<PAGE>   1


we will guarantee performance.

[CONSTRUCTION PHOTO]


CNA Surety offers an unmatched array of surety products and services. We pride
ourselves on providing custom-tailored surety solutions to virtually all
segments of the market, regardless of size or circumstance.


<PAGE>   2


we will build trust.

[CONSTRUCTION PHOTO]                                   [FACIAL PHOTO]



<PAGE>   3


One of CNA Surety's greatest strengths is the dedicated people who make up our
responsive, service-oriented culture. They are responsible for building the
trust that is the foundation of our long-term relationships.


[HAZE PHOTO]             [PHOTO OF TWO MEN]


<PAGE>   4


                                                                we will prevail.

[SPEAKER PHOTO]

A proven track record of stability and consistency; well-balanced product
portfolio; experienced management team -- these are the elements that allow CNA
Surety to thrive in virtually any type of economic cycle.

<PAGE>   5


                                                           we will lead the way.


[CLASS TRAINING PHOTO]

CNA Surety is a proven leader in the surety marketplace with an eight percent
market share. We know how to identify and take advantage of market opportunities
that enable us to maintain and enhance our leadership position.

<PAGE>   6


the power of CNA Surety.

[CHART OF COMPANY OFFERINGS]

<PAGE>   7



The words "we will" represent a powerful commitment to perform. They accompany
the promise we make to our customers, employees and shareholders based on our
solid foundation and the strength and stability of our organization. We are a
culmination of broad experience, deep-rooted relationships and expert
underwriting discipline -- a formula that brings a culture of flexibility and a
well-balanced product portfolio to all that we do. These qualities further
substantiate our leadership status in the surety industry and the strong
competitive position we maintain in a challenging economic environment. We
remain a steady and reliable force in an ever- changing surety marketplace. This
is what stands behind the promise of "will" and the power of CNA Surety.

Although typically viewed as a segment of the property/casualty industry, surety
is significantly different from a standard, two-party insurance policy. A surety
bond is a three-party agreement in which the surety provider guarantees the
fulfillment of a contractual or other obligation.


CNA Surety's Well-Balanced Portfolio of Solutions: Contract Bonds A broad
classification of bonds primarily backing construction contracts. These bonds
guarantee a contractor's performance and payment for labor and materials.
Construction lenders are also indirectly assured that projects will proceed in
accordance with contract terms. Commercial Bonds A general classification that
refers to all bonds other than contract and performance bonds. Commercial bonds
cover obligations typically required by law or regulation. Each bond is unique
to the circumstances at hand. Fidelity Bonds A broad classification of bonds
designed to guarantee honesty, primarily of employees. They cover losses arising
from employee dishonesty and indemnify the principal for losses caused by the
dishonest actions of its employees. Value-Added Services A variety of CNA Surety
initiatives that use technology to create efficiencies for customers, agents and
brokers. They include, but are not limited to, SurePath,(TM) bONdLINE,(R) Direct
Bill, the Service Center and the FAST-Track Application.


<PAGE>   8



08  CNA Surety Corporation


Dear Fellow Shareholder  Times have definitely changed from one year ago. The
dot-com investing frenzy is being replaced with renewed interest in stable,
profitable companies. Old and new businesses alike are determining how best to
compete in a changing economy. Like so many others, the surety industry is also
facing a period of transition.

         More than a decade of profitability for the surety industry has
contributed to a prolonged soft market. However, we are beginning to see some
important changes: - Consolidation is altering the makeup of many surety
organizations -- some are much larger, others no longer exist. - A changing U.S.
economy is impacting credit quality and the availability of financing. -
E-Commerce and technology are redefining standard processes that have been in
place for years.

At CNA Surety, we are not immune to these challenges; however, we are in a
strong competitive position to face them. Our track record of financial
stability combined with a culture that thrives on flexibility allows us to adapt
to the changing marketplace. We are confident that CNA Surety will remain a
long-term leader in this changing business environment. That is the power of CNA
Surety.


Financial performance Although the accelerating downturn in the U.S. economy in
the fourth quarter of 2000 did impact our year-end results, we continued to
deliver a strong bottom line. For the full year, CNA Surety reported both net
income and operating earnings after taxes of $53.6 million, or $1.25 per share,
a five percent reduction from 1999's record year-end results.


         While our core gross written premiums grew at a healthy five percent,
core net written premiums increased four percent to $298.5 million. Net written
premiums

[01 SCREEN PHOTO]

01 Fast-Track Application CNA Surety's one-page, on-line application form that
makes submissions for small contract bonds under $100,000 quick and easy. For
qualified applicants, a reply is typically provided within 24 hours of receipt
of the form. 02 Employee Dishonesty Bonds Two types: blanket and schedule.
Blanket bonds provide protection against employee theft of money, merchandise or
other property owned by the insured. These bonds cover all employees except
those specifically excluded. Schedule bonds provide similar protection, but only
for specific individuals or positions named in the policy.

[02 FACIAL EYE PHOTO]

<PAGE>   9

                                                           2000 Annual Report 09

were impacted by increased reinsurance costs associated with large loss activity
in the commercial surety segment.


       CNA Surety delivered an outstanding combined ratio of 78.6 percent for
2000, despite the challenging business environment. Our ability to achieve this
exceptional combined ratio further reflects our underwriting discipline and
financial strength. Ratings from A.M. Best of "A+" and Standard & Poor's of "A"
also confirm our financial strength, placing CNA Surety in an elite class of
surety providers.

Operations update One of CNA Surety's greatest strengths is our well-balanced
product portfolio. Unlike most surety organizations, CNA Surety's portfolio is
almost equally divided between contract and commercial surety. In addition, our
product, size of bond, customer, and geographic diversification help produce
strong cash flows under various economic conditions.

Contract -- In 2000, domestic gross premiums for our contract segment grew nine
percent to $153.4 million. Growth within the middle and large contract segments
is expected to continue, based on anticipated spending levels in highway,
airport, education and other public works. We expect near-term growth of four to
six percent in our contract business, driven primarily by our core, middle
market segment. We are seeing early signs of a hardening of the contract markets
in terms of price and underwriting, particularly in the small contract arena. As
a strong, stable organization, we are in a good position to take advantage of
any instabilities in the marketplace and capitalize on profitable growth
opportunities.

Commercial -- Domestic gross premiums for our commercial book grew approximately
one percent in 2000 to $120.1 million, reflecting mixed results between the


[01 CONSTRUCTION WORKER PHOTO]

01 Performance Bonds A specific type of contract bond. Performance bonds
guarantee that the project work will be performed according to the plans and
specifications, on time, and at the agreed upon price. These bonds protect the
owner, or obligee, from financial loss should the contractor fail to perform. 02
Public Official Bonds Guarantee taxpayers that the public official will
"faithfully and honestly" perform the duties of the office. By law, public
officials are required to furnish a bond to qualify for state, county or
municipal office, as well as for school boards and water and drainage district
commissions.

[02 SPEAKER PHOTO]

<PAGE>   10

10  CNA Surety Corporation

small and large segments of this market. Small commercial products, generally
less sensitive to economic conditions, grew about six percent. We continue to
see favorable demand for our small commercial products, particularly license and
permit bonds. In addition, the changing economy and deteriorating conditions in
commercial credit markets required us to re-evaluate our credit exposures and
underwriting requirements for large commercial clients. Domestic gross premiums
declined in this segment in the second half of 2000, and we expect these
challenging market conditions to continue. On balance, we are anticipating
domestic commercial surety growth in 2001 at or below three percent.

International -- Our international expansion efforts support our long-term
growth and profit objectives for our contract and commercial segments. In 2000,
our direct international business grew 13 percent to $10.6 million. Our Canadian
operation contributed about $1.8 million in gross premiums and provided valuable
support to our U.S. customers doing business in Canada. We also purchased an
equity interest in DeMontfort Insurance Company, PLC, a United Kingdom-based
surety company. This strategic investment provides a platform to pursue business
in the UK and the Republic of Ireland. In January 2001, CNA Surety and
DeMontfort jointly established a London office to further support our European
expansion.

Value-added services While technology is a powerful tool for improving
efficiency and reducing expenses, in the surety business, nothing takes the
place of knowledgeable, customer-oriented service. At CNA Surety, we use a
combination of technology and personal service to provide our customers, agents
and brokers with superior resources that allow them to be more productive.

[01 SAFETY CONES PHOTO]

01 License and Permit Bonds Protect the public by ensuring that individuals and
companies conform to the ordinances or laws relating to their businesses. There
are four general types of license and permit bonds. These bonds include: public
safety; regulatory; public protection; and financial credit guarantee.
02 Court Bonds A general term that covers bonds required of participants
in court proceedings. They permit litigants to pursue certain legal remedies.
Principals on court bonds have a financial responsibility to pay monetary
damages or costs to the opposing party if they are unsuccessful in their
litigation.


[02 COURTROOM PHOTO]

<PAGE>   11

                                                           2000 Annual Report 11

InSure Vision -- Our alliance with InSure Vision Technologies (IVT) reinforces
this commitment by offering cutting-edge technology that provides our
distribution partners with the ability to better automate processing, lower
their costs and increase efficiency. The response to IVT's SurePath product has
been extremely positive and further enhances our growth opportunities with these
key constituents.

Service Center -- The Service Center concept was introduced in 1998 to provide
agents the ability to outsource surety processing. Using our unique
infrastructure and information base for our small commercial surety and fidelity
products, our Service Center has evolved from processing and automation to
include a variety of customized services to address the growing needs of our
customers. As a measure of our processing capacity, CNA Surety has over 1.7
million bonds in force; the Service Center handles more than 1.4 million new and
renewal transactions annually.

Shareholder value Providing shareholder value is always a primary focus at CNA
Surety. Stockholders' equity at year-end was $374 million, or $8.76 per share,
an increase of 15 percent from 1999. Since the formation of CNA Surety in 1997,
our tangible book value has increased 163 percent to $5.39 per share.

       Shareholders also received payment of an eight cent per share quarterly
dividend. In addition, we reinstated our share repurchase program in response to
a market that we felt did not reflect the true or intrinsic value of our
organization.

Future outlook As we continue into 2001, our focus will remain on profitable
growth. We believe that our average annual premium growth rate of six to nine
percent is still a feasible long-term target. In light of current economic
conditions,

[01 CLASS TRAINING PHOTO]

01 Agency Training/Workshops and Education A variety of contract, commercial and
surety industry seminars hosted by CNA Surety to help agents and brokers more
effectively understand and provide our full-range of products and services to
their clients. 02 bONdLINE(R) On-line system that streamlines the issuance and
reporting of commercial and fidelity bonds. Provides direct access to an
extensive library of the most common commercial surety and fidelity bond forms,
offers single-screen data entry and produces bond forms direct from an agent's
printer. Data is automatically captured for easy electronic reporting.

[02 EYE FACIAL PHOTO]

<PAGE>   12

12  CNA Surety Corporation


however, an annual premium growth rate of three to five percent is more
realistic for the short-term. We will continue to review our underwriting
discipline on a regular basis and will make appropriate adjustments to best
serve our customers and our shareholders for the long term.

       Although we clearly see challenging times ahead, we also see many
interesting opportunities. At CNA Surety, our management team has experience in
every stage of the economic cycle; we know how to successfully grow the business
in both good and difficult times. With an eight percent share of the market, CNA
Surety remains one of the surety industry leaders. Our history of financial
stability has proven that we can stand the test of time.

       Attracting high quality talent focused on profitable growth further
enhances the value of our franchise. While other companies are in transition, we
are proud of our dedicated employees, along with our seasoned management team,
who forge the valuable long-term relationships that build our business. They
provide the real power of CNA Surety.

Sincerely,

/s/ Thomas F. Taylor                    /s/ Mark C. Vonnahme
----------------------------------      ------------------------------------
Thomas F. Taylor                        Mark C. Vonnahme
Chairman of the Board of Directors      President and Chief Executive Officer

March 05, 2001

[01 SHIP PHOTO]

01 Customs Bonds Protect U.S. Customs revenues and ensure compliance with
Customs regulations. Anyone wishing to import goods into the United States or
engage in import-related operations is required to post a surety bond with U.S.
Customs. CNA Surety offers customs bonds through its affiliation with C.A. Shea
& Company, Inc. 02 Fiduciary Bonds Also known as probate bonds. Fiduciary bonds
guarantee an honest accounting and faithful performance of duties by
administrators, trustees, guardians, executors, and other fiduciaries. These
bonds are required by statutes, courts or legal documents.

[02 BUILDING PHOTO]

<PAGE>   13


                                                           2000 Annual Report 13


Financial Highlights

<TABLE>
<CAPTION>
In millions, except per share data                 Year ended December 31           2000           1999          % Change
-------------------------------------------------------------------------------------------------------------------------
<S>                                                <C>                           <C>               <C>              <C>
GROSS WRITTEN PREMIUM                                                             $316.7            $306.9            3%
NET WRITTEN PREMIUM                                                                304.5             299.0            2
UNDERWRITING INCOME                                                                 64.5              71.9          (10)
NET INVESTMENT INCOME AND REALIZED
   INVESTMENT GAINS                                                                 30.5              25.9           18
PRETAX INCOME                                                                       81.4              85.9           (5)
NET INCOME                                                                          53.6              56.5           (5)
NET INCOME PER SHARE                                                                1.25              1.28           (2)
NET OPERATING INCOME PER SHARE                                                      1.25              1.28           (2)
-------------------------------------------------------------------------------------------------------------------------
</TABLE>

Balance Sheet Data

<TABLE>
<CAPTION>
In millions, except per share data                            December 31           2000            1999         % Change
-------------------------------------------------------------------------------------------------------------------------
<S>                                                           <C>                <C>               <C>              <C>
INVESTED ASSETS AND CASH                                                          $556.0            $499.4           11%
INTANGIBLE ASSETS                                                                  149.9             156.0           (4)
TOTAL ASSETS                                                                       950.6             851.6           12
INSURANCE RESERVES                                                                 406.6             357.2           14
DEBT                                                                               101.6             101.9
TOTAL LIABILITIES                                                                  576.6             525.3           10
STOCKHOLDERS' EQUITY                                                               374.0             326.3           15
BOOK VALUE PER SHARE                                                                8.76              7.59           15
TANGIBLE BOOK VALUE PER SHARE                                                       5.39              4.11           31
DEBT TO TOTAL CAPITALIZATION                                                          21%               24%
-------------------------------------------------------------------------------------------------------------------------
</TABLE>

Net Written Premiums by Product

<TABLE>
<CAPTION>
In millions         Year ended December 31            2000        % of Total       1999          % of Total       % Change
-------------------------------------------------------------------------------------------------------------------------
<S>                                                 <C>               <C>         <C>                <C>             <C>
CONTRACT                                            $150.5             49%        $145.6              49%             3%
COMMERCIAL                                           126.9             42          128.8              43             (1)
FIDELITY AND OTHER                                    27.1              9           24.6               8             10
-------------------------------------------------------------------------------------------------------------------------
TOTAL                                               $304.5            100%        $299.0             100%             2%
-------------------------------------------------------------------------------------------------------------------------
</TABLE>


MANAGEMENT'S DISCUSSION AND ANALYSIS                                       14

CONSOLIDATED FINANCIAL STATEMENTS                                          27

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                 31

INDEPENDENT AUDITORS' REPORT                                               47

DIRECTORS AND OFFICERS                                                     48

CORPORATE INFORMATION                                                      49


<PAGE>   14

14 CNA SURETY CORPORATION

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

The following is a discussion and analysis of CNA Surety Corporation ("CNA
Surety" or the "Company") and its subsidiaries' operating results, liquidity and
capital resources, and financial condition. This discussion should be read in
conjunction with the Consolidated Financial Statements of CNA Surety and notes
thereto.

FORMATION OF CNA SURETY CORPORATION AND MERGER

In December 1996, CNA Financial Corporation ("CNAF") and Capsure Holdings Corp.
("Capsure") agreed to merge (the "Merger") the surety business of CNAF with
Capsure's insurance subsidiaries, Western Surety Company ("Western Surety") and
Universal Surety of America ("USA"), into CNA Surety Corporation ("CNA Surety"
or the "Company"). CNAF, through its operating subsidiaries, writes multiple
lines of property and casualty insurance, including surety business that is
reinsured by Western Surety. CNAF owns approximately 64% of the outstanding
common stock of CNA Surety. Loews Corporation owns approximately 87% of the
outstanding common stock of CNAF. The principal operating subsidiaries of CNAF
that wrote the surety line of business for their own account prior to the Merger
were Continental Casualty Company and its property and casualty affiliates
(collectively, "CCC") and The Continental Insurance Company and its property and
casualty affiliates (collectively, "CIC"). CIC was acquired by CNAF on May 10,
1995. The combined surety operations of CCC and CIC are referred to herein as
CCC Surety Operations ("Predecessor").

