CNA Surety leases its executive offices and its shared branch locations with Continental Casualty Company ("CCC") under the Administrative Services Agreement. CNA Surety currently uses approximately 91,800 square feet and related personal property at 33 branch locations and its home and executive offices (20,484 square feet), in Chicago, Illinois. CNA Surety's annual rent for this space is approximately $2.8 million. CNA Surety may terminate its use of these locations as set forth in the Administrative Services Agreement, without material penalty, by providing CCC with 30 days written notice. In 2005, CNA Surety intends to enter into separate lease or sub-lease agreements with CCC for these shared locations.
CNA Surety leases approximately 81,100 square feet of office space for its primary processing and service center at 101 South Phillips Avenue, Sioux Falls, South Dakota, under a lease expiring in 2012. The annual rent, which is subject to annual adjustments, was $0.9 million as of December 31, 2004. CNA Surety also leases space for contract and commercial branch offices in Tallahassee, Florida, New York, New York; Troy, Michigan; Roseville, California; Houston, Texas; and San Juan, Puerto Rico. Annual rent for these offices was $0.5 million with leases terminating in 2005, 2007, 2005, 2005, 2006, and 2006, respectively.
(1) Includes the effect of recording revisions of prior year reserves. The dollar amount and the percentage point effect on the loss ratio of these reserve revisions were a reduction of $613, or 0.2%, for the year ended December 31, 2004, an addition of $39,290, or 12.9% for the year ended December 31, 2003, an addition of $6,180, or 2.1%, for the year ended December 31, 2002, an addition of $4,812, or 1.5%, for the year ended December 31, 2001, and a reduction of $7,093, 2.4%, for the year ended December 31, 2000.
The following is a discussion and analysis of CNA Surety Corporation ("CNA Surety" or "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.
Beginning in 2002, the Company's unaffiliated reinsurers excluded certain accounts (for which the Company had continuing exposure from bonds written in prior years) from the reinsurance programs. For these accounts, the Company would retain up to $60 million of loss. Due to the improved financial condition of some of these accounts and the Company's efforts to have these accounts covered, only one remains excluded from the 2005 reinsurance program. This account is a large national contractor that is discussed in detail on page 25.
Reinsurance coverage is an important component of the Company's capital structure. Reinsurance allows the Company to meet certain regulatory restrictions that would otherwise limit the size of bonds that the Company writes and limit the market segments in which the Company could compete. In addition, reinsurance reduces the potential volatility of earnings and protects the Company's capital by limiting the amount of loss associated with any one bond principal. Due to increased loss frequency and severity for both the Company and within the surety industry in general that began emerging in 1999, the Company, beginning in 2002, paid substantially higher reinsurance premiums and was required to retain higher amounts of its per principal exposure. Through aggressive exposure reduction efforts and continued underwriting discipline, the Company has been able to purchase additional limits and more expansive reinsurance protection for 2004 and 2005, with substantial cost savings achieved for 2005 relative to 2004. The availability and cost of reinsurance protection for 2006 and beyond will depend on a number of factors such as the Company's loss experience, the surety industry's loss experience, the number of reinsurers willing to provide coverage, and broader economic conditions.
Surety bond principals and obligees often refer to the financial strength ratings assigned by A.M. Best Company, Inc. ("A.M. Best"), Standard and Poor's ("S&P") and other similar companies when they are choosing a surety company. Because the Company uses the underwriting capacity of Continental Casualty Company ("CCC") to serve larger accounts, the insurer financial strength rating of both the Company and CCC factor into customers' decisions. After reporting a significant net loss in the third quarter of 2003, the Company's A.M. Best rating was lowered from A+ to A with a negative outlook. CCC also reported a significant net loss in the third quarter of 2003, but A.M. Best affirmed CCC's rating of A with a negative outlook. Management believes that the current ratings are sufficient for the Company to conduct all aspects of its business. Management also believes that a one level reduction in ratings would have only a minimal impact on operations. A further decrease beyond one level would likely have a material adverse impact on the Company's ability to write business. Management believes that the likelihood of further ratings downgrades has been reduced by ongoing efforts to reduce large exposures, lower per principal retentions under the 2004
The Company's results of operations are impacted by general corporate credit conditions, as well as by the condition of the public construction segment of the economy. Corporate credit default rates have improved from the historically high levels of 2002 and 2003, and the amount of new public construction spending appears to be strong. An improvement in overall corporate default rates could be expected to have a favorable impact on the Company's loss costs. Strong public construction spending could be expected to benefit the Company's written premium production and loss costs. Changes in these factors could have a material impact on the Company's financial condition and results of operations. Management believes that the diversification of the Company's book of business, with approximately 40% of premium from products that are less sensitive to economic conditions, mitigates the impact of these economic factors.
Management believes that the impact of the factors listed above, and others, may not be fully quantifiable through actuarial analysis. Accordingly, management may apply its judgment of the impact of these factors, and others, to its selection of the recorded loss reserves.
Receivables recorded with respect to insurance losses ceded to reinsurers under reinsurance contracts are estimated in a manner similar to liabilities for insurance losses and, therefore, are also subject to uncertainty. In addition to the factors cited above, estimates of reinsurance recoveries may prove uncollectible if the
reinsurer is unable to perform under the contract. Reinsurance contracts do not relieve the ceding company of its obligations to indemnify its own policyholders.
