
    (101
    )
    
    
    18,382Credit card receivables
    
    
    17,232
    
    
    
    15
    
    
    
    (1
    )
    
    
    
    
    
    
    17,246Other
    
    
    10,805
    
    
    
    63
    
    
    
    
    
    
    
    (213
    )
    
    
    10,655Total fixed income securities
    
    
    855,090
    
    
    
    7,452
    
    
    
    (5,578
    )
    
    
    (5,915
    )
    
    
    851,049Equity securities
    
    
    1,664
    
    
    
    236
    
    
    
    
    
    
    
    
    
    
    
    1,900Total
    
    $
    856,754
    
    
    $
    7,688
    
    
    $
    (5,578
    )
    
    $
    (5,915
    )
    
    $
    852,949
 27




---



##### Table of Contents



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
  June 30, 2007
    
    
    December 31, 2006Estimated
    
    
    Gross
    
    
    Estimated
    
    
    GrossUnrealized Loss Aging
    
    Fair Value
    
    
    Unrealized Loss
    
    
    Fair Value
    
    
    Unrealized LossFixed income securities:Investment grade:0-6 months
    
    $
    242,588
    
    
    $
    5,032
    
    
    $
    75,215
    
    
    $
    2057-12 months
    
    
    34,362
    
    
    
    546
    
    
    
    10,104
    
    
    
    4013-24 months
    
    
    104,508
    
    
    
    4,914
    
    
    
    137,954
    
    
    
    3,457Greater than 24 months
    
    
    16,461
    
    
    
    876
    
    
    
    16,206
    
    
    
    684Total investment grade
    
    
    397,919
    
    
    
    11,368
    
    
    
    239,479
    
    
    
    4,386Non-investment grade
    
    
    3,908
    
    
    
    125
    
    
    
    3,960
    
    
    
    77Total
    
    $
    401,827
    
    
    $
    11,493
    
    
    $
    243,439
    
    
    $
    4,463
     28




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
    
    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.
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HypotheticalEstimated Fair
    
    
    PercentageHypothetical
    
    
    Value After
    
    
    IncreaseFair Value at
    
    
    Change in
    
    
    Hypothetical
    
    
    (Decrease) inJune 30,
    
    
    Interest Rate
    
    
    Change in
    
    
    Stockholders2007
    
    
    (bp=basis points)
    
    
    Interest Rate
    
    
    Equity(Dollars in thousands)U.S. Government and government agencies and authorities
    
    $
    145,984
    
    
    200 bp increase
    
    $
    133,775
    
    
    
    (1.3
    )%100 bp increase
    
    
    140,206
    
    
    
    (0.6
    )100 bp decrease
    
    
    150,407
    
    
    
    0.5200 bp decrease
    
    
    153,153
    
    
    
    0.8States, municipalities and political subdivisions
    
    
    567,329
    
    
    200 bp increase
    
    
    501,168
    
    
    
    (7.2
    )100 bp increase
    
    
    533,500
    
    
    
    (3.7
    )100 bp decrease
    
    
    602,997
    
    
    
    3.9200 bp decrease
    
    
    641,594
    
    
    
    8.0Corporate bonds and all other
    
    
    137,736
    
    
    200 bp increase
    
    
    127,914
    
    
    
    (1.1
    )100 bp increase
    
    
    132,699
    
    
    
    (0.5
    )100 bp decrease
    
    
    143,053
    
    
    
    0.6200 bp decrease
    
    
    148,625
    
    
    
    1.2Total fixed income securities available-for-sale
    
    $
    851,049
    
    
    200 bp increase
    
    
    762,857
    
    
    
    (9.6
    )100 bp increase
    
    
    806,405
    
    
    
    (4.8
    )100 bp decrease
    
    
    896,457
    
    
    
    5.0200 bp decrease
    
    
    943,372
    
    
    
    10.0
 31




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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
 32




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##### Table of Contents



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. 33




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##### Table of Contents



/s/ John F. Welch

John F. WelchPresident and Chief Executive Officer/s/ John F. Corcoran

John F. CorcoranSenior Vice President and Chief Financial Officer
  34




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##### Table of Contents



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.
 35