         Pursuant to a reorganization agreement, CCC Surety Operations and
Capsure merged their respective operations at the close of business on September
30, 1997 ("Merger Date"). CNAF, through its property and casualty subsidiaries,
CCC and CIC, contributed $52.25 million of capital to CNA Surety. Through
reinsurance agreements, CCC and CIC ceded to Western Surety all of their net
unearned premiums and loss and loss adjustment expense reserves, as of the
Merger Date, and will cede to Western Surety all surety business written or
renewed by CCC and CIC for a period of five years thereafter. Further, CCC and
CIC have agreed to assume the obligation for any adverse development on recorded
reserves for CCC Surety Operations as of the Merger Date, to limit the loss
ratio on certain defined business written by CNA Surety through December 31,
2000 and to provide certain additional excess of loss reinsurance.

PROPOSED TENDER OFFER

On March 20, 2000, CCC proposed a cash tender offer to purchase the remaining
common stock of CNA Surety that it and its affiliates did not own for $13.00 per
share. On May 26, 2000, CCC informed CNA Surety that CCC did not intend to
pursue a proposed tender offer to acquire the remaining equity interests of the
Company not currently owned by CCC. The Company recorded a non-recurring charge
of $0.5 million before income taxes, or $0.3 million after tax (1 cent per
share), for costs incurred with respect to the proposed tender offer by CCC.

         As reported in CNAF public filings, CCC and other insurance
subsidiaries of CNAF that own shares of CNA Surety may review their respective
positions of CNA Surety shares from time to time and may acquire additional
shares or dispose of shares depending upon market conditions or other factors
existing at the time of such review, resulting in increases or decreases in
their respective ownership positions.

BUSINESS

CNA Surety's insurance subsidiaries write surety and fidelity bonds in all 50
states through a combined network of approximately 37,000 independent agencies.
CNA Surety's principal insurance subsidiaries are Western Surety and USA. The
insurance subsidiaries write, on a direct basis or as business assumed from CCC
and CIC, small fidelity and non-contract surety bonds, referred to as commercial
bonds; small, medium and large contract bonds; international surety and credit
insurance; and errors and omissions ("E&O") liability insurance. Western Surety
is a licensed insurer in all 50 states and the District of Columbia. USA is
licensed in 44 states and the District of Columbia. Western Surety's affiliated
company, Surety Bonding Company of America ("SBCA"), is licensed in 25 states
and the District of Columbia.

         The Company's corporate objective is to be the leading provider of
surety and surety-related products in the United States and in select
international markets and to be the surety of choice for its customers and
independent agents and brokers.

         Western Surety and USA are both currently rated A+ (Superior) by A.M.
Best Company, Inc. ("A.M. Best"). Through intercompany reinsurance and related
agreements, CNA Surety's customers will continue to have access to CCC's broader
underwriting capacity. CCC is currently rated A by A.M. Best. A.M. Best's letter
ratings range from A++ (Superior) to D (Poor)


<PAGE>   15

                                                           2000 ANNUAL REPORT 15

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

with A++ being highest. An A+ (Superior) rating is assigned to those companies
which A.M. Best believes have achieved superior overall performance when
compared to the norms of the property and casualty insurance industry. A+
(Superior) rated insurers have been shown to be among the strongest in ability
to meet policyholder and other contractual obligations. A rating of A
(Excellent) is assigned to those companies which A.M. Best believes have
achieved excellent overall performance when compared to the norms of the
property and casualty insurance industry and generally have demonstrated a
strong ability to meet their respective policyholder and other contractual
obligations.

         Western Surety and USA are both currently rated A (Strong), by Standard
and Poor's ("S&P"). CCC is currently rated A by S&P. S&P's letter ratings range
from AAA+ (Extremely Strong) to CC (Extremely Weak) with AAA+ being highest. An
insurer rated 'A' has strong financial security characteristics, but is somewhat
more likely to be affected by adverse business conditions than are insurers with
higher ratings.

RESULTS OF OPERATIONS

COMPARISON OF CNA SURETY ACTUAL RESULTS FOR THE YEARS ENDED DECEMBER 31, 2000,
1999 AND 1998

The components of income for the Company for the years ended December 31, 2000,
1999 and 1998 are summarized as follows:

<TABLE>
<CAPTION>

IN THOUSANDS             YEARS ENDED DECEMBER 31            2000          1999          1998
--------------------------------------------------------------------------------------------
<S>                                                   <C>           <C>           <C>
Total revenues                                          $332,273      $309,405      $283,840
--------------------------------------------------------------------------------------------
Underwriting income                                     $ 64,481      $ 71,894      $ 61,773
Net investment income                                     29,897        25,850        24,259
Net realized investment gains                                557            15           844
Interest expense                                           6,956         5,846         7,218
Non-recurring charges                                        500            --            --
Amortization of intangible assets                          6,097         5,982         5,900
--------------------------------------------------------------------------------------------
Income before income taxes                                81,382        85,931        73,758
Income taxes                                              27,780        29,433        28,243
--------------------------------------------------------------------------------------------
Net income                                              $ 53,602      $ 56,498      $ 45,515
Net income per share                                    $   1.25      $   1.28      $   1.04
--------------------------------------------------------------------------------------------
</TABLE>

INSURANCE UNDER WRITING

Underwriting results for the Company for the years ended December 31, 2000, 1999
and 1998 are summarized in the following table:

<TABLE>
<CAPTION>

IN THOUSANDS             YEARS ENDED DECEMBER 31            2000          1999          1998
--------------------------------------------------------------------------------------------
<S>                                                   <C>           <C>           <C>
Gross written premium                                   $316,667      $306,859      $278,224
--------------------------------------------------------------------------------------------
Net written premiums                                    $304,468      $298,987      $270,602
--------------------------------------------------------------------------------------------
Net earned premiums                                     $301,819      $283,540      $258,737
Net losses and loss adjustment expenses                   55,683        44,672        44,998
Net commissions, brokerage and other                     181,655       166,974       151,966
--------------------------------------------------------------------------------------------
Underwriting income                                     $ 64,481      $ 71,894      $ 61,773
--------------------------------------------------------------------------------------------
Loss ratio                                                  18.4%         15.7%         17.4%
Expense ratio                                               60.2          58.9          58.7
--------------------------------------------------------------------------------------------
Combined ratio                                              78.6%         74.6%         76.1%
--------------------------------------------------------------------------------------------
</TABLE>

PREMIUMS WRITTEN

CNA Surety primarily markets contract and commercial surety bonds. Contract
surety bonds generally secure a contractor's performance and/or payment
obligation with respect to a construction project. Contract surety bonds are
generally required by federal, state and local governments for public works
projects. The most common types include bid, performance and payment bonds.
Commercial surety bonds include all surety bonds other than contract and cover

<PAGE>   16


16 CNA SURETY CORPORATION

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

obligations typically required by law or regulation. The commercial surety
market includes numerous types of bonds categorized as court judicial, court
fiduciary, public official, license and permit and many miscellaneous bonds that
include guarantees of financial performance. The Company also writes fidelity
bonds which cover losses arising from employee dishonesty and other insurance
products.

         Gross written premiums for the years ended December 31, 2000, 1999 and
1998 are shown in the table below:

<TABLE>
<CAPTION>

IN THOUSANDS            YEARS ENDED DECEMBER 31         2000           1999          1998
-----------------------------------------------------------------------------------------
<S>                                               <C>            <C>           <C>
Contract                                            $161,539       $150,022      $132,242
Commercial                                           128,556        130,502       121,046
Fidelity and other                                    26,572         26,335        24,936
-----------------------------------------------------------------------------------------
                                                    $316,667       $306,859      $278,224
-----------------------------------------------------------------------------------------
</TABLE>

Gross written premiums for the year ended December 31, 2000 increased 3.2%, or
$9.8 million, for the year ended December 31, 2000 over the comparable period in
1999. This change in full year gross production reflects an estimated $5.3
million reduction associated with the mid-year decision by CNA Reinsurance
Company, Limited (London) ("CNA Re"), an affiliate of CCC, to discontinue
writing assumed international credit and surety business. Assumed international
surety and credit business from CNA Re for the year ended December 31, 2000
decreased to $6.0 million from $11.3 million in 1999. Excluding international
reinsurance business assumed from CNA Re, core direct gross written premiums
increased 5.1%, or $15.1 million, for the full year of 2000. Gross written
premiums for contract surety increased 7.7%, or $11.5 million, as compared to
1999 due to generally favorable economic conditions for public construction in
the first half of the year. A slowing domestic economy and unfavorable weather
patterns in the fourth quarter reduced construction activity in the second half
of 2000. Gross written premiums for core direct commercial surety increased
2.8%, or $3.3 million, primarily due to volume growth of small commercial
products, particularly license and permit bonds, and increased direct
international production. Market conditions in the large commercial segment
continue to be difficult given general economic conditions and deteriorating
commercial credit markets. Fidelity and other products increased 0.9%, or $0.2
million, to $26.6 million for the year ended December 31, 2000.

         Gross written premiums increased 10.3%, or $28.6 million, for the year
ended December 31, 1999 over the comparable period in 1998. Gross written
premiums for contract surety increased 13.4%, or $17.8 million, as compared to
1998. This increase reflected volume growth from new account activity, generally
favorable economic conditions for public construction nationwide and an increase
of $8.0 million of direct international premium. The highway/bridge sector had
shown particular strength in new account and bid activity since the United
States Congressional passage of the Transportation Equity Act for the 21st
Century ("TEA-21"). TEA-21 authorizes a 40% increase in total Federal funding
for highway and transit systems to over $200 billion in the six-year period from
1998 to 2004. Commercial surety, excluding international reinsurance business
assumed from CNA Re, increased 7.4%, or $8.2 million, for the year ended
December 31, 1999 reflecting positive new and renewal activity on larger
accounts during the fourth quarter and the addition of $1.0 million in
non-recurring premiums associated with large court bond obligations. CNA Surety
assumed $11.3 million and $10.0 million of international surety and credit
business in 1999 and 1998, respectively, through a quota share reinsurance
treaty with CNA Re, an affiliate of CCC. Fidelity and other products increased
5.6%, or $1.4 million, to $26.3 million for the year ended December 31, 1999.

         Net written premiums for the years ended December 31, 2000, 1999 and
1998 are shown in the table below:

<TABLE>
<CAPTION>

IN THOUSANDS            YEARS ENDED DECEMBER 31         2000           1999          1998
-----------------------------------------------------------------------------------------
<S>                                               <C>            <C>           <C>
Contract                                            $150,504       $145,616      $127,114
Commercial                                           126,923        128,834       120,638
Fidelity and other                                    27,041         24,537        22,850
-----------------------------------------------------------------------------------------
                                                    $304,468       $298,987      $270,602
-----------------------------------------------------------------------------------------
</TABLE>


<PAGE>   17

                                                           2000 ANNUAL REPORT 17

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

Net written premiums for the year ended December 31, 2000 increased 1.8%
percent, or $5.5 million, reflecting the aforementioned gross production
variances and the effects of higher reinsurance costs. The reinsurance costs
reflected in ceded premiums are based upon reinsurers' loss experience under the
Company's surety excess of loss reinsurance contract. Due primarily to increased
large losses reported to the Company's excess of loss reinsurers, ceded written
premiums increased $4.3 million to $12.2 million in 2000. Net written premiums
increased 3.4%, or $4.9 million, for the contract surety business. Commercial
surety net written premiums, excluding international reinsurance business
assumed, increased 2.8%, or $3.3 million, in 2000. The fidelity and other
products increased 10.2%, or $2.5 million, to $27.0 million, for the year ended
December 31, 2000. This increase is primarily due to the cancellation of
reinsurance for other products as of fourth quarter 1999 that increased the
Company's retention rate on this business from 20% to 100%.

         Since the second half of calendar year 1999, the Company has
experienced an increase in claim severity in the most recent accident years,
primarily with respect to large commercial risks. As a result of this increase
in large loss activity where the Company cedes loss amounts in excess of $5
million per principal under its excess of loss reinsurance program, CNA Surety
is paying higher costs for reinsurance. The increase in reinsurance costs
reduced net earned premiums in 2000 by approximately $7.4 million. Given the
relatively unfavorable economic outlook for at least the first half of 2001, the
Company's reinsurance costs are unlikely to return to historical levels in 2001.
The higher reinsurance costs will have an adverse impact on the Company's future
results of operations.

         For the year ended December 31, 1999, net written premiums increased
10.5%, or $28.4 million, over the comparable period in 1998 consistent with the
changes in gross written premiums described above and changes in reinsurance.
Net written premiums increased 14.6%, or $18.5 million, for the contract surety
business. Commercial surety net written premiums, excluding international
reinsurance business assumed, increased 6.3%, or $6.9 million, in 1999. Fidelity
and other products increased 7.4%, or $1.7 million, in 1999.

UNDER WRITING INCOME

Underwriting income decreased 10.3% to $64.5 million for the year ended December
31, 2000 compared to 1999, primarily due to adverse claim trends in large
commercial risks. Increased claim severity in this segment has reduced
underwriting profits by increasing the cost of reinsurance and estimates of
incurred losses for more recent accident years. Underwriting income increased
16.4% to $71.9 million for the year ended December 31, 1999 compared to 1998.
The period to period changes in underwriting income were due to fluctuations in
both the loss and expense ratios as more fully described below.

LOSS RATIO

The loss ratios for the years ended December 31, 2000, 1999 and 1998 were 18.4%,
15.7% and 17.4%, respectively. The loss ratios included $7.1 million, $13.1
million and $4.4 million in net favorable loss reserve development for the years
ended December 31, 2000, 1999 and 1998, respectively. Net favorable loss reserve
development in 2000 reflects positive loss and recovery trends primarily with
respect to accident years prior to 1997 partially offset by adverse development
in more recent accident years. The adverse loss reserve development in more
recent accident years primarily relates to increased severity in large
commercial risks. These reserve developments also primarily relate to surety
business assumed from CCC and CIC. Approximately $7.1 million of the net
favorable loss reserve development recorded in 2000 relates to business assumed
from CCC and CIC. These net reserve changes in 2000 include $5.9 million in
reserve strengthening for the 1998 and 1999 accident years which brought each
year's estimated accident year net loss ratios to 24.0%. The surety business
assumed from CCC and CIC is subject to an aggregate stop loss reinsurance
contract between CCC and the Company that limits the Company's accident year net
loss ratio on this business to 24% for accident years 1997 (October 1, 1997 to
December 31, 1997), 1998, 1999 and 2000. Excluding the impact of the net
favorable reserve development, the loss ratios would have been 20.8%, 20.4% and
19.1% for the years ended December 31, 2000, 1999 and 1998, respectively. The
increase in the adjusted loss ratio in 2000 relates primarily to changes in
business mix to a higher proportion of contract surety business which carries a
higher accident year loss ratio and increased retentions on agent E&O business
which also carries a higher accident year loss ratio.


<PAGE>   18

18 CNA SURETY CORPORATION

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

EXPENSE RATIO

The expense ratio increased to 60.2% for the year ended December 31, 2000 as
compared to 58.9% for 1999. The increase in the expense ratio for the year ended
December 31, 2000 primarily reflects the impact of higher reinsurance costs on
net earned premiums. The increase in reinsurance costs reduced net earned
premiums in the 2000 by approximately $7.4 million. Absent this reduction in net
earned premiums, the expense ratio in 2000 would have been approximately 58.7%.
Net earned premiums increased 6.5% in 2000 and operating expenses increased at a
slightly higher rate of 8.8%. The Company is working to offset higher
reinsurance costs and softness in certain markets with continued productivity
improvements and operating efficiencies.

         The expense ratio increased slightly to 58.9% for the year ended
December 31, 1999 as compared to 58.7% for 1998. The 1999 increase was primarily
due to the additional costs to support technology investments and related
back-office integration efforts and expansion in select international and
domestic markets. Net earned premiums increased 9.6% in 1999 and operating
expenses increased at a slightly higher rate of 9.9%.

INVESTMENT INCOME

For the year ended December 31, 2000, net investment income was $29.9 million
compared to net investment income for the years ended December 31, 1999 and 1998
of $25.9 million and $24.3 million, respectively. The annualized pretax yield
was 5.6%, 5.2% and 5.4% for the years ended December 31, 2000, 1999 and 1998,
respectively. The annualized after-tax yield was 4.3%, 4.0% and 3.8% for the
years ended December 31, 2000, 1999 and 1998, respectively.

         The increase in investment income for the year ended December 31, 2000
is attributable to higher average invested assets and a higher portfolio yield.
The increase in investment income for the year ended December 31, 1999 is
attributable to higher average invested assets and general interest rate
increases offset by the effects of a higher proportion of the portfolio being
invested in tax exempt securities.

         Net realized investment gains were $0.6 million for the year ended
December 31, 2000 compared to net realized investment gains of approximately
$15,000, and $0.8 million for the years ended December 31, 1999 and 1998,
respectively.

ANALYSIS OF OTHER OPERATIONS

Amortization expense was $6.1 million for the year ended December 31, 2000
compared to $6.0 million and $5.9 million for the years ended December 31, 1999
and 1998, respectively. Intangible assets primarily represent goodwill and
identified intangibles arising from the acquisition of Capsure. Intangible
assets are generally amortized over 30 years.