The Company's Consolidated Balance Sheet includes estimated liabilities for unpaid losses and loss adjustment expenses of $363.4 million and reinsurance receivables related to unpaid losses of $116.8 million at December 31, 2004 compared to estimates of $413.5 million and $158.4 million, respectively, at December 31, 2003.
CNA Surety's Consolidated Balance Sheet as of December 31, 2004 includes intangible assets of $138.8 million. These amounts represent goodwill and identified intangibles with indefinite useful lives arising from the acquisition of Capsure. Prior to 2002, goodwill from this and other acquisitions were generally amortized as a charge to earnings over periods not exceeding 30 years. Under Statement of Financial Accounting Standards ("SFAS") No. 142 entitled "Goodwill and Other Intangible Assets" ("SFAS 142"), which was adopted by CNA Surety as of January 1, 2002, periodic amortization ceased, in accordance with an impairment-only accounting model.
A significant amount of judgment is required in performing goodwill impairment tests. Such tests include periodically determining or reviewing the estimated fair value of CNA Surety's reporting units. Under SFAS 142, fair value refers to the amount for which the entire reporting unit may be bought or sold. There are several methods of estimating fair value, including market quotations, asset and liability fair values and other valuation techniques, such as discounted cash flows and multiples of earnings or revenues. If the carrying amount of a reporting unit, including goodwill, exceeds the estimated fair value, then individual assets, including identifiable intangible assets, and liabilities of the reporting unit are estimated at fair value. The excess of the estimated fair value of the reporting unit over the estimated fair value of net assets would establish the implied value of goodwill. The excess of the recorded amount of intangible assets over the implied value of intangible assets is recorded as an impairment loss.
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. The Company periodically tests that deferred acquisition costs are recoverable based on the expected profitability embedded in the reserve for unearned premium. If the expected profitability is less than the balance of deferred acquisition costs, a charge to net income is taken and the deferred acquisition cost balance is reduced to the amount determined to be recoverable. Anticipated investment income is considered in the determination of the recoverability of deferred acquisition costs.
The Company had net income of $39.7 million for the year ended December 31, 2004 as compared to a net loss of $14.2 million for the year ended December 31, 2003, and net income of $30.1 million for the year ended December 31, 2002. The increase in 2004 reflects the absence of material adverse loss development which occurred during the third quarter of 2003, higher net earned premium and higher net investment income, partially offset by higher expenses. The decrease in 2003 compared to 2002 was driven by higher incurred losses and lower investment income.
Gross written premiums for the year ended December 31, 2003 increased 3.2%, or $11.5 million, over the comparable period in 2002. Gross written premiums for contract surety increased 5.4%, or $10.6 million, reflecting improving rates. Gross written premiums for commercial surety decreased 0.2%, or $0.3 million, for the year ended December 31, 2003 reflecting the Company's ongoing effort to reduce aggregate exposures to large commercial accounts that was offset by continued volume growth of small commercial products and improving rates on large commercial bonds. Fidelity and other products increased 4.3% or $1.2 million, for the year ended December 31, 2003 as compared to the same period in 2002 due primarily to volume growth in fidelity and E&O products that are related to small commercial surety bonds.
For the year ended December 31, 2003 net written premiums increased 4.1% to $319.2 million as compared to the same period in 2002, reflecting the aforementioned gross production. Ceded written premiums decreased $1.0 million to $52.2 million for the year ended December 31, 2003. Net written premiums for contract surety business increased 6.8% to $184.4 million. Net written premiums for commercial surety decreased 0.4% to $106.9 million for the year ended December 31, 2003. Fidelity and other products increased 4.2% to $27.9 million for the year 2003 as compared to 2002 primarily due to the aforementioned gross production.
Effective January 1, 2004, CNA Surety entered into a new excess of loss treaty ("2004 Excess of Loss Treaty") with a group of third party reinsurers that reduced its net retention per principal to $10 million with a 5% co-participation in the $90 million layer of third party reinsurance coverage above the Company's retention. This new excess of loss treaty replaced the $45 million excess of $15 million per principal coverage, as well as the $40 million excess of $60 million per principal and the $3 million excess of $12 million coverage that had been provided by CCC. The material differences between the 2004 Excess of Loss Treaty excess of loss reinsurance program and the Company's 2003 Excess of Loss Treaty are as follows. The annual aggregate coverage increased from $110 million in 2003 to $157 million in 2004. The premium for the 2004 Excess of Loss Treaty was $50.6 million (net of expected return premium) compared to a total of $42.0 million of reinsurance premiums paid in 2003 (net of expected return premium) for the $45 million excess of $15 million, the $40 million excess of $60 million and the $3 million excess of $12 million treaties. The contract also included an optional twelve month extended discovery period, for an additional premium (a percentage of the original premium based on any unexhausted aggregate limit by layer), which would provide coverage for losses discovered in 2005 on bonds that were in force during 2004. The Company did not elect to purchase the extended discovery period because it obtained coverage for 2005 under a new treaty. The 2004 Excess of Loss Treaty also provided for somewhat less restrictive special acceptance provisions for larger contract accounts than those contained in the 2003 Excess of Loss Treaty. In addition to the one large contract principal (described later) and the two commercial principals excluded (based upon class of business), the Company's reinsurers had excluded three other contract principals from the 2003 Excess of Loss Treaty, for a total of six excluded principals. The one large contract principal and the two commercial principals remained excluded from the 2004 Excess of Loss Treaty. Of the two commercial principals, one is a domestic electric utility with an estimated bonded exposure of $38 million and is currently rated B- by S&P. This rating was increased from CCC+ during the third quarter of 2004 due to significant recapitalization efforts by the principal. The bonded exposure will decline over the term of the bond which extends until 2007. The other commercial principal is a foreign industrial enterprise that fulfilled its bonded obligations in the second quarter of 2004, so the Company no longer has any exposure.
