UNITED STATES SECURITIES AND EXCHANGE COMMISSION

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CNA Surety Corporation

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CNA SURETY CORPORATION

333 S. Wabash Ave., 41st Floor

Chicago, Illinois 60604

(312) 822-5000

 

NOTICE OF ANNUAL MEETING OF SHAREHOLDERS

On April 23, 2009

 

To: The Shareholders of CNA Surety Corporation

 

NOTICE IS HEREBY GIVEN that the Annual Meeting of Shareholders of CNA Surety Corporation (the “Company”) will be held at the Company’s business offices located at 333 S. Wabash Ave., 41st Floor, Chicago, Illinois 60604, on Thursday, April 23, 2009, at 9:00 A.M. CDT, for the following purposes:

 

 

The Board of Directors has fixed the close of business on March 2, 2009, as the record date for the determination of shareholders entitled to notice of, and to vote at, the Annual Meeting. You are cordially invited to attend the meeting. In the event you will be unable to attend, you are respectfully requested to complete, date, sign and return the enclosed proxy card at your earliest convenience in the enclosed return envelope.

 

By Order of the Board of Directors

 

Rosemary Quinn

Senior Vice President, General Counsel and Secretary

 

March 19, 2009

Chicago, Illinois

 

IMPORTANT:

 

PLEASE FILL IN, DATE, SIGN AND PROMPTLY MAIL THE ENCLOSED PROXY CARD IN THE POSTPAID ENVELOPE PROVIDED TO ASSURE THAT YOUR SHARES ARE REPRESENTED AT THE MEETING. IF YOU ATTEND THE MEETING YOU MAY VOTE IN PERSON IF YOU WISH TO DO SO EVEN THOUGH YOU HAVE SENT IN YOUR PROXY.

 

Important Notice Regarding the Availability of Proxy Materials for the Shareholder Meeting to be held on April 23, 2009. The Proxy Statement and the 2008 Annual Report to Shareholders are available at http://www.cnasurety.com/about/investor_information.htm.

CNA Surety Corporation
333 S. Wabash Ave. 41st Floor

Chicago, Illinois 60604

(312) 822-5000

 

PROXY STATEMENT

 

 

INTRODUCTION

 

This Proxy Statement is being mailed or otherwise furnished to shareholders of CNA Surety Corporation, a Delaware corporation (“we,” “us,” “our,” the “Company” or “CNA Surety”), on or about March 19, 2009, in connection with the solicitation by the Board of Directors of the Company (the “Board”) of proxies to be voted at the Annual Meeting of Shareholders (“the Annual Meeting”) of the Company to be held at the Company’s business offices located at 333 S. Wabash Ave., 41st Floor, Chicago, Illinois 60604, at 9:00 A.M. CDT, on Thursday, April 23, 2009, and at any adjournment thereof. Shareholders who, after reading this Proxy Statement, have any questions should contact Rosemary Quinn, Secretary of the Company, in Chicago at (312) 822-5893.

 

MATTERS TO BE CONSIDERED AT THE ANNUAL MEETING

 

At the Annual Meeting, shareholders of the Company will consider and vote upon:

 

 

The date of this Proxy Statement is March 19, 2009.

 

PROXY SOLICITATION

 

The enclosed proxy is solicited by the Board. The cost of this proxy solicitation is anticipated to be nominal and will be borne by the Company, including charges and expenses of brokerage firms and others for forwarding solicitation material to the Company’s Shareholders. The solicitation generally will be effected by mail and such cost will include the cost of preparing and mailing the proxy materials. In addition to the use of the mail, proxies also may be solicited by personal interview, telephone, or other similar means. Although solicitation will be made primarily through the use of the mail, officers, directors, or employees of the Company may solicit proxies personally or by the above described means without additional remuneration for such activity. The Company will arrange for brokerage houses, nominees and other custodians holding common stock of the Company to forward proxy-soliciting material to the beneficial owners of such shares, and will reimburse such record owners for the reasonable out-of-pocket expenses incurred by them. The Proxy Statement and the 2008 Annual Report to Shareholders are available at http://www.cnasurety.com/about/investor_information.htmg.