         Interest expense increased 19.0% for the year ended December 31, 2000
compared to the same period in 1999, primarily due to increased interest rates.
The weighted average interest rate for the year ended December 31, 2000 was 6.6%
compared to 5.4% and 5.9% for periods ended December 31, 1999 and 1998,
respectively. Interest expense for the year ended December 31, 1999 decreased
19.0% compared to the same period in 1998, primarily due to lower debt levels.
Average debt outstanding was $101.8 million in 2000 compared to $103.7 million
and $117.6 million in 1999 and 1998, respectively.

INCOME TAXES

Income tax expense was $27.8 million, $29.4 million and $28.2 million and the
effective income tax rates were 34.1%, 34.3% and 38.3% for the years ended
December 31, 2000, 1999 and 1998, respectively. The decrease in the effective
tax rate in 2000 and 1999 primarily relates to increased tax exempt interest
income.

LIQUIDITY AND CAPITAL RESOURCES

It is anticipated that the liquidity requirements of CNA Surety will be met
primarily by funds generated from operations. The principal sources of operating
cash flows are premiums, investment income, and sales and maturities of
investments. CNA Surety also may generate funds from additional borrowings under
the credit facility described below. The primary cash flow uses are payments for
claims, operating expenses, federal income taxes, debt service for the credit
facility, as well as dividends to CNA Surety stockholders. In general, surety
operations generate premium collections from customers in advance of cash
outlays for claims. Premiums are invested until such time as funds are required
to pay claims and claims adjusting expenses.


<PAGE>   19

                                                           2000 ANNUAL REPORT 19

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

The Company believes that total invested assets, including cash and short-term
investments, are sufficient in the aggregate and have suitably scheduled
maturities to satisfy all policy claims and other operating liabilities,
including dividend and income tax sharing payments of its insurance
subsidiaries. At December 31, 2000, the carrying value of the Company's
insurance subsidiaries' invested assets was comprised of $453.2 million of fixed
income securities, $33.9 million of equity securities, $8.7 million of
short-term investments, $5.1 million of other investments and $4.0 million of
cash. At December 31, 1999, the carrying value of the Company's insurance
subsidiaries' invested assets was comprised of $418.0 million of fixed income
securities, $25.9 million of equity securities, $31.4 million of short-term
investments, $5.3 million of other investments and $5.8 million of cash.

         Cash flow at the parent company level is derived principally from
dividend and tax sharing payments from its insurance subsidiaries. The principal
obligations at the parent company level are to service debt, pay operating
expenses and pay dividends to stockholders. At December 31, 2000, the parent
company's invested assets consisted of $5.1 million of fixed income securities,
$44.0 million of short-term investments and $2.0 million of cash. At December
31, 1999, the parent company's invested assets consisted of $11.6 million of
short-term investments and $1.4 million of cash.

         The Company's consolidated net cash flow provided by operating
activities was $79.2 million, $67.6 million and $88.7 million for the years
ended December 31, 2000, 1999 and 1998. The increase in net cash flow provided
by operating activities in 2000 primarily relates to increased underwriting cash
flows with increased gross reserves for unpaid losses and loss adjustment
expenses partially offset by the increase in insurance receivables primarily
associated with reinsured losses.

         CNA Surety's bank borrowings are under a five-year unsecured revolving
credit facility (the "Credit Facility") that provides for borrowings of up to
$130 million. As of December 31, 2000, the Company has unused capacity under the
revolver of approximately $30 million.

         The interest rate on borrowings under the Credit Facility may be fixed,
at CNA Surety's option, for a period of one, two, three or six months and is
based on, among other rates, the London Interbank Offered Rate ("LIBOR"), plus
the applicable margin. The margin, including the facility fee, was 0.3% at
December 31, 2000 and can vary based on CNA Surety's leverage ratio (debt to
total capitalization) from 0.25% to 0.40%. As of December 31, 2000, the weighted
average interest rate was 6.9% on the $100.0 million of outstanding borrowings.
As of December 31, 1999, the weighted average interest rate was 6.4% on the
$100.0 million of outstanding borrowings.

         The Credit Facility contains, among other conditions, limitations on
CNA Surety with respect to the incurrence of additional indebtedness and
requires the maintenance of certain financial ratios. As of December 31, 2000,
the Company was in compliance with all restrictions and covenants contained in
the Credit Facility agreement. The Credit Facility provides for the payment of
all outstanding principal balances by September 30, 2002 with no required
principal payments prior to such time. Principal prepayments, if any, and
interest payments are expected to be funded primarily through dividends from CNA
Surety's insurance subsidiaries.

         In 1999, CNA Surety acquired certain assets of Clark Bonding Company,
Inc., a Charlotte, North Carolina, insurance agency and brokerage doing business
as The Bond Exchange for $5.9 million. As part of this acquisition, the Company
incurred an additional $1.9 million of debt in the form of a promissory note.
The promissory note matures on July 27, 2004 and has an interest rate of 5.0%.
The Company made a $0.3 million payment on this promissory note. The balance of
this promissory note at December 31, 2000 was $1.6 million.

         As an insurance holding company, CNA Surety is dependent upon dividends
and other permitted payments from its insurance subsidiaries to pay operating
expenses, meet debt service requirements, as well as to pay cash dividends. The
payment of dividends by the insurance subsidiaries is subject to varying degrees
of supervision by the insurance regulatory authorities in South Dakota and
Texas. In South Dakota, where Western Surety and SBCA are domiciled, insurance
companies may only pay dividends from earned surplus excluding surplus arising
from unrealized capital gains or revaluation of assets. In Texas, where USA is
domiciled, an insurance company may only declare or pay dividends to
stockholders from the insurer's earned surplus. The insurance subsidiaries may
pay dividends without obtaining prior regulatory approval only if such dividend
or distribution (together with dividends or distributions made within the
preceding 12-month period) is less than, as of the end of the immediately
preceding year, the greater of (i) 10% of the insurer's surplus to policyholders
or


<PAGE>   20

20 CNA SURETY CORPORATION

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

(ii) statutory net income. In South Dakota, net income includes net realized
capital gains in an amount not to exceed 20% of net unrealized capital gains.
All dividends must be reported to the appropriate insurance department prior to
payment.

         The dividends that may be paid without prior regulatory approval are
determined by formulas established by the applicable insurance regulations, as
described above. The formulas that determine dividend capacity in the current
year are dependent on, among other items, the prior year's ending statutory
surplus and statutory net income. Dividend capacity for 2001 will be based on
statutory surplus and income at and for the year ended December 31, 2000.
Without prior regulatory approval in 2001, CNA Surety's insurance subsidiaries
may pay dividends of $60.2 million in the aggregate. CNA Surety received $56.5
million in dividends from its insurance subsidiaries in 2000 and $33.3 million
in 1999.

         In accordance with the provisions of intercompany tax sharing
agreements between CNA Surety and its subsidiaries, the tax of each subsidiary
shall be determined based upon each subsidiary's separate return liability.
Intercompany tax payments are made at such times as estimated tax payments would
be required by the Internal Revenue Service ("IRS"). CNA Surety received tax
sharing payments from its subsidiaries of $29.1 million for the year ended
December 31, 2000 and $28.7 million for the year ended through December 31,
1999.

         CNA Surety management believes that the Company has sufficient
available resources to meet its present capital needs.

FINANCIAL CONDITION

INVESTMENT PORTFOLIO

The following table summarizes the distribution of the Company's fixed income
and equity portfolios at estimated fair values as of December 31, 2000 and 1999:

<TABLE>
<CAPTION>

                                                    ESTIMATED                 ESTIMATED
                                                   FAIR VALUE                FAIR VALUE
                                                  DECEMBER 31    PERCENT    DECEMBER 31     PERCENT
                                                         2000   OF TOTAL           1999    OF TOTAL
---------------------------------------------------------------------------------------------------
<S>                                                <C>          <C>          <C>          <C>
Fixed income securities:
U.S. Treasury securities and obligations of
  U.S. Government and agencies:
    U.S. Treasury                                   $  19,998       4.1%       $ 17,452        3.9%
    U.S. Agencies                                      54,383      11.0          48,080       10.8
    Collateralized mortgage obligations                 1,090       0.2           2,116        0.5
Mortgage pass-through securities                       42,014       8.5          45,091       10.2
Obligations of states and political subdivisions      212,630      43.2         218,153       49.2
Corporate bonds                                        60,719      12.3          40,464        9.1
Non-agency collateralized mortgage obligations         12,257       2.5          12,567        2.8
Other asset-backed securities:
  Second mortgages/home equity loans                   17,993       3.7          18,820        4.2
  Credit card receivables                              10,591       2.2           7,779        1.8
  Manufactured housing                                 12,875       2.6           1,217        0.3
  Other                                                 1,338       0.3           6,217        1.4
Redeemable preferred stock                             12,396       2.5              --         --
---------------------------------------------------------------------------------------------------
  Total fixed income securities                       458,284      93.1%        417,956       94.2%
Equity securities                                      33,927       6.9          25,897        5.8
---------------------------------------------------------------------------------------------------
  Total                                             $ 492,211     100.0%       $443,853      100.0%
---------------------------------------------------------------------------------------------------
</TABLE>

The Company's investment portfolio is managed to maximize after-tax investment
return while minimizing credit risk with investments concentrated in high
quality fixed income securities to support its insurance underwriting
operations. The Company's investment policies emphasize high credit quality and
diversification by industry, issue and issuer.


<PAGE>   21

                                                           2000 ANNUAL REPORT 21

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

The following table sets forth the ratings assigned by The Standard & Poor's
Corporation ("S&P") or Moody's Investor Services, Inc. ("Moody's") of the fixed
income securities portfolio of the Company as of December 31, 2000 and 1999:

<TABLE>
<CAPTION>

IN THOUSANDS                                                  2000                            1999
--------------------------------------------------------------------------------------------------
CREDIT RATING                           FAIR VALUE      % OF TOTAL      FAIR VALUE      % OF TOTAL
--------------------------------------------------------------------------------------------------
<S>                                   <C>             <C>             <C>              <C>
AAA/Aaa                                   $293,756            64.1%       $275,488            65.9%

AA/Aa                                       87,580            19.1          92,811            22.2

A/A                                         40,255             8.8          24,574             5.9

BBB                                         31,129             6.8          25,083             6.0

Not Rated                                    5,564             1.2              --              --
--------------------------------------------------------------------------------------------------
  Total                                   $458,284           100.0%       $417,956           100.0%
--------------------------------------------------------------------------------------------------
</TABLE>

As of December 31, 2000 and 1999, respectively, 99% and 100% of the Company's
fixed income securities were considered investment grade by S&P or Moody's and
83% and 88% were rated at least AA by those agencies for 2000 and 1999,
respectively. The Company's investments in fixed income securities do not
contain any industry concentration of credit risk.

         As of December 31, 2000, municipal securities of the State of Texas,
State of Illinois and the State of North Carolina and each state's related
political subdivisions each represent 5.9%, 5.7% and 4.9%, respectively, of the
estimated fair value of the Company's fixed income portfolio. Municipal
securities of each other state individually represents less than 4% of the
Company's fixed income portfolio.

MARKET RISK

CNA Surety's investment portfolio is subject to economic losses due to adverse
changes in the fair value of its financial instruments, or market risk. Interest
rate risk represents the largest market risk factor affecting the Company's
consolidated financial condition due to its significant level of investments in
fixed income securities. Increases and decreases in prevailing interest rates
generally translate into decreases and increases in the fair value of the
Company's fixed income portfolio. The fair value of these interest rate
sensitive instruments may also be affected by the credit worthiness of the
issuer, prepayment options, relative value of alternative investments, the
liquidity of the instrument, income tax considerations and general market
conditions. The Company manages its exposure to interest rate risk primarily
through an asset/liability matching strategy. The Company's exposure to interest
rate risk is mitigated by the relative short-term nature of its insurance and
other liabilities. The targeted effective duration of the Company's investment
portfolio is approximately 4.75 years consistent with the expected duration of
its insurance and other liabilities.

<PAGE>   22


22 CNA SURETY CORPORATION

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

The tables below summarize the estimated effects of certain hypothetical
increases and decreases in interest rates. It is assumed that the changes occur
immediately and uniformly across each investment category. The hypothetical
changes in market interest rates selected reflect the Company's expectations of
the reasonably possible best or worst case scenarios over a one-year period. The
hypothetical fair values are based upon the same prepayment assumptions that
were utilized in computing fair values as of December 31, 2000. Significant
variations in market interest rates could produce changes in the timing of
repayments due to prepayment options available. The fair value of such
instruments could be affected and therefore actual results might differ from
those reflected in the following table.

<TABLE>
<CAPTION>

                                                                                                                  HYPOTHETICAL
                                                                                               ESTIMATED FAIR       PERCENTAGE
                                                                               HYPOTHETICAL       VALUE AFTER         INCREASE
                                                          FAIR VALUE AT           CHANGE IN      HYPOTHETICAL    (DECREASE) IN
                                                            DECEMBER 31       INTEREST RATE         CHANGE IN    STOCKHOLDERS'
IN THOUSANDS                                                       2000    (BP=BASIS POINTS)    INTEREST RATE           EQUITY
------------------------------------------------------------------------------------------------------------------------------
<S>                                                          <C>          <C>                      <C>                  <C>
Fixed Income Securities:

U.S. Government and government agencies and authorities        $117,485     200 bp increase          $105,783             (2.0)%
                                                                            100 bp increase           110,697             (1.2)
                                                                            100 bp decrease           121,373              0.7
                                                                            200 bp decrease           125,534              1.4

States, municipalities and political subdivisions               212,630     200 bp increase           192,552             (3.5)
                                                                            100 bp increase           201,918             (1.9)
                                                                            100 bp decrease           223,776              1.9
                                                                            200 bp decrease           236,143              4.1

Corporate bonds and all other                                   128,169     200 bp increase           117,209             (1.9)
-----------------------------------------------------------------------     100 bp increase           122,122             (1.1)
                                                                            100 bp decrease           134,368              1.1
                                                                            200 bp decrease           140,664              2.2

Total fixed income securities                                  $458,284     200 bp increase           415,544             (7.4)
-----------------------------------------------------------------------     100 bp increase           434,737             (4.1)
                                                                            100 bp decrease           479,517              3.7
                                                                            200 bp decrease           502,341              7.7
</TABLE>


<PAGE>   23

                                                           2000 ANNUAL REPORT 23

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

<TABLE>
<CAPTION>

                                                                                                                  HYPOTHETICAL
                                                                                               ESTIMATED FAIR       PERCENTAGE
                                                                               HYPOTHETICAL       VALUE AFTER         INCREASE
                                                          FAIR VALUE AT           CHANGE IN      HYPOTHETICAL    (DECREASE) IN
                                                            DECEMBER 31       INTEREST RATE         CHANGE IN    STOCKHOLDERS'
IN THOUSANDS                                                       1999    (BP=BASIS POINTS)    INTEREST RATE           EQUITY
------------------------------------------------------------------------------------------------------------------------------
<S>                                                          <C>          <C>                      <C>                  <C>
Fixed Income Securities:
U.S. Government and government agencies and authorities        $112,739     200 bp increase          $104,108             (1.7)%
                                                                            100 bp increase           107,847             (1.0)
                                                                            100 bp decrease           117,220              0.9
                                                                            200 bp decrease           120,561              1.6

States, municipalities and political subdivisions               218,153     200 bp increase           198,855             (3.8)
                                                                            100 bp increase           207,697             (2.1)
                                                                            100 bp decrease           228,990              2.2
                                                                            200 bp decrease           241,474              4.6

Corporate bonds and all other                                    87,064     200 bp increase            79,573             (1.5)
-----------------------------------------------------------------------     100 bp increase            82,805             (0.8)
                                                                            100 bp decrease            91,790              0.9
                                                                            200 bp decrease            95,862              1.8


Total fixed income securities                                  $417,956     200 bp increase           382,536             (7.1)
-----------------------------------------------------------------------     100 bp increase           398,349             (3.9)
                                                                            100 bp decrease           438,000              4.0
                                                                            200 bp decrease           457,897              8.0
</TABLE>

The Company is also exposed to equity price risk as a result of its investment
in equity securities. Equity price risk results from changes in the level or
volatility of equity prices which affect the value of equity securities. The
carrying values of investments subject to equity price risk are based on quoted
market prices or management's estimates of fair value as of the balance sheet
dates. Market prices are subject to fluctuation and, consequently, the amount
realized in the subsequent sale of an investment may significantly differ from
the reported market value. Fluctuation in the market price of a security may
result from perceived changes in the underlying economic characteristics of the
investee, the relative price of alternative investments and general market
conditions. Furthermore, amounts realized in the sale of a particular security
may be affected by the relative quantity of the security being sold.