Effective January 1, 2005, CNA Surety entered into a new excess of loss treaty ("2005 Excess of Loss Treaty") with a group of third party reinsurers on terms similar to the 2004 Excess of Loss Treaty. Under the 2005 Excess of Loss Treaty, the Company's net retention per principal remains at $10 million with a 5% co-participation in the $90 million layer of third party reinsurance coverage above the Company's retention. The material differences between the 2005 Excess of Loss Treaty and the Company's 2004 Excess of Loss Treaty are as follows. The annual aggregate coverage increases from $157 million in 2004 to $185 million in 2005. The base annual premium for the 2005 Excess of Loss Treaty is $40.7 million compared to the actual cost of the 2004 Excess of Loss Treaty of $50.6 million (net of expected return premium). The contract again includes an optional twelve month extended discovery period, for an additional premium (a percentage of the original premium based on any unexhausted aggregate limit by layer) which will provide coverage for losses discovered in 2006 on bonds that were in force during 2005. In addition, the 2005 Excess of Loss Treaty provides coverage for one commercial principal that had been excluded from the 2004 Excess of Loss Treaty. The Company no longer has exposure to a second commercial principal that was excluded from the 2004 Excess of Loss Treaty. Only the large national contractor (described later) that was excluded from the 2004 Excess of Loss Treaty remains excluded from the 2005 Excess of Loss Treaty.
Under the terms of the Quota Share Treaty, CCC has guaranteed the loss and loss adjustment expense reserves transferred to Western Surety as of September 30, 1997 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 re-estimated as of the end of such calendar quarter. There has not been any adverse reserve development for the period from September 30, 1997 (date of inception) through December 31, 2004.
The Company and CCC are presently discussing a possible restructuring of the reinsurance arrangements described in the preceding two paragraphs under which all bonds written for the large national contractor would be reinsured by CCC under an excess of $60 million treaty and other CNA Surety accounts would be covered by a separate $50 million excess of $100 million treaty.
As of December 31, 2004 and December 31, 2003, CNA Surety had an insurance receivable balance from CCC and CIC of $16.4 million and $71.1 million, respectively. CNA Surety had reinsurance payables to CCC and CIC of $0.3 million as of December 31, 2004. CNA Surety had no reinsurance payables to CCC and CIC as of December 31, 2003.
The Company intends to continue to provide surety bonds on behalf of the contractor during the restructuring period, subject to the contractor's initial and ongoing compliance with the Company's underwriting standards. Indemnification and subrogation rights, including rights to contract proceeds on construction projects in the event of default, exist that reduce CNA Surety's exposure to loss. While the Company believes that the contractor's restructuring efforts will be successful and provide sufficient cash flow for its operations, the contractor's failure to achieve its extended restructuring plan or perform its contractual obligations under the Company's surety bonds could have a material adverse effect on CNA Surety's results of operations, cash flow and equity. If such failures occur, the Company estimates that possible losses, net of indemnification and subrogation recoveries, but before recoveries under reinsurance contracts, to be approximately $200 million pretax. However, the related party reinsurance treaties discussed above should limit the Company's per principal loss exposure to approximately $60 million. After consideration of the additional premium due in the event of losses under the reinsurance treaties discussed above, the Company estimates that the financial statement impact of a failure by this contractor would be approximately $52 million after tax.
The favorable loss development recorded in 2004 for prior accident years resulted from loss adjustment expense payments related to prior years that were lower than previously expected. The adverse development on prior accident years that occurred in 2003 was directly related to a significant increase in large claim activity. Management concluded that this claim activity exceeded the assumptions regarding the frequency of severe losses used in determining the then existing reserves. First, additional contract bond claims were received during the third quarter of 2003 on a contractor that had filed for bankruptcy in February, 2003. Upon review and verification of these new claims, the existing case reserve was increased by $7.2 million, net of applicable reinsurance. Second, a demand was made during the third quarter of 2003 against a $45 million insurance program bond issued on behalf of a national trucking concern that was now in bankruptcy. This demand was in contradiction of previous information provided by the obligee on the bond. Based on this new information, management reserved the full remaining limits on this bond which resulted in $15 million of net adverse development after the application of available reinsurance. Third, claims were also received in the third quarter of 2003 on worker's compensation self insurance bonds written between 1975 and 1986 on behalf of two principals. After verifying coverage and obtaining supporting actuarial information on the underlying workers' compensation claims, the Company increased the case reserves on these bonds by $8.4 million, net of applicable reinsurance. Fourth, after receiving a demand on another insurance program bond in the third quarter of 2003, management identified an outstanding insurance program bond written on behalf of a contractor now in bankruptcy. Based on recent experience with this type of bond, which typically has few defenses available to the surety, and in particular with the obligee on this bond, management recorded a loss provision on this bond of $6 million. Finally, management determined that the case reserve on a particular claim was insufficient due to the amount of legal fees that the Company was incurring on the case. Based on their estimate of future legal expenses, management increased the reserve on this bond by $3 million.