 

2008 ANNUAL REPORTS

 

Shareholders are concurrently being furnished with a copy of the Company’s 2008 Annual Report to Shareholders, which contains the Company’s audited financial statements for the year ended December 31, 2008. Additional copies of the Company’s Annual Report to Shareholders and Annual Report on Form 10-K for the year ended December 31, 2008, as filed with the Securities and Exchange Commission (the “SEC”), may be obtained through links on the Company’s web site, www.cnasurety.com, or by contacting Gail Carey, representative

of the Company, at 333 S. Wabash Ave., 41st Floor, Chicago, Illinois 60604, (312) 822-5199, and such copies will be furnished promptly at no expense.

 

VOTING SECURITIES AND PROXIES

 

Only shareholders of record at the close of business on March 2, 2009 (the “Record Date”), have the right to receive notice of and to vote at the Annual Meeting and any adjournment thereof. As of the Record Date, 44,229,982 shares of the Company’s Common Stock (“Common Stock”) were issued and outstanding. Each share outstanding on the Record Date for the Annual Meeting entitles the holder thereof to one vote upon each matter to be voted upon at the Annual Meeting. The shareholders of a majority of the Company’s issued and outstanding Common Stock, present in person or represented by proxy, shall constitute a quorum at the Annual Meeting. Abstentions and broker non-votes are counted as present for purposes of determining the presence or absence of a quorum for the transaction of business. If, however, a quorum is not present or represented at the Annual Meeting, the shareholders entitled to vote at the Annual Meeting, whether present in person or represented by proxy, shall only have the power to adjourn the Annual Meeting until such time as a quorum is present or represented. At such time as a quorum is present or represented by proxy, the Annual Meeting will reconvene without notice to shareholders, other than an announcement at the prior adjournment of the Annual Meeting, unless the adjournment is for more than thirty (30) days or a new record date has been set.

 

If a proxy in the form enclosed is duly executed and returned, the shares of the Company’s Common Stock represented thereby will be voted in accordance with the specifications made thereon by the shareholder. If no such specifications are made, such proxy will be voted (i) for election of the Management Nominees (as hereinafter defined) for directors; (ii) for ratification of Deloitte & Touche LLP as the Company’s independent registered public accounting firm for fiscal year 2009; and (iii) at the discretion of Proxy Agents (as hereinafter defined) with respect to such other business as may properly come before the Annual Meeting or any adjournment thereof. Abstentions are counted in tabulations of the votes cast on proposals presented to shareholders, as to the materials specifically proposed herein. Broker non-votes are not counted for purposes of determining whether a proposal has been approved. Under applicable Delaware law, a broker non-vote will have no effect on the outcome of the election of directors. A proxy is revocable at any time prior to its exercise by either a subsequently dated, properly executed proxy appointment which is received by the Company prior to the time votes are counted at the Annual Meeting, or by a shareholder giving notice of revocation to the Company in writing prior to the Annual Meeting or during the Annual Meeting prior to the time votes are counted. The mere presence at the Annual Meeting of a shareholder who appointed a proxy does not itself revoke the appointment.

 

ELECTION OF DIRECTORS (PROPOSAL 1)

 

VOTING AND THE MANAGEMENT NOMINEES

 

At the Annual Meeting seven directors will be elected to serve one-year terms commencing immediately upon their election, or to serve until their respective successors are duly elected and qualified. The nominees are as follows:

Philip H. Britt

Anthony S. Cleberg

David B. Edelson

D. Craig Mense

Robert A. Tinstman

John F. Welch

Peter W. Wilson

 

All of the nominees are currently serving as directors of the Company. For information regarding the Management Nominees, see “Directors and Executive Officers of the Registrant” section of this proxy.

 

At the Annual Meeting, if a quorum is present, the vote of holders of a majority of the Company’s Common Stock having the power to vote in person or represented by proxy shall elect the directors. It is the present intention of John Corcoran and Rosemary Quinn, who will serve as the Company’s proxy agents at the Annual Meeting (the

“Proxy Agents”), to vote the proxies which have been duly executed, dated and delivered and which have not been revoked in accordance with the instructions set forth thereon or if no instruction had been given or indicated, for the election of the Management Nominees as directors. The Board does not believe that any of the Management Nominees will be unwilling or unable to serve as a director. However, if prior to the election of directors any of the Management Nominees becomes unavailable or unable to serve, the Board reserves the right to name a substitute nominee or nominees, and the Proxy Agents expect to vote the proxies for the election of such substituted nominee or nominees.

 

Vote Required

 

Proposal to elect seven directors requires an affirmative vote of holders of a majority of the voting power represented by shares of our Common Stock present in person or represented by proxy and entitled to vote at the Annual Meeting.