<PAGE>   24

24 CNA SURETY CORPORATION

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

The table below summarizes the Company's equity price risk as of December 31,
2000 and 1999 and shows the effects of a hypothetical 25% increase and a 25%
decrease in market prices as of those dates. The selected hypothetical change
does not reflect what could be considered the best or worst case scenarios.

<TABLE>
<CAPTION>

                                                                                                                  HYPOTHETICAL
                                                                                                                    PERCENTAGE
                                                                                               ESTIMATED FAIR         INCREASE
                                                          FAIR VALUE AT                           VALUE AFTER    (DECREASE) IN
                                                            DECEMBER 31        HYPOTHETICAL      HYPOTHETICAL    STOCKHOLDERS'
IN THOUSANDS                                                       2000        PRICE CHANGE  CHANGE IN PRICES           EQUITY
------------------------------------------------------------------------------------------------------------------------------
<S>                                                          <C>          <C>                      <C>                  <C>
Equity Securities                                               $33,927        25% increase           $42,409              1.5%
                                                                               25% decrease            25,445             (1.5)
</TABLE>

<TABLE>
<CAPTION>
                                                                                                                  HYPOTHETICAL
                                                                                                                    PERCENTAGE
                                                                                               ESTIMATED FAIR         INCREASE
                                                          FAIR VALUE AT                           VALUE AFTER    (DECREASE) IN
                                                            DECEMBER 31        HYPOTHETICAL      HYPOTHETICAL    STOCKHOLDERS'
IN THOUSANDS                                                       1999        PRICE CHANGE  CHANGE IN PRICES           EQUITY
------------------------------------------------------------------------------------------------------------------------------
<S>                                                          <C>          <C>                      <C>                  <C>
Equity Securities                                               $25,897        25% increase           $32,371              1.3%
                                                                               25% decrease            19,423             (1.3)
</TABLE>

RESERVES FOR UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES

CNA Surety's insurance subsidiaries employ generally accepted reserving
approaches in establishing the estimated liability for unpaid losses and loss
adjustment expenses that give consideration to the inherent difficulty and
variability in the estimation process. In addition, CNA Surety utilizes
independent actuarial firms of national standing to conduct periodic reviews of
claim procedures and loss reserving practices, and annually obtains actuarial
certification as to the reasonableness of actuarial assumptions used and the
sufficiency of year-end reserves for each of its principal insurance
subsidiaries.

         The estimated liability for unpaid losses and loss adjustment expenses
includes, on an undiscounted basis, estimates of (a) the ultimate settlement
value of reported claims, (b) incurred but not reported ("IBNR") claims, (c)
future expenses to be incurred in the settlement of claims and (d) claim
recoveries, exclusive of reinsurance recoveries which are reported as an asset.
These estimates are determined based on the Company's and surety industry loss
experience as well as consideration of current trends and conditions. The
estimated liability for unpaid losses and loss adjustment expenses is an
estimate and there is the potential that actual future loss payments will differ
significantly from initial estimates. The methods of determining such estimates
and the resulting estimated liability are regularly reviewed and updated.
Changes in the estimated liability are reflected in operating income in the year
in which such changes are determined to be needed.

         The Company recorded net favorable loss reserve development which
resulted in reductions in the estimated liability of $7.1 million, $13.1 million
and $4.4 million for the years ended December 31, 2000, 1999 and 1998. Note 8 to
the accompanying Consolidated Financial Statements presents a table of the
activity in the reserves for unpaid losses and loss adjustment expenses for the
Company. This table highlights the impact of revisions to the estimated
liability established in prior years.

<PAGE>   25

                                                           2000 ANNUAL REPORT 25

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

RISK BASED CAPITAL ("RBC") AND OTHER REGULATORY RATIOS

The National Association of Insurance Commissioners ("NAIC") has promulgated RBC
requirements for property and casualty insurance companies to evaluate the
adequacy of statutory capital and surplus in relation to investment and
insurance risks such as asset quality, loss reserve adequacy, and other business
factors. The RBC information is used by state insurance regulators as an early
warning mechanism to identify insurance companies that potentially are
inadequately capitalized. In addition, the formula defines minimum capital
standards that supplement the current system of fixed minimum capital and
surplus requirements on a state-by-state basis. Regulatory compliance is
determined by a ratio (the "Ratio") of the enterprise's regulatory total
adjusted capital, as defined by the NAIC, to its authorized control level RBC,
as defined by the NAIC. Generally, a Ratio in excess of 200% of authorized
control level RBC requires no corrective actions on behalf of the company or
regulators. As of December 31, 2000, each of CNA Surety's insurance subsidiaries
had a Ratio that was in compliance with minimum RBC requirements.

         CNA Surety's insurance subsidiaries require capital to support premium
writings. In accordance with industry and regulatory guidelines, the net written
premiums to surplus ratio of a property and casualty insurer generally should
not exceed 3 to 1 (the terms of the Credit Facility also limit this ratio to 3
to 1 for Western Surety and USA). On December 31, 2000, the Company had a
combined statutory surplus of $189.8 million. The combined statutory surplus of
Western Surety and SBCA was $172.9 million and its net written premiums to
surplus ratio was 1.7 to 1. USA's statutory surplus was $16.9 million and the
net written premiums to surplus ratio was 0.6 to 1. On December 31, 1999, the
Company had a combined statutory surplus of $193.5 million. The combined
statutory surplus of Western Surety and SBCA was $177.2 million and its net
written premiums to surplus ratio was 1.6 to 1. USA's statutory surplus was
$16.3 million and its net written premiums to surplus ratio was 1.3 to 1. The
Company believes that each insurance company's statutory surplus is sufficient
to support its current and anticipated premium levels.

         The NAIC has also developed a rating system, the Insurance Regulatory
Information System ("IRIS"), primarily intended to assist state insurance
departments in overseeing the financial condition of all insurance companies
operating within their respective states. IRIS consists of eleven key financial
ratios that address various aspects of each insurer's financial condition and
stability. In 2000, Western's and SBCA's IRIS ratios were within all the "usual"
ranges as defined by the NAIC. USA failed the Change in Net Writings ratio,
primarily due to a decrease in assumed premium due to the discontinuation of an
intercompany reinsurance agreement with Western. In 1999, USA's and SBCA's IRIS
ratios were within all the "usual" ranges as defined by the NAIC. Western failed
the Agents Balance to Surplus ratio, primarily due to increased premiums
written.

IMPACT OF ADOPTING ACCOUNTING PRONOUNCEMENTS

In December 1999, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial
Statements." This bulletin summarizes the SEC Staff's view in applying
accounting principles generally accepted in the United States to revenue
recognition in financial statements. This bulletin, through its subsequent
revised releases SAB No. 101A and No. 101B, is effective for registrants no
later than the fourth fiscal quarter of fiscal years beginning after December
15, 1999. Adoption of this bulletin did not have a significant impact on the
results of operations or equity of the Company.

<PAGE>   26

26 CNA SURETY CORPORATION

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

IMPACT OF ACCOUNTING PRONOUNCEMENTS NOT YET ADOPTED

In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 133 entitled "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS No. 133"). SFAS No. 133 was
subsequently amended by SFAS No. 137, which delayed the effective date by one
year, and SFAS No. 138, which clarified four areas which were causing
difficulties in implementation. SFAS No. 133 requires the recognition of all
derivative financial instruments, including embedded derivative instruments, as
either assets or liabilities in the statement of financial position and
measurement of those instruments at fair value. The accounting for gains and
losses associated with changes in the fair value of a derivative and the effect
on the consolidated financial statements will depend on its hedge designation
and whether the hedge is highly effective in achieving offsetting changes in the
fair value or cash flows of the asset or liability hedged. If the derivative is
designated in a fair value hedge, the changes in the fair value of the
derivative and the hedged item will be recognized in earnings. If the derivative
is designated as a cash flow hedge, changes in the fair value of the derivative
will be recorded in other comprehensive income and will be recognized in the
income statement when the hedged item affects earnings. A derivative that does
not qualify as a hedge will be marked to fair value through earnings.

         The Company is required to adopt SFAS No. 133 effective January 1,
2001. The transition adjustments resulting from adoption must be reported in net
income or other comprehensive income, as appropriate, as the cumulative effect
of a change in accounting principle. The adoption of SFAS No. 133 will have no
initial impact on the Company's results of operations or equity.

         In March of 1998, the NAIC adopted the Codification of Statutory
Accounting Principles ("Codification"). Codification, which is intended to
standardize regulatory accounting and reporting to state insurance departments,
is effective January 1, 2001. However, statutory accounting principles will
continue to be established by individual state laws and permitted practices. The
states in which CNA Surety's insurance subsidiaries conduct business will
require adoption of Codification for the preparation of statutory financial
statements effective January 1, 2001. The Company estimates that the adoption of
Codification will increase statutory capital and surplus as of January 1, 2001
by approximately $21.9 million.

"SAFE HARBOR" STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995

The statements which are not historical facts contained in this Annual Report to
Shareholders are forward-looking statements that involve risks and
uncertainties, including, but not limited to, product and policy demand and
market response risks, the effect of economic conditions, the impact of
competitive products, policies and pricing, product and policy development,
regulatory changes and conditions, rating agency policies and practices,
development of claims and the effect on loss reserves, the performance of
reinsurance companies under reinsurance contracts with the Company, investment
portfolio developments and reaction to market conditions, the results of
financing efforts, the actual closing of contemplated transactions and
agreements, the effect of the Company's accounting policies, and other risks
detailed in the Company's Securities and Exchange Commission filings. No
assurance can be given that the actual results of operations and financial
condition will conform to the forward-looking statements contained herein.

<PAGE>   27


                                                           2000 ANNUAL REPORT 27

CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>

IN THOUSANDS, EXCEPT PER SHARE DATA                     DECEMBER 31                           2000                    1999
--------------------------------------------------------------------------------------------------------------------------
<S>                                                                                     <C>                     <C>
ASSETS
Invested assets and cash:
  Fixed income securities, at fair value (amortized cost: $453,570 and $436,690)          $458,284                $417,956
  Equity securities, at fair value (cost: $37,761 and $23,968)                              33,927                  25,897
  Short-term investments, at cost (approximates fair value)                                 52,660                  43,033
  Other investments, at fair value                                                           5,154                   5,277
  Cash                                                                                       5,950                   7,237
--------------------------------------------------------------------------------------------------------------------------
    Total invested assets and cash                                                         555,975                 499,400
Deferred policy acquisition costs                                                           91,403                  84,924
Insurance receivables:
  Premiums, including $31,607 and $56,127 from affiliates                                   41,207                  65,949
  Reinsurance, including $13,349 and $1,002 from affiliates                                 75,330                  20,031
Intangible assets (net of accumulated amortization: $19,426 and $13,329)                   149,882                 155,980
Property and equipment, at cost (less accumulated depreciation: $13,677 and $11,094)        15,332                  14,769
Prepaid reinsurance premiums                                                                 2,532                   2,302
Receivable for securities sold                                                              10,406                      --
Other assets                                                                                 8,501                   8,220
--------------------------------------------------------------------------------------------------------------------------
    Total assets                                                                          $950,568                $851,575
--------------------------------------------------------------------------------------------------------------------------

LIABILITIES
Reserves:
  Unpaid losses and loss adjustment expenses                                              $204,457                $157,933
  Unearned premiums                                                                        202,179                 199,300
--------------------------------------------------------------------------------------------------------------------------
    Total reserves                                                                         406,636                 357,233
Debt                                                                                       101,556                 101,900
Deferred income taxes, net                                                                  19,700                  10,447
Payable for securities purchased                                                                --                   7,487
Current income taxes payable                                                                 6,820                   7,076
Reinsurance and other payables to affiliates                                                 8,117                   7,229
Other liabilities                                                                           33,707                  33,899
--------------------------------------------------------------------------------------------------------------------------
    Total liabilities                                                                     $576,536                $525,271
--------------------------------------------------------------------------------------------------------------------------
Commitments and contingencies (See Note 9)

STOCKHOLDERS' EQUITY
Preferred stock, par value $.01 per share, 20,000 shares authorized;
  none issued and outstanding                                                                   --                      --
Common stock, par value $.01 per share, 100,000 shares authorized;
  44,146 shares issued and 42,702 shares outstanding at December 31, 2000
  and 44,123 shares issued and 43,006 shares outstanding at December 31, 1999                  441                     441
Additional paid-in capital                                                                 253,497                 253,366
Retained earnings                                                                          135,308                  95,419
Accumulated other comprehensive income (loss)                                                  267                 (11,150)
Treasury stock, at cost                                                                    (15,481)                (11,772)
--------------------------------------------------------------------------------------------------------------------------
    Total stockholders' equity                                                             374,032                 326,304
--------------------------------------------------------------------------------------------------------------------------
    Total liabilities and stockholders' equity                                            $950,568                $851,575
--------------------------------------------------------------------------------------------------------------------------
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements.

<PAGE>   28


28 CNA SURETY CORPORATION

CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>

IN THOUSANDS, EXCEPT PER SHARE DATA                     YEARS ENDED DECEMBER 31         2000            1999            1998
----------------------------------------------------------------------------------------------------------------------------
<S>                                                                               <C>             <C>             <C>
Revenues:
  Net earned premium                                                                $301,819        $283,540        $258,737
  Net investment income                                                               29,897          25,850          24,259
  Net realized investment gains                                                          557              15             844
----------------------------------------------------------------------------------------------------------------------------
    Total revenues                                                                   332,273         309,405         283,840
----------------------------------------------------------------------------------------------------------------------------
Expenses:
  Net losses and loss adjustment expenses                                             55,683          44,672          44,998
  Net commissions, brokerage and other underwriting                                  181,655         166,974         151,966
  Interest expense                                                                     6,956           5,846           7,218
  Non-recurring charge                                                                   500              --              --
  Amortization of intangible assets                                                    6,097           5,982           5,900
----------------------------------------------------------------------------------------------------------------------------
    Total expenses                                                                   250,891         223,474         210,082
----------------------------------------------------------------------------------------------------------------------------
Income before income taxes                                                            81,382          85,931          73,758
Income taxes                                                                          27,780          29,433          28,243
----------------------------------------------------------------------------------------------------------------------------
Net income                                                                          $ 53,602        $ 56,498        $ 45,515
----------------------------------------------------------------------------------------------------------------------------
Earnings per share                                                                  $   1.25        $   1.28        $   1.04
----------------------------------------------------------------------------------------------------------------------------
Earnings per share, assuming dilution                                               $   1.25        $   1.28        $   1.04
----------------------------------------------------------------------------------------------------------------------------
Weighted average shares outstanding                                                   42,898          43,974          43,722
----------------------------------------------------------------------------------------------------------------------------
Weighted average shares outstanding, assuming dilution                                43,028          44,120          43,875
----------------------------------------------------------------------------------------------------------------------------
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements.

<PAGE>   29

                                                           2000 ANNUAL REPORT 29

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>

                                                                                             ACCUMULATED
                                COMMON STOCK          ADDITIONAL                                   OTHER    TREASURY         TOTAL
                                      SHARES  COMMON     PAID-IN  COMPREHENSIVE  RETAINED  COMPREHENSIVE       STOCK  STOCKHOLDERS'
IN THOUSANDS                     OUTSTANDING   STOCK     CAPITAL         INCOME  EARNINGS   INCOME (LOSS)   (AT COST)       EQUITY
-----------------------------------------------------------------------------------------------------------------------------------
<S>                           <C>            <C>      <C>         <C>          <C>          <C>           <C>        <C>
Balance, December 31, 1997            43,320    $433    $244,829                $  10,996       $    474   $      --      $256,732
Comprehensive income:
Net income                                --      --          --       $ 45,515    45,515             --          --        45,515
Other comprehensive income:
  Change in unrealized gains
  on securities (after income
  taxes), net of reclassification
  adjustment of $208                      --      --          --          2,783        --          2,783          --         2,783
---------------------------------                                      --------
  Total comprehensive income                                           $ 48,298
---------------------------------                                      --------
Issuance of common stock                 628       6       7,525                       --             --          --         7,531
Stock options exercised                  145       2         861                       --             --          --           863
Dividends paid to stockholders            --      --          --                   (3,527)            --          --        (3,527)
----------------------------------------------------------------                --------------------------------------------------
Balance, December 31, 1998            44,093    $441    $253,215                $  52,984       $  3,257   $      --      $309,897
----------------------------------------------------------------                --------------------------------------------------
Comprehensive income:
Net income                                --      --          --         56,498    56,498             --          --        56,498
Other comprehensive income:
  Change in unrealized (losses)
  on securities (after income
  taxes), net of reclassification
  adjustment of $821                      --      --          --        (14,407)       --        (14,407)         --       (14,407)
---------------------------------                                      --------
  Total comprehensive income                                           $ 42,091
---------------------------------                                      --------
Purchase of treasury stock            (1,117)     --          --                       --             --     (11,772)      (11,772)
Stock options exercised and other         30      --         151                       --             --          --           151
Dividends paid to stockholders            --      --          --                  (14,063)            --          --       (14,063)
----------------------------------------------------------------                --------------------------------------------------
Balance, December 31, 1999            43,006    $441    $253,366                $  95,419       $(11,150)  $ (11,772)     $326,304
----------------------------------------------------------------                --------------------------------------------------
Comprehensive income:
Net income                                --      --          --         53,602    53,602             --          --        53,602
Other comprehensive income:
  Change in unrealized gains
  on securities (after income
  taxes), net of reclassification
  adjustment of $(1,263)                  --      --          --         11,417        --         11,417          --        11,417
---------------------------------                                      --------
  Total comprehensive income                                           $ 65,019
---------------------------------                                      --------
Purchase of treasury stock              (327)     --          --                       --             --      (3,709)       (3,709)
Stock options exercised and other         23      --         131                       --             --          --           131
Dividends paid to stockholders            --      --          --                  (13,713)            --          --       (13,713)
----------------------------------------------------------------                --------------------------------------------------
Balance, December 31, 2000            42,702    $441    $253,497                $ 135,308       $    267   $ (15,481)     $374,032
----------------------------------------------------------------                --------------------------------------------------
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements.