In addition to the net unfavorable loss reserve development, the higher net loss ratio in 2003 primarily relates to net reserve additions of approximately $49.0 million for the 2003 accident year due to material adverse loss severity on the Company's branch commercial and contract business. The net additions to reserves for the 2003 accident year resulted from three large contract bond claims totaling $28 million incurred in 2003, an approximately $15 million net loss on an insurance program bond for a now bankrupt large commercial account, and changes in estimates of large losses resulting from this significant adverse claim activity.
the economy and credit markets at that time, the Company increased the 2002 accident year loss ratio assumption on contract and large commercial business.
On January 2, 2003, CNA Surety settled litigation brought by J.P. Morgan Chase & Co. ("Chase") in connection with three surety bonds issued on behalf of Enron Corporation subsidiaries. The penal sums of the three bonds totaled approximately $78 million. The Company paid Chase approximately $40.7 million and assigned its recovery rights in the Enron bankruptcy to Chase in exchange for a full release of its obligations under the bonds. The Company has no other exposure related to the Enron Corporation. CNA Surety's net loss related to the settlement, after anticipated recoveries under excess of loss reinsurance treaties, was previously fully reserved. Immediately upon execution of the settlement documents, the Company sent written notice for reimbursement to its reinsurers. As of December 31, 2004, the Company has billed a total of $37.1 million to its reinsurers. Seven reinsurers responsible for payment of 63% of the treaty proceeds either have paid their portions of the claim or have reached agreement with the Company and paid the Company to commute the entire reinsurance treaty under which the Enron claim was made. Pursuant to the treaty, the Company demanded and began arbitration proceedings against the two other reinsurers who have not paid their portions of the claim or commuted their treaties. Management believes that these reinsurers do not have valid defenses under the reinsurance treaties to avoid payment, and that the Company will fully recover all reinsurance recoverables recorded related to this settlement. As such, the Company has not recorded a reduction with respect to the remaining reinsurance recoverables of $13.7 million as of December 31, 2004.
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. The Company recorded estimated reinsurance recoveries from CCC of $29.9 in 2003, $2.5 million in 2002, $16.6 million in 2001 and $5.8 million in 2000 under this contract. No reinsurance recoveries from CCC were recorded in 2004. As of December 31, 2004, there was no unpaid balance related to amounts due under the Stop Loss Contract.
With respect to contract surety, the Company's portfolio is predominantly comprised of contractors with bonded backlog of less than $30 million. Bonded backlog is a measure of the Company's exposure in the event of default before indemnification, salvage and subrogation recoveries. The Company does have a number of accounts with higher bonded backlogs. For example, the Company has 13 accounts each with a bonded backlog in excess of $150 million and 14 accounts each with a bonded backlog of between $100 million and $150 million.
The Company will manage its exposure to any one contract credit and aggressively looks for co-surety, shared accounts and other means to support or reduce larger exposures. Reinsurance, indemnification and subrogation rights, including rights to contract proceeds on construction projects in the event of default, exist that substantially reduce CNA Surety's exposure to loss.
The expense ratio increased to 65.2% for the year ended December 31, 2004 as compared to 62.6% for 2003. The increase in the expense ratio for the year ended December 31, 2004 primarily reflects the impact of higher reinsurance costs on net earned premiums and higher operating expenses. Ceded earned premium increased by $10.5 million in 2004, primarily due to the Company's decision to reduce its per principal retention from $15 million in 2003 to $10 million in 2004. The higher ceded earned premium increased the 2004 expense ratio by 2.1 percentage points. Operating expenses increased 8.6% for the year ended December 31, 2004 primarily due to a 6.6% increase in gross earned premium. 2004 operating expenses were impacted by a $4.9 million increase to the accrual for policyholder dividends. This increase added approximately 1.5 percentage points to the 2004 expense ratio. The Company streamlined its field office structure during 2004 in order to add consistency to operations and to reduce expenses. No significant expense impact occurred in 2004 due to severance costs associated with this effort.
Net realized investment gains/losses were $2.8 million and $1.8 million in gains for 2004 and 2003, respectively, and $7.6 million in losses for 2002. The net gains realized in 2004 and 2003 resulted from opportunities to sell securities that the Company believed would maximize the total return on its portfolio. The net realized investment losses in 2002 reflect the Company's insurance subsidiaries' decision to liquidate their common equity portfolios during 2002. The volatility of the equity markets was adversely impacting the Company's reported regulatory capital.
We have audited management's assessment, included in the accompanying Management's Report on Internal Control Over Financial Reporting, that CNA Surety Corporation and subsidiaries (the "Company") maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control -- Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the Company's internal control over financial reporting based on our audit.
The management of CNA Surety Corporation (CNAS) and subsidiaries is responsible for establishing and maintaining adequate internal control over financial reporting. CNAS' internal control system was designed to provide reasonable assurance to the Company's management, its Audit Committee and Board of Directors regarding the preparation and fair presentation of published financial statements.
We have audited the accompanying consolidated balance sheets of CNA Surety Corporation and subsidiaries (the "Company") as of December 31, 2004 and 2003, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2004. Our audits also included the financial statement schedules listed in the Index at Item 15. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedules based on our audits.
