The primary factors that would result in the Company’s actual losses being closer to either end of the reserve range is the emergence of (or lack thereof) a small number of large claims, as well as the recovery of (or lack thereof) a small number of large indemnification amounts. In other words, the primary factors that, if they were to occur, would result in the Company’s actual payments being at the high end of the indicated range are if the Company experiences an unusually high number of large claims and/or an unusually low number of large indemnification recoveries. Conversely, if the Company were to experience an unusually low number of large claims and/or an unusually high number of large indemnification recoveries, the Company’s actual payments would tend to be at the low end of the range. These variations in outcomes could be driven by broader issues such as the state of the construction economy or the level of corporate defaults, or by the specific facts and circumstances
CNA Surety’s Consolidated Balance Sheet as of December 31, 2007 includes intangible assets of $138.8 million. This amount represents goodwill and identified intangibles with indefinite useful lives arising from the acquisition of Capsure Holdings Corp. (“Capsure”).
Cash flow at the parent company level is derived principally from dividend and tax sharing payments from its insurance subsidiaries, and to a lesser extent, investment income. The principal obligations at the parent company level are to service debt and pay operating expenses, including income taxes. At December 31, 2007, the parent company’s invested assets consisted of $1.8 million of equity securities, $7.3 million of short-term investments and $4.8 million of cash. At December 31, 2006, the parent company’s invested assets consisted of $0.8 million of fixed income securities, $1.7 million of equity securities, $9.5 million of short- term investments and $2.9 million of cash. As of December 31, 2007 and December 31, 2006, parent company short-term investments and cash included $9.8 million and $9.4 million, respectively, of restricted cash and short-term investments primarily related to premium receipt collections ultimately due to the Company’s insurance subsidiaries.
The Company’s consolidated net cash flow provided by operating activities was $129.2 million, $124.2 million and $70.0 million for 2007, 2006 and 2005, respectively. The increase in net cash flow provided by operating activities in 2007 primarily relates to lower loss payments of $13.3 million, partially offset by higher income tax payments of $3.9 million and $5.3 million returned to CCC under the Stop Loss Contract discussed previously. The increase in net cash flow provided by operating activities in 2006 primarily related to higher premiums received, lower loss payments and the absence of the deposit with the affiliated ceding company made in 2005.
The subordinated debenture bears interest at a rate of LIBOR plus 337.5 basis points and matures in April of 2034. As of December 31, 2007 and 2006, the interest rate on the junior subordinated debenture was 8.24% and 8.75%, respectively.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedules as of and for the year ended December 31, 2007, of the Company and our report dated February 19, 2008, expressed an unqualified opinion on the consolidated financial statements and financial statement schedules. Such report includes an explanatory paragraph relating to the changes in the Company’s method of accounting for defined benefit postretirement plans and for stock-based compensation in 2006.
CNA Surety management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2007. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework. Based on our assessment we believe that, as of December 31, 2007, the Company’s internal control over financial reporting is effective based on those criteria.
In July 2006, the FASB issued FIN 48. FIN 48 prescribes a comprehensive model for how a company should recognize, measure, present, and disclose in its financial statements uncertain tax positions that the company has taken or expects to take on a tax return. FIN 48 states that a tax benefit from an uncertain position may be recognized only if it is “more likely than not” that the position is sustainable, based on its technical merits. The tax benefit of a qualifying position is the largest amount of tax benefit that is greater than 50 percent likely of being realized upon ultimate settlement with a taxing authority having full knowledge of all relevant information. FIN 48 is effective for fiscal years beginning after December 15, 2006. As discussed previously, FIN 48 was adopted by the Company as of January 1, 2007. The Company has elected to classify interest, if any, recognized in accordance with FIN 48 as interest expense. Likewise, penalties, if any, recognized in accordance with FIN 48 will be classified as miscellaneous expense. No amounts have been recognized subject to these provisions as of December 31, 2007. As of December 31, 2007, the tax years 2004 through 2007 remain subject to examination by the Internal Revenue Service. Adoption and subsequent application of this standard did not have an impact on the Company’s results of operations and financial condition.
As of December 31, 2007, 53 securities held by the Company were in an unrealized loss position. The Company believes that 48 of these securities are in an unrealized loss position because of changes in interest rates and expects these securities will recover in value at or before maturity. Of these 48 securities, 28 were rated AAA by Standard & Poor’s (“S&P”) and Aaa by Moody’s Investor Services (“Moody’s”) and all were investment grade. None of these 48 securities was in a loss position that exceeded 5% of its book value. The largest unrealized loss was
Effective January 1, 2007, CNA Surety entered into a new excess of loss treaty (“2007 Excess of Loss Treaty”) with a group of third party reinsurers on terms similar to the 2006 Excess of Loss Treaty. Under the 2007 Excess of