<PAGE>   30

30 CNA SURETY CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>

IN THOUSANDS                                    YEARS ENDED DECEMBER 31              2000           1999           1998
-----------------------------------------------------------------------------------------------------------------------
<S>                                                                           <C>            <C>            <C>
OPERATING ACTIVITIES
Net income                                                                      $  53,602      $  56,498      $  45,515
Adjustments to reconcile net income to net cash
  provided by operating activities:
  Depreciation and amortization                                                     9,291          8,414          7,720
  Accretion of bond discount, net                                                   1,043          2,085          2,065
  Net realized investment gains                                                      (557)           (15)          (844)
Changes in:
  Insurance receivables                                                           (30,557)       (21,680)           534
  Reserve for unearned premiums                                                     2,879         15,592         11,921
  Reserve for unpaid losses and loss adjustment expenses                           46,524          7,913         19,639
  Deferred policy acquisition costs                                                (6,479)       (10,436)       (10,344)
  Deferred income taxes, net                                                        3,078          7,506          7,485
  Reinsurance and other payables to affiliates                                        888          5,320            766
  Other assets and liabilities                                                       (468)        (3,585)         4,236
-----------------------------------------------------------------------------------------------------------------------
    Net cash provided by operating activities                                      79,244         67,612         88,693
-----------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Fixed income securities:
  Purchases                                                                      (133,679)      (172,746)      (297,654)
  Maturities                                                                       35,394         45,610         56,947
  Sales                                                                            77,788        107,243         86,170
Purchases of equity securities                                                    (19,587)       (24,444)            --
Proceeds from the sale of equity securities                                         8,525            477             --
Changes in short-term investments                                                  (9,228)        14,832         89,370
Purchases of property and equipment                                                (4,166)        (5,566)        (3,458)
Acquisition of businesses, net of cash acquired                                        --         (5,900)            --
Changes in receivables/payables for securities sold/purchased                     (17,894)        (1,030)        (2,092)
Other, net                                                                            (21)           241            133
-----------------------------------------------------------------------------------------------------------------------
    Net cash used in investing activities                                         (62,868)       (41,283)       (70,584)
-----------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Proceeds from debt                                                                     --          1,900             --
Principal payments on debt                                                           (344)       (13,000)        (5,000)
Proceeds from issuance of common stock                                                 --             --          7,531
Dividends to stockholders                                                         (13,713)       (14,063)        (3,527)
Purchase of treasury stock                                                         (3,709)       (11,772)            --
Other                                                                                 103             97            503
-----------------------------------------------------------------------------------------------------------------------
    Net cash used in financing activities                                         (17,663)       (36,838)          (493)
-----------------------------------------------------------------------------------------------------------------------
Increase (decrease) in cash                                                        (1,287)       (10,509)        17,616
Cash at beginning of period                                                         7,237         17,746            130
-----------------------------------------------------------------------------------------------------------------------
Cash at end of period                                                           $   5,950      $   7,237      $  17,746
-----------------------------------------------------------------------------------------------------------------------
Supplemental Disclosure of Cash Flow Information:
  Cash paid during the period for:
    Interest                                                                    $   7,363      $   5,826      $   6,721
    Income taxes                                                                $  24,050      $  20,600      $  17,750
-----------------------------------------------------------------------------------------------------------------------
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements.

<PAGE>   31


                                                           2000 ANNUAL REPORT 31

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1.  SIGNIFICANT ACCOUNTING POLICIES

FORMATION OF CNA SURETY CORPORATION AND MERGER

In December 1996, CNA Financial Corporation ("CNAF") and Capsure Holdings Corp.
("Capsure") agreed to merge (the "Merger") the surety business of CNAF with
Capsure's insurance subsidiaries, Western Surety Company ("Western Surety") and
Universal Surety of America ("USA"), into CNA Surety Corporation ("CNA Surety"
or the "Company"). CNAF, through its operating subsidiaries, writes multiple
lines of property and casualty insurance, including surety business that is
reinsured by Western Surety. CNAF owns approximately 64% of the outstanding
common stock of CNA Surety. Loews Corporation owns approximately 87% of the
outstanding common stock of CNAF. The principal operating subsidiaries of CNAF
that wrote the surety line of business for their own account prior to the Merger
were Continental Casualty Company and its property and casualty affiliates
(collectively, "CCC") and The Continental Insurance Company and its property and
casualty affiliates (collectively, "CIC"). CIC was acquired by CNAF on May 10,
1995. The combined surety operations of CCC and CIC are referred to herein as
CCC Surety Operations ("Predecessor").

         Pursuant to a reorganization agreement, CCC Surety Operations and
Capsure merged their respective operations at the close of business on September
30, 1997 ("Merger Date"). CNAF, through its property and casualty subsidiaries,
CCC and CIC, contributed $52.25 million of capital to CNA Surety. Through
reinsurance agreements, CCC and CIC ceded to Western Surety all of their net
unearned premiums and loss and loss adjustment expense reserves, as of the
Merger Date, and will cede to Western Surety all surety business written or
renewed by CCC and CIC for a period of five years thereafter. Further, CCC and
CIC have agreed to assume the obligation for any adverse development on recorded
reserves for CCC Surety Operations as of the Merger Date, to limit the loss
ratio on certain defined business written by CNA Surety through December 31,
2000 and to provide certain additional excess of loss reinsurance.

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of CNA Surety
Corporation and all majority-owned subsidiaries.

ESTIMATES

The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of financial statements and the
reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.

INVESTMENTS

Management believes the Company has the ability to hold all fixed income
securities to maturity. However, the Company may dispose of securities prior to
their scheduled maturity due to changes in interest rates, prepayments, tax and
credit considerations, liquidity or regulatory capital requirements, or other
similar factors. As a result, the Company considers all of its fixed income
securities (bonds and redeemable preferred stocks) and equity securities as
available-for-sale. These securities are reported at fair value, with unrealized
gains and losses, net of deferred income taxes, reported as a separate component
of stockholders' equity. Cash flows from purchases, sales and maturities are
reported gross in the investing activities section of the cash flow statement.

         The amortized cost of fixed income securities is determined based on
cost and the cumulative effect of amortization of premiums and accretion of
discounts to maturity. Such amortization and accretion are included in
investment income. For mortgage-backed and certain asset-backed securities, the
Company recognizes income using the effective-yield method based on estimated
cash flows. Investment gains or losses realized on the sale of securities are
determined using the specific identification method. Investments with an
other-than-temporary decline in value are written down to fair value, resulting
in losses that are included in realized investment gains and losses.

         Short-term investments which generally include U.S. Treasury bills,
corporate notes, money market funds and investment grade commercial paper
equivalents, are carried at amortized cost which approximates fair value.

<PAGE>   32

32 CNA SURETY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DEFERRED POLICY ACQUISITION COSTS

Policy acquisition costs, consisting of commissions, premium taxes and other
underwriting expenses which vary with, and are primarily related to, the
production of business, net of reinsurance commissions, are deferred and
amortized as a charge to income as the related premiums are earned.

INTANGIBLE ASSETS

The Merger of CCC Surety Operations and Capsure has been accounted for by CNA
Surety as an acquisition of Capsure, using purchase accounting. Intangible
assets represent goodwill and identified intangibles arising from the
acquisition of Capsure and goodwill arising from the May 1995 acquisition of CIC
by CNAF that was allocated to the surety business of CIC. Intangible assets
arising from the Merger were $20.5 million related to the agency force, which is
being amortized over 20 years, and $134.5 million for goodwill amortized over 30
years.

         In 1999, CNA Surety acquired certain assets of Clark Bonding Company,
Inc., a Charlotte, North Carolina, insurance agency and brokerage doing business
as The Bond Exchange. Goodwill arising from this acquisition was $5.9 million
and is being amortized over 30 years.

         Management assesses the recoverability of intangible assets based upon
estimates of undiscounted future operating cash flows whenever significant
events or changes in circumstances suggest that the carrying amount of an asset
may not be recoverable.

RESERVES FOR UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES

The estimated liability for unpaid losses and loss adjustment expenses includes,
on an undiscounted basis, estimates of (a) the ultimate settlement value of
reported claims, (b) incurred but not reported ("IBNR") claims, (c) future
expenses to be incurred in the settlement of claims and (d) claim recoveries,
before reinsurance recoveries which are reported as an asset. These estimates
are determined based on the Company's loss experience as well as consideration
of industry experience, current trends and conditions. The estimated liability
for unpaid losses and loss adjustment expenses is an estimate and there is the
potential that actual future loss payments will differ significantly from
initial estimates. The methods of determining such estimates and the resulting
estimated liability are regularly reviewed and updated. Changes in the estimated
liability are reflected in operating income in the year in which such changes
are determined to be needed.

INSURANCE PREMIUMS

Insurance premiums are recognized as revenue ratably over the terms of the
related policies. Premium revenues are net of amounts ceded to reinsurers.
Unearned premiums represent the portion of premiums written, before ceded
reinsurance which is shown as an asset, applicable to the unexpired terms of
policies in force determined on a pro rata basis.

REINSURANCE

The Company assumes and cedes insurance with other insurers and reinsurers to
limit maximum loss, provide greater diversification of risk and minimize
exposure on larger risks. Premiums and loss and loss adjustment expenses that
are ceded under reinsurance arrangements reduce the respective revenues and
expenses. Amounts recoverable from reinsurers are estimated in a manner
consistent with the claim liability associated with the reinsured policy and are
reported as reinsurance receivables rather than netted against the estimated
liability for unpaid losses and loss adjustment expenses.

STOCK-BASED COMPENSATION

As allowed under Statement of Financial Accounting Standards ("SFAS") No. 123,
"Accounting for Stock-Based Compensation," the Company accounts for its stock
option plans in accordance with Accounting Principles Board ("APB") Opinion No.
25, "Accounting for Stock Issued to Employees." The Company has not issued stock
options where the exercise price is less than the fair market value of the
Company's common stock on the date of grant and, accordingly, no compensation
expense has been recognized.

<PAGE>   33

                                                           2000 ANNUAL REPORT 33

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

INCOME TAXES

The Company accounts for income taxes under the liability method. Under the
liability method, deferred income taxes are established for the future tax
effects of temporary differences between the tax and financial reporting bases
of assets and liabilities using currently enacted tax rates. Such temporary
differences primarily relate to insurance reserves, deferred policy acquisition
costs and intangible assets. The effect on deferred taxes of a change in tax
rates is recognized in income in the period of enactment.

PROPERTY AND EQUIPMENT

Property and equipment are carried at cost less accumulated depreciation.
Depreciation is based on the estimated useful lives of the various classes of
property and equipment and determined principally on a straight-line basis. The
cost of maintenance and repairs is charged to income as incurred, major
improvements are capitalized.

EARNINGS PER SHARE

Basic earnings per common share is computed by dividing income available to
common stockholders by the weighted average number of common shares outstanding
for the period. Diluted earnings per common share is computed based on the
weighted average number of shares outstanding plus the dilutive effect of common
stock equivalents which is computed using the treasury stock method.

ACCOUNTING PRONOUNCEMENTS

In December 1999, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial
Statements." This bulletin summarizes the SEC Staff's view in applying
accounting principles generally accepted in the United States to revenue
recognition in financial statements. This bulletin, through its subsequent
revised releases SAB No. 101A and No. 101B, is effective for registrants no
later than the fourth fiscal quarter of fiscal years beginning after December
15, 1999. Adoption of this bulletin did not have a significant impact on the
results of operations or equity of the Company.

         In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 133 entitled "Accounting for
Derivative Instruments and Hedging Activities" ("SFAS No. 133"). SFAS No. 133
was subsequently amended by SFAS No. 137, which delayed the effective date by
one year, and SFAS No. 138, which clarified four areas which were causing
difficulties in implementation. SFAS No. 133 requires the recognition of all
derivative financial instruments, including embedded derivative instruments, as
either assets or liabilities in the statement of financial position and
measurement of those instruments at fair value. The Company is required to adopt
SFAS 133 effective January 1, 2001. The transition adjustments resulting from
adoption must be reported in net income or other comprehensive income, as
appropriate, as the cumulative effect of a change in accounting principle. The
adoption of SFAS 133 will have no initial impact on the Company's results of
operations or equity.

RECLASSIFICATIONS

Certain reclassifications have been made to the 1999 and 1998 financial
statements to conform with the presentation in the 2000 Consolidated Financial
Statements.

NOTE 2.  PROPOSED TENDER OFFER

On March 20, 2000, Continental Casualty Company ("CCC") proposed a cash tender
offer to purchase the remaining common stock of CNA Surety that it and its
affiliates did not own for $13.00 per share. On May 26, 2000, CCC informed CNA
Surety that CCC did not intend to pursue a proposed tender offer to acquire the
remaining equity interests of the Company not currently owned by CCC. The
Company recorded a non-recurring charge of $0.5 million before income taxes, or
$0.3 million after tax (1 cent per share), for costs incurred with respect to
the proposed tender offer by CCC.

         As reported in CNA Financial Corporation ("CNAF") public filings, CCC
and other insurance subsidiaries of CNAF that own shares of CNA Surety may
review their respective positions of CNA Surety shares from time to time and may
acquire additional shares or dispose of shares depending upon market conditions
or other factors existing at the time of such review, resulting in increases or
decreases in their respective ownership positions.

<PAGE>   34

34 CNA SURETY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 3.  INVESTMENTS

The estimated fair value and amortized cost of fixed income and equity
securities held by CNA Surety by investment category, were as follows:

<TABLE>
<CAPTION>

                                                                                       GROSS            GROSS
                                                               AMORTIZED COST     UNREALIZED       UNREALIZED        ESTIMATED
IN THOUSANDS                              DECEMBER 31, 2000           OR COST          GAINS           LOSSES       FAIR VALUE
------------------------------------------------------------------------------------------------------------------------------
<S>                                                                <C>             <C>             <C>              <C>
Fixed income securities:
U.S. Treasury securities and obligations of
    U.S. Government and agencies:
  U.S. Treasury                                                      $ 19,727        $    279        $     (8)        $ 19,998
  U.S. Agencies                                                        52,760           1,835            (212)          54,383
  Collateralized mortgage obligations                                   1,098               1              (9)           1,090
  Mortgage pass-through securities                                     42,054             149            (189)          42,014
Obligations of states and political subdivisions                      208,423           5,136            (929)         212,630
Corporate bonds                                                        62,055             675          (2,011)          60,719
Non-agency collateralized mortgage obligations                         12,319              70            (132)          12,257
Other asset-backed securities:
  Second mortgages/home equity loans                                   18,043             160            (210)          17,993
  Credit card receivables                                              10,490             106              (5)          10,591
  Manufactured housing                                                 12,967             143            (235)          12,875
  Other                                                                 1,272              69              (3)           1,338
Redeemable preferred stock                                             12,362              89             (55)          12,396
------------------------------------------------------------------------------------------------------------------------------
    Total fixed income securities                                     453,570           8,712          (3,998)         458,284
Equity securities                                                      37,761           3,562          (7,396)          33,927
------------------------------------------------------------------------------------------------------------------------------
    Total                                                            $491,331        $ 12,274        $(11,394)        $492,211
------------------------------------------------------------------------------------------------------------------------------
</TABLE>

<TABLE>
<CAPTION>

                                                                                       GROSS            GROSS
                                                               AMORTIZED COST     UNREALIZED       UNREALIZED        ESTIMATED
IN THOUSANDS                              DECEMBER 31, 1999           OR COST          GAINS           LOSSES       FAIR VALUE
------------------------------------------------------------------------------------------------------------------------------
<S>                                                                <C>             <C>             <C>              <C>
Fixed income securities:
U.S. Treasury securities and obligations of
    U.S. Government and agencies:
  U.S. Treasury                                                      $ 17,575        $      6        $   (129)        $ 17,452
  U.S. Agencies                                                        49,786              58          (1,764)          48,080
  Collateralized mortgage obligations                                   2,123               3             (10)           2,116
  Mortgage pass-through securities                                     46,701              --          (1,610)          45,091
Obligations of states and political subdivisions                      229,499              56         (11,402)         218,153
Corporate bonds                                                        43,395               3          (2,934)          40,464
Non-agency collateralized mortgage obligations                         12,845              --            (278)          12,567
Other asset-backed securities:
  Second mortgages/home equity loans                                   19,041              16            (237)          18,820
  Credit card receivables                                               8,101               1            (323)           7,779
  Manufactured housing                                                  1,236              --             (19)           1,217
  Other                                                                 6,388               2            (173)           6,217
Redeemable preferred stock                                                 --              --              --               --
------------------------------------------------------------------------------------------------------------------------------
    Total fixed income securities                                     436,690             145         (18,879)         417,956
Equity securities                                                      23,968           3,274          (1,345)          25,897
------------------------------------------------------------------------------------------------------------------------------
    Total                                                            $460,658        $  3,419        $(20,224)        $443,853
------------------------------------------------------------------------------------------------------------------------------
</TABLE>

<PAGE>   35

                                                           2000 ANNUAL REPORT 35

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The Company's insurance subsidiaries, as required by state law, deposit certain
securities with state insurance regulatory authorities. At December 31, 2000,
securities on deposit had an aggregate carrying value of $3.4 million.