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, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
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") Surety Bonding Company of America ("Surety Bonding") and Universal Surety of America ("USA"), into CNA Surety Corporation ("CNA Surety" or "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 ("Loews") owns approximately 91% 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").
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. All securities transactions are recorded on the trade date. 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 net realized investment gains/losses.
The Company completed its annual intangible asset impairment test as of October 1, 2004, whereby no impairment was indicated.
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 recorded amounts. The methods of determining such estimates and the resulting estimated liability are regularly reviewed and updated. Changes in the estimated liability are reflected in the Statement of Income in the period in which such changes are determined to be needed.
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.
As allowed under SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), the Company accounts for its stock option plans in accordance with Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"). 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.
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 unearned premium reserves and deferred policy acquisition costs. The effect on deferred taxes of a change in tax rates is recognized in income in the period of enactment.
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. Depreciation expense for 2004, 2003, and 2002 was $4.5 million, $4.2 million, and $3.9 million, respectively. The cost of maintenance and repairs is charged to income as incurred; major improvements are capitalized.
In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (an interpretation of FASB SFAS Nos. 5, 57, and 107 and rescission of FASB Interpretation No. 34)" ("FIN 45"). FIN 45 clarifies the requirements of FASB SFAS No. 5, "Accounting for Contingencies" relating to a guarantor's accounting for, and disclosure of, the issuance of certain types of guarantees. FIN 45 provided for additional disclosure requirements related to guarantees, effective for financial periods ended after December 15, 2002. Additionally, FIN 45 outlined provisions for initial recognition and measurement of the liability incurred in providing a guarantee. These provisions are applied to guarantees issued or modified after December 31, 2002. The Company has adopted the disclosure requirements of FIN 45 and the provisions for initial recognition and measurement for all guarantees issued or modified after December 31, 2002. The adoption of FIN 45 did not have a significant impact on the Company's financial position or results of operations.
In January 2003, FASB issued FASB Interpretation ("FIN") No. 46, "Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin ("ARB") No. 51" ("ARB No. 51") ("FIN No. 46"). In December of 2003, the FASB issued a revision to FIN No. 46 ("FIN No. 46R"), which superceded FIN No. 46 and further clarified the application of ARB No. 51. Per ARB No. 51, as a general rule, ownership by the parent, either directly or indirectly, of over fifty percent of the outstanding voting shares of a subsidiary is a condition pointing toward preparation of consolidated financial statements of the parent and its subsidiary. However, application of the majority voting interest requirement of ARB No. 51 to certain types of entities may not identify the party with a controlling financial interest because the controlling financial interest may be achieved through arrangements that do not involve voting interest. FIN No. 46R clarifies the applicability of ARB No. 51 to entities in which the equity investors do not have the characteristics of a
In April 2003, the FASB issued SFAS No. 149 entitled "Amendment of Statement 133 on Derivative Instruments and Hedging Activities" ("SFAS 149"). SFAS 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133 entitled "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. Adoption of SFAS 149 did not have a significant impact on the Company's financial position or results of operations.
Application to Certain Investments" ("EITF 03-1"). Under EITF 03-1 an investment is impaired if the fair value of the investment is less than its cost including adjustments for amortization, accretion, foreign exchange, and hedging. An impairment would be considered other-than-temporary unless a) the investor has the ability and intent to hold an investment for a reasonable period of time sufficient for the recovery of the fair value up to (or beyond) the cost of the investment and b) evidence indicating that the cost of the investment is recoverable within a reasonable period of time outweighs evidence to the contrary. This new guidance for determining whether the decline in the fair value of the investment is other-than-temporary was to be effective for reporting periods beginning after June 15, 2004. In September of 2004, the FASB issued FSP EITF Issue 03-1-1, which delayed the effective date for the measurement and recognition guidance included in EITF Issue 03-1 related to other-than-temporary impairment pending additional implementation guidance. As a result of the delay the Company continues to apply existing accounting literature for determining when a decline in fair value is other-than-temporary.
The Company's insurance subsidiaries, as required by state law, deposit certain securities with state insurance regulatory authorities. At December 31, 2004, securities on deposit had an aggregate carrying value of $3.4 million.
The amortized cost and estimated fair value of fixed income securities, by contractual maturity, at December 31, 2004 and 2003 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 (dollars in thousands):
Major categories of net investment income of available-for-sale securities were as follows (dollars in thousands):
The following table provides the composition of fixed income securities with an unrealized loss at December 31, 2004 in relation to the total of all fixed income securities by contractual maturities:
The following table summarizes for fixed income securities in an unrealized loss position at December 31, 2004 and 2003, the aggregate fair value and gross unrealized loss by length of time those securities have been continuously in an unrealized loss position (dollars in thousands):
There were no non-investment grade fixed income or equity securities in an unrealized loss position at December 31, 2004 or 2003.
In May 2004, the Company, through a wholly-owned trust, privately issued $30 million of preferred securities through two pooled transactions. These securities bear interest at a rate London Interbank Offered Rate ("LIBOR") plus 337.5 basis points with a 30-year term and are redeemable after five years. The securities were issued by CNA Surety Capital Trust I (the "Issuer Trust"). The sole asset of the Issuer Trust consists of a $30.9 million junior subordinated debenture issued by the Company to the Issuer Trust. The Company has also guaranteed the dividend payments and redemption of the preferred securities issued by the Issuer Trust. The maximum amount of undiscounted future payments the Company could make under the guarantee is $75.0 million, consisting of annual dividend payments of $1.5 million over 30 years and the redemption value of $30.0 million. Because payment under the guarantee would only be required if the Company does not fulfill its obligations under the debentures held by the Issuer Trust, the Company has not recorded any additional liabilities related to this guarantee.
