The Company's investment portfolio is monitored by management through analyses of various factors including unrealized gains and losses on securities, portfolio duration, and exposure to interest rate, market and credit risk. Based on such analyses, the Company may record an other-than-temporary impairment on an investment security in accordance with its policy, or sell a security. Such activities will produce net realized investment gains and losses.
While management uses various GAAP and non-GAAP financial measures to monitor various aspects of the Company's performance, net income is the most directly comparable GAAP measure and represents a more comprehensive measure of operating performance. Management believes that its process of evaluating performance through the use of these non-GAAP financial measures provides a basis for enhanced understanding of its operating performance and the impact to net income as a whole. Management also believes that investors may find these widely used financial measures described above useful in interpreting the underlying trends and performance, as well as to provide visibility into the significant components of net income.
For the year ended December 31, 2005, net written premiums increased by $47.7 million to $365.9 million as compared to 2004 reflecting the increase in gross written premiums discussed previously and the reduction in the cost of the Company's 2005 reinsurance program. Ceded written premiums decreased $19.6 million to $51.6 million for the year ended December 31, 2005 compared to the prior year. Net written premiums for contract surety business increased 17.7% to $202.8 million. Net written premiums for commercial surety increased 10.9% to $128.0 million for the year ended December 31, 2005. Significant reductions in exposures to large commercial bonds have caused a greater share of reinsurance protection to be allocated to contract bonds. Fidelity and other products increased 15.0% to $35.1 million for the year 2005 as compared to 2004 reflecting the increase in gross written premiums discussed previously.
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, 2005.
The expense ratio increased to 65.2% for 2004 as compared to 62.6% for 2003. The increase in the expense ratio for 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 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
As an insurance holding company, CNA Surety is dependent upon dividends and other permitted payments from its insurance subsidiaries to pay operating expenses and 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 Surety Bonding are domiciled, insurance companies may only pay dividends from earned surplus excluding surplus arising
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
The Company's insurance subsidiaries, in the ordinary course of business, cede insurance to other insurance companies and affiliates. Reinsurance arrangements are used to limit maximum loss, provide greater diversification of risk and minimize exposure on larger risks. Reinsurance contracts do not relieve the Company of its primary obligations to claimants. Therefore, a contingent liability exists with respect to insurance ceded to the extent that any reinsurer is unable to meet the obligations assumed under the reinsurance contracts. The Company evaluates the financial condition of its reinsurers, assesses the need for allowances for uncollectible amounts and monitors concentrations of credit risk. At December 31, 2005, CNA Surety's largest reinsurance receivable from an affiliate, CCC, an A (Excellent) rated company by A.M. Best was approximately $53.0 million. At December 31, 2005, CNA Surety's largest reinsurance receivable from a non-affiliate reinsurer was approximately $14.1 million with a company rated A (Excellent) by A.M. Best.
The increase in the provision for insured events of current period and net payments attributable to current period events in 2005 reflects the establishment of the reserve for and payments related to the large national contractor described in Note 6. The Company recorded net loss reserve development in prior accident years which
At December 31, 2005 the future minimum commitments under operating leases are as follows: 2006 -- $1.9 million; 2007 -- $1.8 million; 2008 -- $1.6 million; 2009 -- $1.6 million; 2010 -- $1.6 million and thereafter -- $2.3 million. Total rental expense for 2005, 2004 and 2003 was $5.0 million, $5.1 million and $4.6 million, respectively.
The components of deferred income taxes as of December 31, 2005 and 2004 were as follows (dollars in thousands):
CNA Surety and its subsidiaries file a consolidated federal income tax return. The income tax allocation between the Company and its subsidiaries is subject to written agreement, approved by the Board of Directors. Allocation is based upon separate return calculations in accordance with the Internal Revenue Code of 1986 with current credit being given to separate company net losses. The Company and its subsidiaries remit their estimated tax payments at such times as would be required to be made to the Internal Revenue Service. Inter-company tax balances are generally settled in full in the third quarter of the following year.
Effective April 1, 2000, CNA Surety established the CNA Surety Corporation Deferred Compensation Plan which is an unfunded, nonqualified deferred compensation plan for a select group of management or highly compensated employees. The purpose of the CNA Surety Corporation Deferred Compensation 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.
determined in accordance with statutory accounting practices prescribed or permitted by insurance regulatory authorities (dollars in thousands):
Western Surety has entered into a series of business transactions with entities in which an affiliate of CCC had an interest. The first 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"), an unconsolidated affiliate of CCC. The transactions involve policies with limits totaling approximately $11.5 million. CCC reinsured the full extent of RVI -- America's exposure on the policies. Pursuant to the Quota Share Treaty, Western Surety was, in turn, reinsuring all of CCC's exposures on the policies. Western Surety reinsured all of its exposure on the policies with RVI-Bermuda, a non-admitted reinsurer. The policy limits range from $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 retained in 2000 relative to these reinsurance transactions totaled $0.5 million as follows: RVI -- America, $0.1 million; CCC, $0.1 million; Western Surety, $0.1 million; and RVI -- Bermuda, $0.2 million. CCC's ownership interest of RVI -- Bermuda was disposed of in December 2005.
The following is a summary of the quarterly results of operations for the years ended December 31, 2005, 2004 and 2003 (dollars in thousands, except per share amounts):