         Short-term investments are generally comprised of U.S. Treasury bills,
corporate notes, money market funds and investment grade commercial paper
equivalents.

         The amortized cost and estimated fair value of fixed income securities,
by contractual maturity, at December 31, 2000 and 1999 are shown below. Actual
maturities may differ from contractual maturities as borrowers may have the
right to call or prepay obligations with or without call or prepayment
penalties:

<TABLE>
<CAPTION>

IN THOUSANDS                                                                     2000                            1999
---------------------------------------------------------------------------------------------------------------------
                                                            AMORTIZED       ESTIMATED       AMORTIZED       ESTIMATED
                                                                 COST      FAIR VALUE            COST      FAIR VALUE
---------------------------------------------------------------------------------------------------------------------
<S>                                                        <C>             <C>             <C>             <C>
Fixed Income Securities:
Due within one year                                          $ 20,087        $ 20,104        $     --        $     --
Due after one year but within five years                       22,770          23,213          47,697          47,022
Due after five years but within ten years                     114,938         117,038         117,047         112,286
Due after ten years                                           197,532         199,771         175,511         164,841
---------------------------------------------------------------------------------------------------------------------
                                                              355,327         360,126         340,255         324,149
---------------------------------------------------------------------------------------------------------------------
Mortgage pass-through securities, collateralized
  mortgage obligations and asset-backed securities             98,243          98,158          96,435          93,807
---------------------------------------------------------------------------------------------------------------------
                                                             $453,570        $458,284        $436,690        $417,956
---------------------------------------------------------------------------------------------------------------------
</TABLE>

Major categories of net investment income and net realized investment gains
(losses) were as follows:

<TABLE>
<CAPTION>

IN THOUSANDS                    YEARS ENDED DECEMBER 31           2000            1999           1998
-----------------------------------------------------------------------------------------------------
<S>                                                         <C>             <C>            <C>
Investment income:
  Fixed income securities                                     $ 25,623        $ 22,593       $ 22,111
  Equity securities                                                372              92             --
  Short-term investments                                         3,998           2,917          2,233
  Other                                                            563             866            523
-----------------------------------------------------------------------------------------------------
  Total investment income                                       30,556          26,468         24,867
Investment expenses                                               (659)           (618)          (608)
-----------------------------------------------------------------------------------------------------
Net investment income                                         $ 29,897        $ 25,850       $ 24,259
-----------------------------------------------------------------------------------------------------
Gross realized investment gains:
  Fixed income securities                                     $    197        $    690       $    867
  Equity securities                                              3,054               2             --
  Other                                                             --              --              2
Gross realized investment losses:
  Fixed income securities                                       (2,371)           (674)           (19)
  Equity securities                                               (323)             (1)            --
  Other                                                             --              (2)            (6)
-----------------------------------------------------------------------------------------------------
Net realized investment gain                                  $    557        $     15       $    844
-----------------------------------------------------------------------------------------------------
</TABLE>

<PAGE>   36

2000 ANNUAL REPORT 36

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Net unrealized gain and loss on securities included in stockholders' equity at
December 31, 2000 and 1999 was comprised of the following:

<TABLE>
<CAPTION>

IN THOUSANDS                                                          2000                                        1999
-----------------------------------------------------------------------------------------------------------------------
                                       GAINS         LOSSES            NET          GAINS         LOSSES            NET
-----------------------------------------------------------------------------------------------------------------------
<S>                               <C>            <C>            <C>            <C>            <C>            <C>
Fixed income securities             $  8,712       $ (3,998)      $  4,714       $    145       $(18,879)      $(18,734)
Equity securities                      3,562         (7,396)        (3,834)         3,274         (1,345)         1,929
Other                                     --           (469)          (469)            --           (349)          (349)
-----------------------------------------------------------------------------------------------------------------------
                                    $ 12,274       $(11,863)           411       $  3,419       $(20,573)       (17,154)
-----------------------------------------------------------------------------------------------------------------------
Deferred income taxes                                                 (144)                                       6,004
-----------------------------------------------------------------------------------------------------------------------
Net unrealized gain (loss)
  on securities                                                   $    267                                     $(11,150)
-----------------------------------------------------------------------------------------------------------------------
</TABLE>

NOTE 4.  DEBT

CNA Surety has a five-year unsecured revolving credit facility that provides for
borrowings of up to $130 million. The interest rate on borrowings under the
credit facility may be fixed, at CNA Surety's option, for a period of one, two,
three or six months and is based on, among other rates, the London Interbank
Offered Rate ("LIBOR") plus applicable margin. The margin, including the
facility fee, varies based on CNA Surety's leverage ratio (debt to total
capitalization) and ranges from 0.25% to 0.40%. The credit facility provides for
the payment of all outstanding principal balances by September 30, 2002 with no
required principal payments prior to such time.

         The credit facility contains among other conditions, limitations on CNA
Surety with respect to the incurrence of additional indebtedness and requires
the maintenance of certain financial ratios. As of December 31, 2000, management
believes that the Company was in compliance with all restrictions or covenants
contained in the credit facility agreement.

         In 1999, CNA Surety acquired certain assets of Clark Bonding Company,
Inc., a Charlotte, North Carolina, insurance agency and brokerage doing business
as The Bond Exchange for $5.9 million. As part of this acquisition, the Company
incurred an additional $1.9 million of debt in the form of a promissory note.
The promissory note matures on July 27, 2004 and has an interest rate of 5.0%.
The Company made a $0.3 million payment on this promissory note in 2000. The
balance of this promissory note at December 31, 2000 was $1.6 million.

         The consolidated balance sheet reflects total debt of $101.6 and $101.9
million at December 31, 2000 and 1999, respectively. The weighted average
interest rate on outstanding borrowings was 6.86% and 6.33% at December 31, 2000
and 1999, respectively.

NOTE 5.  FAIR VALUE OF FINANCIAL INSTRUMENTS

The following table summarizes fair value information about financial
instruments, whether or not recognized in the balance sheet, for which it is
practicable to estimate that value. In cases where quoted market prices are not
available, fair values may be based on estimates using present value or other
valuation techniques. These techniques are significantly affected by the
assumptions used, including the discount rates and estimates of future cash
flows. Potential taxes and other transaction costs have not been considered in
estimating fair value. Accordingly, the estimates presented herein are
subjective in nature and are not necessarily indicative of the amounts that the
Company could realize in a current market exchange. This information excludes
certain financial instruments, such as insurance contracts, and all
non-financial instruments from fair value disclosure. Therefore, these fair
value amounts cannot be aggregated to determine the underlying economic value of
the Company.

<PAGE>   37

                                                           2000 ANNUAL REPORT 37

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The carrying amounts and estimated fair values of financial instruments at
December 31, 2000 and 1999 were as follows:

<TABLE>
<CAPTION>

IN THOUSANDS                                               2000                                      1999
---------------------------------------------------------------------------------------------------------
                                  CARRYING            ESTIMATED             CARRYING            ESTIMATED
                                    AMOUNT           FAIR VALUE               AMOUNT           FAIR VALUE
---------------------------------------------------------------------------------------------------------
<S>                             <C>                  <C>                  <C>                  <C>
Fixed income securities           $458,284             $458,284             $417,956             $417,956
Equity securities                   33,927               33,927               25,897               25,897
Short-term investments              52,660               52,660               43,033               43,033
Other investments                    5,154                5,154                5,277                5,277
Cash                                 5,950                5,950                7,237                7,237
Debt                               101,556              101,556              101,900              101,900
</TABLE>

The following methods and assumptions were used by the Company in estimating
fair values of financial instruments:

         INVESTMENTS The estimated fair values for the fixed income securities
and equity securities are based upon quoted market prices, where available. For
fixed income securities not actively traded, the estimated fair values are
determined using values obtained from independent pricing services or, in the
case of private placements, by discounting expected future cash flows using a
current market rate applicable to the yield, credit quality and maturity of the
investments.

         CASH, SHORT-TERM INVESTMENTS AND OTHER INVESTMENTS The carrying value
for these instruments approximates their estimated fair values.

         DEBT The estimated fair value of the Company's debt is based on the
quoted market prices for the same or similar issues or on the current rates
offered to the Company for debt of the same remaining maturity.

NOTE 6.  DEFERRED POLICY ACQUISITION COSTS

Policy acquisition costs deferred and the related amortization of deferred
policy acquisition costs were as follows:

<TABLE>
<CAPTION>

IN THOUSANDS    YEARS ENDED DECEMBER 31           2000            1999            1998
--------------------------------------------------------------------------------------
<S>                                       <C>             <C>             <C>
Balance at beginning of period              $   84,924      $   74,488      $   64,144
  Costs deferred                               140,114         130,182         115,764
  Amortization                                (133,635)       (119,746)       (105,420)
--------------------------------------------------------------------------------------
Balance at end of period                    $   91,403      $   84,924      $   74,488
--------------------------------------------------------------------------------------
</TABLE>

NOTE 7.  REINSURANCE

The Company's insurance subsidiaries, in the ordinary course of business, cede
reinsurance to other insurance companies to limit their exposure to loss.
Reinsurance arrangements are used to limit maximum loss, provide greater
diversification of risk and minimize exposure on larger risks. Reinsurance
contracts do not ordinarily relieve the Company of its primary obligations to
claimants. Therefore, a contingent liability exists with respect to reinsurance
ceded to the extent that any reinsurer is unable to meet the obligations assumed
under the reinsurance agreements. The Company evaluates the financial condition
of its reinsurers, establishes allowances for uncollectible amounts and monitors
concentrations of credit risk. At December 31, 2000, CNA Surety's largest
reinsurance receivable was approximately $13.3 million with a company rated A++
(Superior) by A.M. Best Company, Inc.

<PAGE>   38

38 CNA SURETY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The effect of reinsurance on premiums written and earned was as follows:

<TABLE>
<CAPTION>

                   YEARS ENDED
IN THOUSANDS       DECEMBER 31                      2000                            1999                            1998
------------------------------------------------------------------------------------------------------------------------
                                 WRITTEN          EARNED         WRITTEN          EARNED         WRITTEN          EARNED
------------------------------------------------------------------------------------------------------------------------
<S>                          <C>             <C>             <C>             <C>             <C>             <C>
Direct                         $ 115,100       $ 109,472       $ 108,968       $ 103,993       $ 105,289       $ 103,298
Assumed from affiliates          201,567         207,178         197,891         186,939         172,935         163,003
Ceded                            (12,199)        (14,831)         (7,872)         (7,392)         (7,622)         (7,564)
------------------------------------------------------------------------------------------------------------------------
Net premiums                   $ 304,468       $ 301,819       $ 298,987       $ 283,540       $ 270,602       $ 258,737
------------------------------------------------------------------------------------------------------------------------
</TABLE>

Assumed premiums from affiliates are comprised of all surety business written or
renewed, net of reinsurance, by CCC and CIC, and their affiliates, after the
Merger Date that is reinsured by Western Surety pursuant to intercompany
reinsurance and related agreements.

         The effect of reinsurance on losses and loss adjustment expenses
incurred was as follows:

<TABLE>
<CAPTION>

IN THOUSANDS                            YEARS ENDED DECEMBER 31           2000           1999           1998
------------------------------------------------------------------------------------------------------------
<S>                                                                 <C>            <C>             <C>
Gross losses and loss adjustment expenses                             $136,004       $ 63,933        $53,828
Reinsurance recoveries                                                 (80,321)       (19,261)        (8,830)
------------------------------------------------------------------------------------------------------------
Net losses and loss adjustment expenses                               $ 55,683       $ 44,672        $44,998
------------------------------------------------------------------------------------------------------------
</TABLE>

NOTE 8.  RESERVES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES

Activity in the reserves for unpaid losses and loss adjustment expenses was as
follows:

<TABLE>
<CAPTION>

IN THOUSANDS                                        YEARS ENDED DECEMBER 31         2000           1999           1998
----------------------------------------------------------------------------------------------------------------------
<S>                                                                          <C>            <C>            <C>
Reserves at beginning of period:
Gross                                                                          $ 157,933      $ 150,020      $ 130,381
Ceded reinsurance                                                                 20,464          7,986          7,656
----------------------------------------------------------------------------------------------------------------------
  Net reserves at beginning of period                                            137,469        142,034        122,725
----------------------------------------------------------------------------------------------------------------------
Net incurred loss and loss adjustment expenses:
  Provision for insured events of current period                                  62,776         57,757         49,350
  Decrease in provision for insured events of prior periods                       (7,093)       (13,085)        (4,352)
----------------------------------------------------------------------------------------------------------------------
    Total net incurred                                                            55,683         44,672         44,998
----------------------------------------------------------------------------------------------------------------------
Net payments attributable to:
  Current period events                                                           23,029         16,809          6,094
  Prior period events                                                             35,825         32,428         19,595
----------------------------------------------------------------------------------------------------------------------
    Total net payments                                                            58,854         49,237         25,689
----------------------------------------------------------------------------------------------------------------------
Net reserves at end of period                                                    134,298        137,469        142,034
Ceded reinsurance at end of period                                                70,159         20,464          7,986
----------------------------------------------------------------------------------------------------------------------
  Gross reserves at end of period                                              $ 204,457      $ 157,933      $ 150,020
----------------------------------------------------------------------------------------------------------------------
</TABLE>

The Company recorded net favorable reserve development which resulted in
reductions in the estimated liability of $7.1 million, $13.1 million and $4.4
million for the years ended December 31, 2000, 1999 and 1998. Net favorable loss
reserve development for the three years ended December 31, 2000, reflects
positive loss and recovery trends primarily with respect to accident years prior
to 1997, partially offset in 2000 by adverse development in more recent accident
years.

<PAGE>   39

                                                           2000 ANNUAL REPORT 39

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 9.  COMMITMENTS AND CONTINGENCIES

At December 31, 2000, the future minimum commitment under operating leases was
as follows: 2001 - $2.8 million, 2002 - $1.6 million, 2003 - $1.5 million, 2004
- $1.3 million and 2005 and thereafter - $7.2 million. Total rental expense for
the years ended December 31, 2000, 1999 and 1998 was $3.5 million, $3.4 million
and $3.3 million, respectively.

         The Company is party to various lawsuits arising in the normal course
of business, some seeking material damages. The Company believes the resolution
of these lawsuits will not have a material adverse effect on its financial
condition or its results of operations.

NOTE 10.  INCOME TAXES

The components of deferred income taxes as of December 31, 2000 and 1999 were as
follows:

<TABLE>
<CAPTION>

IN THOUSANDS                                                          2000                     1999
---------------------------------------------------------------------------------------------------
<S>                                                              <C>                      <C>
Deferred tax assets related to:
  Unearned premium reserve                                         $13,975                  $13,790
  Unrealized loss on securities                                        144                    6,004
  Loss and loss adjustment expense reserve                           2,935                    2,785
  Accrued expenses                                                   1,063                    1,288
  Other                                                              3,340                    4,200
---------------------------------------------------------------------------------------------------
    Total deferred tax assets                                       21,457                   28,067
---------------------------------------------------------------------------------------------------
Deferred tax liabilities related to:
  Deferred policy acquisition costs                                 32,230                   29,963
  Intangible assets                                                  6,009                    6,368
  Unrealized gain on securities                                         --                       --
  Other                                                              2,918                    2,183
---------------------------------------------------------------------------------------------------
    Total deferred tax liabilities                                  41,157                   38,514
---------------------------------------------------------------------------------------------------
Net deferred tax liability                                         $19,700                  $10,447
---------------------------------------------------------------------------------------------------
</TABLE>

CNA Surety and its subsidiaries file a consolidated federal income tax return.