On September 30, 2002, the Company refinanced $65 million in outstanding borrowings under its previous credit facility with a new credit facility (the "2002 Credit Facility"). The 2002 Credit Facility, as amended September 30, 2003, provides an aggregate of up to $50.0 million in borrowings divided between a revolving credit facility (the "Revolving Credit Facility") of $30.0 million and a term loan facility (the "Term
Loan Facility") of $20.0 million. The Revolving Credit Facility matures on September 30, 2005. The Revolving Credit Facility may be increased from time to time by the amount of repayments under the Term Loan Facility up to an additional $10.0 million. Such increase is subject to consent by each bank participating in the Revolving Credit Facility, and will take place upon receipt by the banks of the respective installment payments under the Term Loan Facility.
Effective January 30, 2003, the Company entered into an interest rate swap on the Term Loan Facility which fixed the previously floating interest rate. As a result, the effective interest rate on the term loan as of December 31, 2004 was 2.77%.
The 2002 Credit Facility contains, among other conditions, limitations on CNA Surety with respect to the incurrence of additional indebtedness and maintenance of a rating of at least "A" by A.M. Best for each of the Company's insurance subsidiaries. The 2002 Credit Facility also requires the maintenance of certain financial ratios as follows: a) maximum funded debt to total capitalization ratio of 25%, b) minimum net worth of $350.0 million and c) minimum fixed charge coverage ratio of 2.5 times. Due to the net loss reported for the third quarter of 2003, the Company was in violation of the minimum fixed charge coverage test. The lenders granted the Company a waiver for this violation and amended the 2002 Credit Facility to replace the fixed charge coverage ratio requirement for the next three quarters with a minimum earnings requirement. At March 31, 2004, the Company was in violation of this minimum earnings requirement and received a waiver for this requirement in the second quarter of 2004. The Company is in compliance with the debt covenants as of and for the quarter ended December 31, 2004.
Net commissions, brokerage and other underwriting expenses were comprised as follows (dollars in thousands):
The effect of reinsurance on the Company's provision for loss and loss adjustment expenses and the corresponding ratio to earned premium was as follows (dollars in thousands):
With respect to the three excluded contract principals other than the large national contractor, two contract principals have completed asset sales and other reorganization efforts and have been accepted into the 2004 Excess of Loss Treaty. The Company received claims related to the third contract principal in 2003, making it ineligible for inclusion in the 2004 Excess of Loss Treaty. The Company believes it is adequately reserved for any exposure related to this principal and is currently not providing bonds to this principal.
The Services and Indemnity Agreement provides the Company's insurance subsidiaries with the authority to perform various administrative, management, underwriting and claim functions in order to conduct the business of CCC and CIC and to be reimbursed by CCC for services rendered. In consideration for providing the foregoing services, CCC has agreed to pay Western Surety a quarterly fee of $50,000. This agreement was renewed on January 1, 2004 and expires on December 31, 2004 and is annually renewable thereafter. There was no amount due to the CNA Surety insurance subsidiaries as of December 31, 2004.
The Quota Share Treaty had an original term of five years from the Merger Date and was renewed on October 1, 2002 on substantially the same terms with an expiration date of December 31, 2003. The Quota Share Treaty was again renewed on January 1, 2004 on substantially the same terms with an expiration date of December 31, 2004; and is annually renewable thereafter. The ceding commission paid to CCC and CIC by Western Surety remained at 28% of net written premiums and contemplates an approximate 4% override commission for fronting fees to CCC and CIC on their actual direct acquisition costs.
The Stop Loss Contract terminated on December 31, 2000 and was not renewed. The Stop Loss Contract protected 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 limited the insurance subsidiaries' prospective net loss ratios with respect to certain accounts and lines of insured business for three
full accident years following the Merger Date. In the event the insurance subsidiaries' accident year net loss ratio exceeded 24% in any of the accident years 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 paid to CCC an annual premium of $20,000. The CNA Surety insurance subsidiaries have paid CCC all required annual premiums. As of December 31, 2004, the Company had billed and received $54.9 million under the Stop Loss Contract, of which $29.9 million was received in 2004.
The Excess of Loss Contract provided 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 provided $75 million of coverage for losses in excess of the $60 million per principal. 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 provided unlimited 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. In consideration for the reinsurance coverage provided by the Excess of Loss Contracts, the insurance subsidiaries paid 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. The two Excess of Loss Contracts collectively provided 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. Both Excess of Loss Contracts commenced following the Merger Date and continued until September 30, 2002. The discovery period for losses covered by the Excess of Loss Contracts extends until September 30, 2006.
January 1, 2004 to December 31, 2004. The premium for this contract is $3.0 million plus an additional premium of $6 million if a loss is ceded under this contract.
The reinsurance premium for the coverage provided by the $50 million excess of $100 million contract was $6.0 million. This contract expired on December 31, 2003. The Company and CCC entered into a new $50 million excess of $100 million contract for the period of January 1, 2004 to December 31, 2004. The premium for this contract is $6.0 million plus an additional premium of $14 million if a loss is ceded under this contract.
As of December 31, 2004 and December 31, 2003, CNA Surety had an insurance receivable balance from CCC and CIC of $16.4 million and $71.1 million. CNA Surety had reinsurance payables to CCC and CIC of $0.3 million as of December 31, 2004. CNA Surety had no reinsurance payables to CCC and CIC as of December 31, 2003.
The Company has provided significant surety bond protection guaranteeing projects undertaken by the large national contract principal that is excluded from the Company's third party reinsurance. The related party reinsurance available to the Company for this principal and the credit extended to the principal by affiliates of the Company are described below.
For bonds that the Company has written after September 30, 2003, in addition to the coverage provided by excess of loss reinsurance treaties described above ($40 million excess of $60 million and $50 million excess of $100 million) the Company and CCC have entered into facultative reinsurance in connection with larger bonds. The Company's exposure on bonds written from October 1, 2002 through October 31, 2003 was limited to $20 million per bond. For bonds written between November 1, 2003 and December 31, 2004, the Company's exposure was $14.7 million. For bonds written subsequent to December 31, 2004, the Company's exposure will be limited to 10% of policyholders' surplus.
collateral for letters of credit which are charged against the maximum available line and, if drawn upon, would be treated as loans under the credit facility. As of December 31, 2004 and 2003, these guarantees and collateral obligations aggregated $13 million and $7 million.
The Company intends to continue to provide surety bonds on behalf of the contractor during the restructuring period, subject to the contractor's initial and ongoing compliance with the Company's underwriting standards. Indemnification and subrogation rights, including rights to contract proceeds on construction projects in the event of default, exist that reduce CNA Surety's exposure to loss. While the Company believes that the contractor's restructuring efforts will be successful and provide sufficient cash flow for its operations, the contractor's failure to achieve its extended restructuring plan or perform its contractual obligations under the Company's surety bonds could have a material adverse effect on CNA Surety's results of operations, cash flow and equity. If such failures occur, the Company estimates that possible losses, net of indemnification and subrogation recoveries, but before recoveries under reinsurance contracts, to be approximately $200 million pretax. However, the related party reinsurance treaties discussed above should limit the Company's per principal loss exposure to approximately $60 million.
The Company recorded net loss reserve development which resulted in a decrease of the estimated liability of $0.6 million for the year ended December 31, 2004 and increases in the estimated liability of $39.3 million, $6.2 million for the years ended December 31, 2003 and 2002, respectively. The decrease in the estimated liability recorded in 2004 for prior accident years resulted from loss adjustment expense payments related to prior accident years that were lower than previously expected. Adverse claim trends in the 2001 and 2002 accident years, particularly increased claim severity on large commercial accounts, had resulted in increased gross and net incurred loss and loss adjustment expenses for the two years ended December 31, 2003.
workers' compensation claims, the Company increased the case reserves on these bonds by $8.4 million, net of applicable reinsurance. Fourth, after receiving a demand on another insurance program bond in the third quarter of 2003, management identified an outstanding insurance program bond written on behalf of a contractor now in bankruptcy. Based on recent experience with this type of bond, which typically has few defenses available to the surety, and in particular with the obligees on this bond, management recorded a loss provision on this bond of $6 million. Finally, management determined that the case reserve on a particular claim was insufficient due to the amount of legal fees that the Company was incurring on the case. Based on their estimate of future legal expenses, management increased the reserve on this bond by $3 million.
Incurred loss and loss adjustment expenses for the year ended December 31, 2002 included $17 million on a gross basis and $12 million on a net basis (after reinsurance) related to the September 2002 bankruptcy of a large national trucking concern.
On January 2, 2003, CNA Surety settled litigation brought by J.P. Morgan Chase & Co. ("Chase") in connection with three surety bonds issued on behalf of Enron Corporation ("Enron") subsidiaries. The penal sums of the three bonds totaled approximately $78 million. The Company paid Chase approximately $40.7 million and assigned its recovery rights in the Enron bankruptcy to Chase in exchange for a full release of its obligations under the bonds. The Company has no other exposure related to the Enron Corporation. CNA Surety's net loss related to the settlement, after anticipated recoveries under excess of loss reinsurance treaties, was previously fully reserved. Immediately upon execution of the settlement documents, the Company sent written notice for reimbursement to its reinsurers. As of December 31, 2004, the Company has billed a total of $37.1 million to its reinsurers. Seven reinsurers responsible for payment of 63% of the treaty proceeds either have paid their portions of the claim or have reached agreement with the Company and paid the Company to commute the entire reinsurance treaty under which the Enron claim was made. Pursuant to the treaty, the Company demanded and began arbitration proceedings against the two other reinsurers who have not paid their portions of the claim or commuted their treaties. Management believes that these reinsurers do not have valid defenses under the reinsurance treaties to avoid payment, and that the Company will fully recover all reinsurance recoverable recorded related to this settlement. As such, the Company has not recorded a reduction with respect to these reinsurance recoverable of $13.7 million as of December 31, 2004.
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.
CNA Surety and its subsidiaries file a consolidated federal income tax return.