The income tax provisions consisted of the following:

<TABLE>
<CAPTION>

IN THOUSANDS         YEARS ENDED DECEMBER 31           2000            1999          1998
-----------------------------------------------------------------------------------------
<S>                                               <C>             <C>           <C>
Federal current                                     $23,753         $21,074       $20,087
Federal deferred                                      3,078           7,506         7,485
State                                                   949             853           671
-----------------------------------------------------------------------------------------
Total income tax expense                            $27,780         $29,433       $28,243
-----------------------------------------------------------------------------------------
</TABLE>

A reconciliation from the federal statutory tax rate to the effective tax rate
is as follows:

<TABLE>
<CAPTION>

                                       YEARS ENDED DECEMBER 31         2000            1999         1998
---------------------------------------------------------------------------------------------------------
<S>                                                                  <C>             <C>          <C>
Federal statutory rate                                                 35.0%           35.0%        35.0%
Tax exempt income deduction                                            (4.0)           (3.4)        (1.7)
Non-deductible expenses, principally amortization of goodwill           2.4             2.2          2.6
State income tax, net of federal income tax benefit                     0.8             0.6          1.0
Other                                                                  (0.1)           (0.1)         1.4
---------------------------------------------------------------------------------------------------------
Total income tax expense                                               34.1%           34.3%        38.3%
---------------------------------------------------------------------------------------------------------
</TABLE>

<PAGE>   40

40 CNA SURETY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 11.  EMPLOYEE BENEFITS

CNA Surety sponsors a tax deferred savings plan ("401(k) plan") covering
substantially all of its employees. Under the 401(k) plan, the Company matches
70% of the participating employee's contribution up to 6% of eligible
compensation (4.2% maximum matching). Effective January 1, 2000, the Company
match was increased to 100% of the participating employees contribution up to 3%
of eligible compensation and 50% of the participating employees contribution
between 3% and 6% of eligible compensation (4.5% maximum matching). In addition,
the Company may also make an annual discretionary profit sharing contribution to
the 401(k) plan, subject to the approval of the Company's Board of Directors.
The profit sharing contribution may be restricted by plan and regulatory
limitations. The Company contribution, including profit sharing, to the 401(k)
plan was $3.3 million, $3.3 million and $3.2 million for the year ended December
31, 2000, 1999 and 1998, respectively.

         Western Surety sponsors two post-retirement benefit plans covering
certain employees. One plan provides medical benefits, and the other plan
provides sick leave termination payments. The post-retirement health care plan
is contributory and the sick leave plan is non-contributory. The actuarially
determined net periodic post-retirement costs for these plans were $0.6 million
for the years ended December 31, 2000 and 1999 and $0.4 million for the year
ended December 31, 1998. The unfunded accumulated post-retirement benefit
obligation (for retirees and fully vested active plan participants) was $5.8
million and $5.4 million as of December 31, 2000 and 1999, respectively, and is
included in other liabilities in the consolidated balance sheet. The following
table summarizes the actuarial accounting assumptions for post-retirement
benefit plans.

<TABLE>
<CAPTION>

                                                2000     1999    1998
--------------------------------------------------------------------------------
<S>                                            <C>      <C>     <C>
Discount Rate                                    6.5%     6.5%    7.0%
Initial healthcare cost trend                    7.0%     8.0%    9.0%
Ultimate healthcare cost trend                   5.0%     5.0%    5.0%
Ultimate medical trend reached in fiscal year   2005     2002    2002
</TABLE>

NOTE 12.  STOCKHOLDERS' EQUITY

The Company has reserved shares of its common stock for issuance to directors,
officers, employees and certain advisors of the Company through incentive stock
options, non-qualified stock options and stock appreciation rights ("SARs") to
be granted under the CNA Surety 1997 Long-Term Equity Compensation Plan ("CNA
Surety Plan"). The Company has also reserved shares of its common stock for
issuance to Capsure option holders under the CNA Surety Corporation Replacement
Stock Option Plan ("Replacement Plan"). The CNA Surety Plan and Replacement Plan
are collectively referred to as the "Plan." The aggregate number of shares
available for which options may be granted under the Plan is 3,000,000.

         Options issued under the Replacement Plan have the same exercise price,
rights, benefits, terms and conditions as the Capsure options replaced. The
number of unexercised and outstanding Capsure options issued to the holders
under the Replacement Plan on September 30, 1997 was 335,235. The exercise
prices of the replacement options ranged between $0.05 and $8.00 per share on
September 30, 1997.

         The Compensation Committee (the "Committee") of the Board of Directors,
consisting of independent members of the Board of Directors, administers the
Plan. The Committee determines the option prices. Prices may not be less than
the fair market value of the Company's common stock on the date of grant for
incentive stock options and may not be less than the par value of the Company's
common stock for non-qualified stock options.

         The Plan provides for the granting of incentive stock options as
defined under the Code. All non-qualified stock options and incentive stock
options granted under the Plan expire ten years after the date of grant and in
the case of the Replacement Plan the options expire ten years from the original
Capsure grant date.

<PAGE>   41

                                                           2000 ANNUAL REPORT 41

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>

                                                                 WEIGHTED
                                         SHARES SUBJECT    AVERAGE OPTION
                                              TO OPTION   PRICE PER SHARE
--------------------------------------------------------------------------------
<S>                                   <C>                 <C>
Balance at December 31, 1997                    749,372            $10.68
  Options granted                               153,200            $15.50
  Options cancelled                             (15,475)           $15.87
  Options exercised                            (145,031)           $ 3.47
-------------------------------------------------------
Balance at December 31, 1998                    742,066            $13.34
-------------------------------------------------------
  Options granted                               570,200            $11.06
  Options cancelled                             (61,300)           $13.83
  Options exercised                             (29,437)           $ 2.97
-------------------------------------------------------
Balance at December 31, 1999                  1,221,529            $12.50
-------------------------------------------------------
  Options granted                               323,200            $11.50
  Options cancelled                             (68,342)           $13.24
  Options exercised                             (22,897)           $ 4.51
-------------------------------------------------------
Balance at December 31, 2000                  1,453,490            $12.37
-------------------------------------------------------
</TABLE>

As of December 31, 2000, the number of shares available for granting of options
under the Plan were 1,323,145.

The following table summarizes information about stock options outstanding at
December 31, 2000:

<TABLE>
<CAPTION>

                                                          OPTIONS OUTSTANDING                          OPTIONS EXERCISABLE
--------------------------------------------------------------------------------------------------------------------------
                                      WEIGHTED AVERAGE       WEIGHTED AVERAGE                             WEIGHTED AVERAGE
RANGE OF                   NUMBER            REMAINING               EXERCISE              NUMBER                 EXERCISE
EXERCISE PRICES       OUTSTANDING     CONTRACTUAL LIFE                  PRICE         EXERCISABLE                    PRICE
--------------------------------------------------------------------------------------------------------------------------
<S>                  <C>             <C>                     <C>                 <C>                              <C>
$2.25 to $15.875        1,453,490            7.9 years                 $12.37             754,782                   $13.24
--------------------------------------------------------------------------------------------------------------------------
</TABLE>

The weighted average fair market value (at grant date) per option granted was
$4.33, $4.29 and $5.04, respectively, for options granted during 2000, 1999 and
1998. The fair value of these options was estimated at grant date using a
Black-Scholes option pricing model with the following weighted average
assumptions for the year ended December 31, 2000: risk free interest rate of
5.50%; dividend yield of 3.0%; expected option life of six years; and volatility
of 42.3%. Similar assumptions for the years ended December 31, 1999 and 1998
were: risk free interest rate of 5.25% and 4.45%; dividend yield of 2.0% and
2.0%; expected option life of 6 years; and volatility of 40.3% and 33.4%,
respectively.

         The Company adopted the financial disclosure provisions of SFAS No.
123, "Accounting for Stock-Based Compensation" with respect to its stock-based
incentive plans. The Company applies APB Opinion No. 25, "Accounting for Stock
Issued to Employees," and related interpretations, in accounting for its plans
as allowed for under the provisions of SFAS No. 123. Accordingly, no
compensation cost has been recognized for its stock-based incentive plans as the
exercise price of the granted options equals the market price at the grant date.
Had compensation cost for these plans been determined on the fair value at the
grant date for options granted, the Company's pro forma net income for the years
ended December 31, 2000, 1999 and 1998 would have been $53.0 million, $55.2
million and $44.8 million, respectively. Diluted net income per share would have
been $1.24, $1.25 and $1.02 for the years ended December 31, 2000, 1999 and
1998.

         Effective January 1, 1998, the Company established the CNA Surety
Corporation Non-Employee Directors Deferred Compensation Plan. Under this plan,
each director who is not a full-time employee of the Company or any of its
affiliates may defer all or a portion of the annual retainer fee that would
otherwise be paid to such director. The deferral amount, which must be in
multiples of 10% of the retainer fee, will be credited to a deferred
compensation account and will be deemed invested in Common Stock Units equal to
the deferred fees divided by the fair market value of CNA Surety common stock as
of each quarterly meeting date. Each director will be fully vested in his or her
deferred compensation amount. Aggregate common stock units outstanding as of
December 31, 2000 were 27,659. Common Stock Units are convertible into CNA
Surety common stock at the election of the director.

<PAGE>   42

42 CNA SURETY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 13.  SEGMENT INFORMATION

The Company is a leading provider of surety and fidelity bonds in the United
States. According to A.M. Best, the surety and fidelity segment of the domestic
property and casualty insurance industry aggregates approximately $4.1 billion
in direct written premiums, comprised of approximately $3.3 billion in surety
premiums and $0.8 billion in fidelity premiums.

         Surety bonds are three-party agreements in which the issuer of the bond
(the surety) joins with a second party (the principal) in guaranteeing to a
third party (the owner/obligee) the fulfillment of some obligation on the part
of the principal. The surety is the party who guarantees fulfillment of the
principal's obligation to the obligee. There are two broad types of surety
products-contract surety and commercial surety bonds.

         Contract surety bonds secure a contractor's performance and/or payment
obligation generally with respect to a construction project. Contract surety
bonds are generally required by federal, state and local governments for public
works projects. Commercial surety bonds include all surety bonds other than
contract and cover obligations typically required by law or regulation. Fidelity
bonds cover losses arising from employee dishonesty.

         Although all of its products are sold through the same independent
insurance agent and broker distribution network, the Company's underwriting and
management reporting are organized by the two broad types of surety products -
contract surety and commercial surety, which also includes fidelity bonds and
other insurance products for these purposes. These two operating segments have
been aggregated into one reportable business segment for financial reporting
purposes because of their similar economic and operating characteristics.

         The following tables set forth gross and net written premiums, in
thousands of dollars, by product and between domestic and international risks
and the respective percentage of the total for the past three years.

GROSS WRITTEN PREMIUM

<TABLE>
<CAPTION>

FOR THE YEARS ENDED DECEMBER 31                       2000                         1999                         1998
--------------------------------------------------------------------------------------------------------------------
<S>                                <C>              <C>         <C>              <C>         <C>              <C>
Contract                             $161,539         51.0%       $150,022         48.9%       $132,242         47.5%
Commercial                            128,556         40.6         130,502         42.5         121,046         43.5
Fidelity and other                     26,572          8.4          26,335          8.6          24,936          9.0
--------------------------------------------------------------------------------------------------------------------
  Total                              $316,667        100.0        $306,859        100.0        $278,224        100.0
--------------------------------------------------------------------------------------------------------------------
Domestic                             $300,079         94.8%       $286,253         93.3%       $266,998         96.0%
International                          16,588          5.2          20,606          6.7          11,226          4.0
--------------------------------------------------------------------------------------------------------------------
  Total                              $316,667        100.0        $306,859        100.0        $278,224        100.0
--------------------------------------------------------------------------------------------------------------------
</TABLE>

NET WRITTEN PREMIUM

<TABLE>
<CAPTION>

FOR THE YEARS ENDED DECEMBER 31                       2000                          1999                        1998
--------------------------------------------------------------------------------------------------------------------
<S>                                <C>              <C>         <C>               <C>        <C>              <C>
Contract                             $150,504         49.4%       $145,616          48.7%      $127,114         47.0%
Commercial                            126,923         41.7         128,834          43.1        120,638         44.6
Fidelity and other                     27,041          8.9          24,537           8.2         22,850          8.4
--------------------------------------------------------------------------------------------------------------------
  Total                              $304,468        100.0        $298,987         100.0       $270,602        100.0
--------------------------------------------------------------------------------------------------------------------
Domestic                             $289,049         94.9%       $280,463          93.8%      $260,506         96.3%
International                          15,419          5.1          18,524           6.2         10,096          3.7
--------------------------------------------------------------------------------------------------------------------
  Total                              $304,468        100.0        $298,987         100.0       $270,602        100.0
--------------------------------------------------------------------------------------------------------------------
</TABLE>

Approximately $63.1 million, or 19.9%, of gross written premiums were generated
from national insurance brokers in 2000 with the single largest national broker
production comprising $22.8 million, or 7.2%, of gross written premiums.

NOTE 14.  STATUTORY FINANCIAL DATA

CNA Surety's insurance subsidiaries file financial statements prepared in
accordance with statutory accounting practices prescribed or permitted by
applicable insurance regulatory authorities. Prescribed statutory accounting
practices

<PAGE>   43


                                                           2000 ANNUAL REPORT 43

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

include state laws, regulations and general administrative rules, as well as
guidance provided in a variety of publications of the National Association of
Insurance Commissioners ("NAIC"). Permitted statutory accounting practices
encompass all accounting practices that are not prescribed. The permitted
statutory accounting practices of CNA Surety's insurance subsidiaries did not
have a material effect on reported statutory surplus or income. The principal
differences between statutory financial statements and financial statements
prepared in accordance with generally accepted accounting principles are that
statutory financial statements do not reflect deferred policy acquisition costs
and deferred income taxes and fixed income securities are generally carried at
amortized cost in statutory financial statements.

         In March of 1998, the NAIC adopted the Codification of Statutory
Accounting Principles ("Codification"). Codification, which is intended to
standardize regulatory accounting and reporting to state insurance departments,
is effective January 1, 2001. However, statutory accounting principles will
continue to be established by individual state laws and permitted practices. The
states in which CNA Surety's insurance subsidiaries conduct business will
require adoption of Codification for the preparation of statutory financial
statements effective January 1, 2001. The Company estimates that the adoption of
Codification will increase statutory capital and surplus as of January 1, 2001
by approximately $21.9 million.

         The NAIC has promulgated Risk Based Capital ("RBC") requirements for
property and casualty insurance companies to evaluate the adequacy of statutory
capital and surplus in relation to investment and insurance risks such as asset
quality, loss reserve adequacy and other business factors. The RBC information
is used by state insurance regulators as an early warning mechanism to identify
insurance companies that potentially are inadequately capitalized. In addition,
the formula defines new minimum capital standards that supplement the current
system of fixed minimum capital and surplus requirements on a state-by-state
basis. Regulatory compliance is determined by a ratio (the "Ratio") of the
enterprise's regulatory total adjusted capital, as defined by the NAIC, to its
authorized control level RBC, as defined by the NAIC. Generally, a Ratio in
excess of 200% of authorized control level RBC requires no corrective actions by
the company or regulators. As of December 31, 2000, each of CNA Surety's
insurance subsidiaries had a Ratio that was in compliance with the minimum RBC
requirements.

         CNA Surety's insurance subsidiaries are subject to regulation and
supervision by the various state insurance regulatory authorities in which they
conduct business. Such regulation is generally designed to protect policyholders
and includes such matters as maintenance of minimum statutory surplus and
restrictions on the payment of dividends. Generally, statutory surplus of each
insurance subsidiary in excess of a statutorily prescribed minimum is available
for payment of dividends to the parent company. However, such distributions as
dividends may be subject to prior regulatory approval. Without prior regulatory
approval in 2001, CNA Surety's insurance subsidiaries may pay dividends of $60.2
million in the aggregate. Combined statutory surplus for the insurance
subsidiaries at December 31, 2000 was $189.8 million.

NOTE 15.  RELATED PARTY TRANSACTIONS

CCC and the insurance subsidiaries of the Company have entered into various
reinsurance agreements designed to protect against adverse loss experience
related to the CCC Surety Operations reserves at the Merger Date, through the
year 2000. The reinsurance agreements together with the Services and Indemnity
Agreement, that is described below, provided for the initial transfer of the CCC
Surety Operations to CNA Surety's insurance subsidiaries. The reinsurance
agreements entered into at the Merger Date are: (i) the Surety Quota Share
Treaty (the "Quota Share Treaty"); (ii) the Aggregate Stop Loss Reinsurance
Contract (the "Stop Loss Contract"); and (iii) the Surety Excess of Loss
Reinsurance Contract (the "Excess of Loss Contract").

         The Services and Indemnity Agreement provides the insurance
subsidiaries with the authority to perform various administrative, management,
underwriting and claim functions in order to conduct the business of the CCC
Surety Operations and to be reimbursed by CCC for services rendered. In
consideration for providing the foregoing services, CCC has agreed to pay the
insurance subsidiaries a quarterly fee of $50,000. There was no amount due to
the CNA Surety insurance subsidiaries as of December 31, 2000.