CNA Surety sponsors a tax deferred savings plan ("401(k) plan") covering substantially all of its employees. Prior to December 31, 1999, the Company matched 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 employee's contribution up to 3% of eligible compensation and 50% of the participating employee's contribution between 3% and 6% of eligible compensation (4.5% maximum matching). Effective January 1, 2004, the Company implemented an additional basic contribution for eligible 401(k) plan participants of 3% (if under age 45) or 5% (if 45 or older) of eligible compensation. 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 $3.5 million, $2.3 million, and $2.9 million for the years ended December 31, 2004, 2003 and 2002, respectively.
CNA Surety established the CNA Surety Corporation Deferred Compensation Plan, effective April 1, 2000. The Company established and maintains the Plan as an unfunded, nonqualified deferred compensation plan for a select group of management or highly compensated employees. The purpose of the Plan is to permit designated employees of the Company and participating affiliates to accumulate additional retirement income through a nonqualified deferred compensation plan that enables them to defer compensation to which they will become entitled in the future. The Company holds equity securities with a fair value of $1.2 million as of December 31, 2004 in respect of this deferred compensation plan.
The plans' combined net periodic post-retirement benefit cost for the last three fiscal years included the following components (dollars in thousands):
The following table summarizes stock option activity for 2004, 2003 and 2002.
The weighted average fair market value (at grant date) per option granted was $3.82, $3.72 and $3.69 respectively, for options granted during 2004, 2003 and 2002. 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, 2004: risk free interest rate of 1.1%; dividend yield of 0.0%; expected option life of six years; and volatility of 30.4%. Similar assumptions for the years ended December 31, 2003 and 2002 were: risk free interest rate of 1.10% and 1.50%; dividend yield of 0.0%; expected option life of 6 years; and volatility of 39.8%.
The following table illustrates the effect on net income and earnings per share data if the Company had applied the fair value recognition provisions of SFAS 123 to stock based compensation under the Company's stock-based compensation plan.
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, 2004 and 2003 were 15,079 and 12,932, respectively. Common Stock Units are convertible into CNA Surety common stock at the election of the director.
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.
Approximately $68.1 million, or 17.5%, of gross written premiums were generated from national insurance brokers in 2004 with the single largest national broker production comprising $18.5 million, or 4.7%, of gross written premiums. In 2003, approximately $61.2 million, or 16.5%, of gross written premiums were generated from national insurance brokers with the single largest national broker production comprising $19.2 million, or 5.2%, of gross written premiums. In 2002, approximately $72.4 million, or 20.1%, of gross written premiums were generated from national insurance brokers with the single largest national broker production comprising $28.3 million, or 7.9%, of gross written premiums.
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 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 Company's insurance subsidiaries follow three permitted accounting practices which did not have a material effect on reported statutory surplus or income. The Company was given permission to report activity in the Small Business Administration's Surety Bond Guarantee program as a reinsurance program and to report all salvage and subrogation recoveries as recoveries of loss rather than allocating recoveries between loss and loss adjustment expenses. Also, Surety Bonding has been given permission to report ceding commissions received from Western Surety that exceed the acquisition costs related to the business ceded as a reduction to commission expense. Historically, 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, deferred income taxes are recorded but there are limitations as to the amount of deferred tax assets that may be reported as "admitted" assets and fixed income securities are generally carried at amortized cost in statutory financial statements.
The following table reconciles consolidated stockholders' equity at December 31, 2004 and 2003 as reported herein in conformity with GAAP with total statutory capital and surplus of CNA Surety's insurance
subsidiaries, determined in accordance with statutory accounting practices prescribed or permitted by insurance regulatory authorities (dollars in thousands):
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 a company or regulators. As of December 31, 2004 each of CNA Surety's insurance subsidiaries had a Ratio that was in compliance with the minimum RBC requirements.
the Consumer Price Index for All Urban Consumers for the Chicago, Illinois area as reported by the Bureau of Labor Statistics for the 12 month period immediately preceding the adjustment date. The agreement was amended in 2003 to allow CCC to purchase services from the Company. In 2004 and 2003, CCC paid the Company $0.5 million for services in connection with licensing and appointing CCC's insurance producers as required by state insurance laws. 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.
In addition from time to time Western Surety provided surety bonds guaranteeing insurance payments of certain companies to CCC and its affiliates under retrospectively rated insurance policies underwritten by CCC and its affiliates. Under the terms of these bonds, referred to as insurance program bonds, if the principal, the insured company, failed to make required a required premium payment, CCC and its affiliates would have a claim against the Company under the bond. The Company now has a policy not to issue such bonds to companies insured by CCC and its affiliates. The last such bond was written in 2001 and currently bonds with $13.9 million of total penal sums remain as of December 31, 2004.
The following is a summary of the quarterly results of operations for the years ended December 31, 2004, 2003, and 2002 (dollars in thousands, except per share amounts):
On October 27, 2004, the Company announced that it had tentatively agreed to sell all of its financial interest in United Kingdom ("UK") based DeMontfort Group, Ltd. to HCC Insurance Holdings, Inc. The agreement covers CNA Surety's 34% ownership in the common shares and certain preferred shares and indebtedness of the DeMontfort Group. The transaction settled on January 5, 2005. The Company expects to realize a gain of approximately $2.0 million before the effect of income taxes in the first quarter 2005, however the decision to sell the investment is not otherwise expected to have a material impact on the Company's ongoing operations or financial position.