         Through the Quota Share Treaty, CCC and CIC transfer to Western Surety
all surety business written or renewed by CCC and CIC after the Merger Date. CCC
and CIC transfer the related liabilities of such business and pay to Western
Surety an amount in cash equal to CCC's and CIC's net written premiums written
on all such business, minus a quarterly ceding commission to be retained by CCC
and CIC equal to $50,000 plus 28% of net written premiums written on such
business.

<PAGE>   44

44 CNA SURETY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

CCC and CIC paid Western Surety, net of commissions and reinsured loss payments,
$88.6 million, $103.8 million and $100.8 million for the years ended December
31, 2000, 1999 and 1998. As of December 31, 2000 and 1999, CNA Surety had an
insurance receivable balance from CCC and CIC of $45.0 million and $57.1
million, respectively. This balance is primarily comprised of direct premium
receivables of CCC and CIC with respect to the surety business ceded to Western
Surety. CNA Surety had reinsurance payables to CCC and CIC of $4.1 million and
$6.9 million as of December 31, 2000 and 1999, respectively, primarily related
to reinsured losses.

         Under the terms of the Quota Share Treaty, CCC has guaranteed the loss
and loss adjustment expenses transferred to Western Surety by agreeing to pay
Western Surety, within 30 days following the end of each calendar quarter, the
amount of any adverse development on such reserves, as reestimated as of the end
of such calendar quarter. There was not any adverse reserve development for the
period from September 30, 1997 (date of inception) through December 31, 2000.
The Quota Share Treaty has a term of five years from the Merger Date.

         The Stop Loss Contract protects the insurance subsidiaries from adverse
loss experience on certain business underwritten after the Merger Date. The Stop
Loss Contract between the insurance subsidiaries and CCC limits the insurance
subsidiaries' prospective net loss ratios with respect to certain accounts and
lines of insured business for at least three fiscal years following the Merger
Date. In the event the insurance subsidiaries' accident year net loss ratio
exceeds 24% in any of 1997 through 2000 on certain insured accounts (the "Loss
Ratio Cap"), the Stop Loss Contract requires CCC at the end of each calendar
quarter following the Merger Date, to pay to the insurance subsidiaries a dollar
amount equal to (i) the amount, if any, by which their actual accident year net
loss ratio exceeds the applicable Loss Ratio Cap, multiplied by (ii) the
applicable net earned premiums. In consideration for the coverage provided by
the Stop Loss Contract, the insurance subsidiaries will pay to CCC an annual
premium of $20,000. The CNA Surety insurance subsidiaries have paid CCC all
required annual premiums. As of December 31, 2000, the Company had an unpaid
loss recoverable balance of approximately $7.6 million under the Stop Loss
Contract.

         The Excess of Loss Contract provides the insurance subsidiaries of CNA
Surety with the capacity to underwrite large surety bond exposures by providing
reinsurance support from CCC. The Excess of Loss Contract provides $75 million
of coverage in excess of the $55 million of coverage provided to the insurance
subsidiaries by third-party reinsurers, which is in turn in excess of the $5
million of coverage per principal to be retained by the CNA Surety insurance
subsidiaries. Subsequent to the Merger Date, the Company entered into a second
excess of loss contract with CCC ("Second Excess of Loss Contract"). The Second
Excess of Loss Contract provides additional coverage for principal losses that
exceed the foregoing coverage of $75 million per principal provided by the
Excess of Loss Contract, or aggregate losses per principal in excess of $135
million. The two Excess of Loss Contracts collectively provide coverage for
losses discovered on surety bonds in force as of the Merger Date and for losses
discovered on new and renewal business written during the term of the Excess of
Loss Contracts. CCC is also obligated to act as a joint insurer, or "co-surety,"
for business covered by the Excess of Loss Contract when requested by the CNA
Surety insurance subsidiaries. In consideration for the reinsurance coverage
provided by the Excess of Loss Contracts, the insurance subsidiaries pay to CCC,
on a quarterly basis, a premium equal to 1% of the net written premiums
applicable to the Excess of Loss Contract, subject to a minimum premium of
$20,000 and $5,000 per quarter under the Excess of Loss Contract and Second
Excess of Loss Contract, respectively. There were no amounts due to CCC under
the Excess of Loss Contract and Second Excess of Loss Contract as of December
31, 2000. Both Excess of Loss Contracts commenced immediately following the
Merger Date and continue for a period of five years from the Merger Date.

         Effective January 1, 2001, CNA Surety renewed an Administrative
Services Agreement with CCC. The agreement allows the Company to purchase and/or
have access to certain services provided by CNAF. The Company will also pay CNAF
a management fee for its proportionate share of administrative and overhead
costs incurred in supporting the services provided pursuant to this agreement.
The management fee for the year 2001 is $1,552,500 which shall be paid by CNA
Surety to CNAF in equal monthly installments of $129,375 by the last day of each
month. The management fee shall be increased as of January 1, the "adjustment
date," of each year this Administrative Services Agreement is in force by the
greater of 5% or the amount of the increase in the Consumer Price Index for All
Urban Consumers for the Chicago, Illinois

<PAGE>   45

                                                           2000 ANNUAL REPORT 45

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

area as reported by the Bureau of Labor Statistics for the 12-month period
immediately preceding the adjustment date. This agreement shall be effective so
long as CNAF or their affiliates or shareholders shall continue to own a
majority interest in CNA Surety. This agreement may be terminated by either
party upon the provision of 30 days prior notice of such termination to the
other party.

         The Company was charged $5.9 million, $5.5 million and $7.5 million for
the years ended December 31, 2000, 1999 and 1998, respectively, for rents and
services provided under a previous Administrative Services Agreement. In
addition, the Company was charged $1.9 million, $3.0 million and $2.2 million
for direct costs incurred by CCC on the Company's behalf during 2000, 1999 and
1998, respectively. The Company paid CCC $7.9 million and owed $0.5 million
which was reflected in other liabilities in the Company's Consolidated Balance
Sheet at December 31, 2000.

         Western Surety has entered into three series of business transactions
with entities in which either or both CCC or affiliates of CCC have an interest.
One series involves four separate refundment guarantees for the benefit of
wholly owned subsidiaries of Hellespont Shipping Corporation ("Hellespont").
Hellespont is 49 percent owned by Majestic Shipping Corporation which is a
wholly owned subsidiary of Loews Corporation ("Loews"). Loews owns approximately
87 percent of the outstanding stock of CNA Financial Corporation ("CNAF"), CNAF
owns approximately 64 percent of CNA Surety, and CCC is a principal operating
subsidiary of CNAF. As one of several sureties participating in the surety
program for Samsung Heavy Industries Co., Ltd., Seoul, Korea ("Samsung"), CCC
has provided refundment guarantees for repayment of advance payments made by
Hellespont or its subsidiaries on four ship building contracts between Samsung
and Hellespont's subsidiaries should Samsung not perform the contracts. Loews is
also a subordinated beneficiary of the guarantees. These refundment guarantees
were transferred to Western Surety through the Quota Share Treaty and are
covered by the Excess of Loss Contracts provided by CCC. Each guarantee is in
the amount of $55.4 million, plus interest, and will terminate on acceptance of
the ships by their buyers. These acceptances are currently anticipated to be
made upon delivery of the ships now scheduled for December 2001, March 2002, May
2002 and September 2002, respectively. Premiums written on the first two
guarantees totaled $1.29 million in 1999 and on the second two guarantees
totaled $1.07 million in 2000 to Western Surety, of which 28 percent was paid to
CCC as a ceding commission.

         The second series involves five separate real estate residual value
insurance policies issued by R.V.I. America Insurance Company ("RVI-America")
reinsured by Western Surety through the Quota Share Treaty. RVI-America is a
wholly owned subsidiary of R.V.I. America Corporation which is a wholly owned
subsidiary of R.V.I. Guaranty Company Ltd. of Bermuda ("RVI-Bermuda").
RVI-Bermuda is 50 percent owned by CCC. The transactions involve policies with
limits totaling approximately $11.5 million. CCC is reinsuring the full extent
of RVI-America's exposure on the policies. Pursuant to the Quota Share Treaty,
Western Surety is, in turn, reinsuring all of CCC's exposures on the policies.
Western Surety is reinsuring all of its exposure on the policies with
RVI-Bermuda, a non-admitted reinsurer. The policy limits range from
approximately $1.7 million to $3.0 million, with an average policy limit of
approximately $2.3 million and total limits of all policies of $11.5 million.
Net premium amounts to be retained in 2000 relative to these reinsurance
transactions total $519,278 as follows: RVI-America, $51,928; CCC, $130,858;
Western Surety, $67,298; and RVI-Bermuda, $269,194.

         Finally, Western Surety is participating in various transactions
involving the issuance of bonds for certain subsidiaries of CNA UniSource of
America, Inc. (collectively referred to as "CNA UniSource"). CNAF owns 95% of
CNA UniSource. Western Surety, with the approval of the Board of Directors and
the Audit Committee, wrote insurance program bonds guaranteeing CNA UniSource
payment obligations under the April 1, 2000, Paid Loss Retro and WC Deductible
Finance Agreement with CCC insurance affiliates, American Casualty Company of
Reading, PA and Transportation Insurance Company. These CCC affiliates are
providing certain general liability and worker's compensation insurance to CNA
UniSource. In addition, CCC has issued eight professional license, mortgage
broker, employer leasing, non-resident license and financial guarantee bonds for
CNA UniSource to various state government obligees. Western Surety reinsures
these bonds through the Quota Share Treaty. The combined penal amount of the
bonds is approximately $15.8 million. CNAF has entered into an agreement with
Western Surety indemnifying Western Surety from any loss arising from the
issuance of bonds for CNA UniSource.

<PAGE>   46

46 CNA SURETY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 16.  SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)

The following is a summary of the results of operations of CNA Surety for the
years ended December 31, 2000, 1999 and 1998.

CNA SURETY

<TABLE>
<CAPTION>

IN THOUSANDS, EXCEPT PER SHARE AMOUNTS            FIRST QUARTER   SECOND QUARTER    THIRD QUARTER   FOURTH QUARTER
------------------------------------------------------------------------------------------------------------------
<S>                                                   <C>              <C>              <C>              <C>
2000
Revenues                                                $82,884          $83,055          $80,930          $85,404
------------------------------------------------------------------------------------------------------------------
Income before income taxes                              $21,358          $21,590          $19,588          $18,846
Income taxes                                              7,245            7,483            6,250            6,802
------------------------------------------------------------------------------------------------------------------
Net income                                              $14,113          $14,107          $13,338          $12,044
------------------------------------------------------------------------------------------------------------------
Basic and diluted earnings per common share             $  0.33          $  0.33          $  0.31          $  0.28
------------------------------------------------------------------------------------------------------------------

<CAPTION>

1999
<S>                                                   <C>              <C>              <C>              <C>
Revenues                                                $74,607          $75,884          $78,402          $80,512
------------------------------------------------------------------------------------------------------------------
Income before income taxes                              $19,751          $19,482          $23,322          $23,376
Income taxes                                              6,708            6,644            8,118            7,963
------------------------------------------------------------------------------------------------------------------
Net income                                              $13,043          $12,838          $15,204          $15.413
------------------------------------------------------------------------------------------------------------------
Basic and diluted earnings per common share             $  0.30          $  0.29          $  0.34          $  0.35
------------------------------------------------------------------------------------------------------------------

<CAPTION>

1998
<S>                                                   <C>              <C>              <C>              <C>
Revenues                                                $65,534          $69,399          $75,325          $73,582
------------------------------------------------------------------------------------------------------------------
Income before income taxes                              $15,981          $17,800          $18,507          $21,470
Income taxes                                              6,166            6,643            7,025            8,409
------------------------------------------------------------------------------------------------------------------
Net income                                              $ 9,815          $11,157          $11,482          $13,061
------------------------------------------------------------------------------------------------------------------
Basic and diluted earnings per common share             $  0.23          $  0.25          $  0.26          $  0.30
------------------------------------------------------------------------------------------------------------------
</TABLE>

<PAGE>   47

                                                           2000 ANNUAL REPORT 47

INDEPENDENT AUDITORS' REPORT

THE BOARD OF DIRECTORS AND SHAREHOLDERS CNA SURETY CORPORATION

We have audited the consolidated balance sheets of CNA Surety Corporation and
subsidiaries, as of December 31, 2000 and 1999, and the related consolidated
statements of income, stockholders' equity, and cash flows for each of the three
years in the period ended December 31, 2000. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.

         We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing accounting principles used and significant estimates made by
management, as well as evaluating the overall consolidated financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.

         In our opinion, such consolidated financial statements present fairly,
in all material respects, the financial position of CNA Surety Corporation and
subsidiaries as of December 31, 2000 and 1999, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2000, in conformity with accounting principles generally accepted
in the United States of America.

/s/ Deloitte & Touche LLP
-------------------------
Deloitte & Touche LLP
Chicago, Illinois
February 12, 2001


<PAGE>   48

48  CNA SURETY CORPORATION

Directors

Giorgio Balzer
BUSINESS MEN'S ASSURANCE
COMPANY OF AMERICA

Philip H. Britt
BANK ONE N.A.

Edward Dunlop
THE CHUBB CORP.
RETIRED

Melvin Gray
GRAYCOR, INC.

Joe P. Kirby
WESTERN SURETY COMPANY
RETIRED

Roy E. Posner
LOEWS CORPORATION
RETIRED

Thomas F. Taylor
CNA
RESIGNED
FEBRUARY 28, 2001

Adrian M. Tocklin
CNA
RETIRED

Mark C. Vonnahme
CNA SURETY CORPORATION

Oficers

Robert E. Ayo
SENIOR VICE PRESIDENT AND CHIEF UNDERWRITING OFFICER, CONTRACT SURETY

Michael A. Dougherty
SENIOR VICE PRESIDENT AND CHIEF MARKETING OFFICER

Melita H. Geoghegan
VICE PRESIDENT AND CHIEF HUMAN RESOURCES OFFICER

Thomas P. Greasel
VICE PRESIDENT AND CHIEF CLAIMS OFFICER

John S. Heneghan
SENIOR VICE PRESIDENT, CHIEF FINANCIAL OFFICER AND TREASURER

Stephen T. Pate
SENIOR VICE PRESIDENT AND CHIEF OPERATING OFFICER, WESTERN SURETY

David F. Paul
VICE PRESIDENT, INTERNATIONAL SURETY

Thomas A. Pottle
SENIOR VICE PRESIDENT AND CHIEF OPERATIONS OFFICER

Sharon A. Sartori
SENIOR VICE PRESIDENT AND CHIEF UNDERWRITING OFFICER, COMMERCIAL SURETY


Enid Tanenhaus
VICE PRESIDENT, GENERAL COUNSEL AND SECRETARY

Mark C. Vonnahme
PRESIDENT AND CHIEF EXECUTIVE OFFICER

Casey P. Warnecke
VICE PRESIDENT, CONTRACT SURETY

William P. Waters
VICE PRESIDENT, CONTRACT SURETY


<PAGE>   49


we will create efficiencies.

[SCREEN PHOTO]


At CNA Surety, we strive to identify new ways to respond to the changing needs
of the surety marketplace. Combining technology with our high level of
experience and service now makes it even easier for our customers, agents and
brokers to do business with us.


<PAGE>   50

                                                                       willpower



CNA Surety Corporation Annual Report 00

[CNA SURETY LOGO]

SUR-AR-01

CNA Plaza, 13 South, Chicago, IL 60685

                                         CNA Surety Corporation Annual Report 00



<PAGE>   51


                                                              Corporate Offices
                                                                      CNA Plaza
                                                        Chicago, Illinois 60685
                                                              www.cnasurety.com

                                                        Independent Accountants
                                                                   and Auditors
                                                          Deloitte & Touche LLP

                                                                 Annual Meeting
                                                         Tuesday, May 15, 2001,
                                                                    9:00 am CDT
                                                                      CNA Plaza
                                                               333 South Wabash
                                                               13th Floor South
                                                        Chicago, Illinois 60685

                                                              Investor Services
                                                            Questions regarding
                                                             security ownership
                                                             should be directed
                                                               to the Company's
                                                            Finance Department.
                                                         Write to the corporate
                                                              office address or
                                                             call 312.822.1908.
                                                             To request printed
                                                         information, including
                                                                the most recent
                                                              Form 10-K, please
                                                             call the Company's
                                                       information request line
                                                               at 800.262.9740.
                                                          Please send change of
                                                       address notices directly
                                                         to the transfer agent.

                                                                 Transfer Agent
                                                             To keep securities
                                                        information up to date,
                                                              please advise the
                                                         transfer agent of your
                                                          new address or change
                                                         of name. Write or call
                                                              them directly at:
                                                            Fleet National Bank
                                                                  c/o EquiServe
                                                                 P.O. Box 43010
                                                       Providence, Rhode Island
                                                                     02940-3010
                                                                   800.736.3001
                                                              www.equiserve.com


                                                          [SUR LISTED NYSE LOGO]