 

THE BOARD RECOMMENDS A VOTE IN FAVOR OF THE MANAGEMENT NOMINEES. IF A CHOICE IS SPECIFIED ON THE PROXY BY A SHAREHOLDER, THE SHARES WILL BE VOTED AS SPECIFIED. IF NO SPECIFICATION IS MADE, THE SHARES WILL BE VOTED “FOR” THE MANAGEMENT NOMINEES.

 

DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

 

The following sets forth the name, age, position and offices with the Company, present principal occupation or employment and material occupations and employment for the past five years of each person who is presently a director, a nominee for director, or an executive officer of the Company.

 

Philip H. Britt, age 62; Director of the Company since March 1998; Retired; Senior Vice President Insurance Industry Division of Bank One, NA (formerly First Chicago NBD) from April 1988 through February 2002.

 

Anthony S. Cleberg, age 56; Director of the Company since April 2007; Chief Financial Officer and Executive Vice President of Black Hills Corp. since July 2008; Independent Consultant and Investor from 2002 to July 2008; Executive Vice President and Chief Financial Officer of Champion Enterprises from 2000 to 2002.

 

John F. Corcoran, age 44; Senior Vice President and Chief Financial Officer of the Company since January 2004; Executive Officer of the Company since October 2003; Senior Vice President and Senior Financial Officer for Global and Specialty Lines of the insurance subsidiaries of CNA Financial Corporation (“CNAF”) (that own 62.1% of the Company’s stock as of February 28, 2009) from January 2002 to September 2003.

 

Michael A. Dougherty, age 50; Senior Vice President and Chief Information Officer of the Company since January 2007; Senior Vice President Field Operations and Distribution from September 2001 until January 2007.

 

David B. Edelson, age 49; Director of the Company since February 2007 and Chairman since January 2009; Senior Vice President of Loews Corporation (“Loews”), the parent corporation of CNAF, since May 2005; Executive Vice President and Corporate Treasurer of JPMorgan Chase & Co. from January 2003 until April 2005; and Senior Vice President and Corporate Treasurer of JPMorgan Chase & Co. from May 2001 to January 2003. Mr. Edelson joined the Board of Directors of AutoNation, Inc. in July 2008 and is also a member of its Audit Committee.

 

Douglas W. Hinkle, age 56; Chief Underwriting Officer of the Company since March 2004; Western Division Director of Surety for the St. Paul Companies from January 2003 until March 2004; Assistant Vice President and Western Territory Practice Leader of the St. Paul American Surety Division of the St. Paul Companies from December 2001 until 2003.

 

D. Craig Mense, age 57; Director of the Company since April 23, 2007; Executive Vice President and Chief Financial Officer of CNAF since November 2004; President and Chief Executive Officer of Global Run-Off Operations at St. Paul Travelers from July 2004 to November 2004; Chief Operating Officer of the Gulf Insurance Group at Travelers Property Casualty Corp. from May 2003 to July 2004, Senior Vice President Chief Financial and Administrative Officer for Personal Lines at Travelers from July 2002 to May 2003.

Thomas A. Pottle, age 49; Senior Vice President of the Company’s Credit and Field Operations since January 2007; Senior Vice President since March 1999 and Assistant Secretary since May 1998.

 

Rosemary Quinn, age 54; Senior Vice President, General Counsel and Secretary of the Company since April 2008; Assistant Vice President and Assistant General Counsel of the Company from July 2006 through April 2008; General Counsel of GeoVera Insurance Company from 2005 through July 2006; Assistant Vice President of St. Paul Travelers’ Bond Department from April 2004 through 2005; Assistant Vice President of the St. Paul Companies from 1998 to 2004.

 

Robert A. Tinstman, age 62; Director of the Company since August 2004; Executive Chairman of Angelo Iafrate Construction Company and James Construction Group from May 2002 to May 2007. Mr. Tinstman currently serves on the Board of Directors of IdaCorp., Inc. and Idaho Power Company and has been Chairman of their Investment and Compensation Committees since 1999. Mr. Tinstman has been a member of the Board of Directors of Home Federal Bancorp Inc. since 1999 and serves as Chairman of its Audit Committee.

 

John F. Welch, age 52; Director of the Company since June 2003; President and Chief Executive Officer of the Company since June 2003; Chief Underwriting Officer of Surety for the St. Paul Companies from May 2002 until June 2003; President of Afianzadora Insurgentes SA CV located in Mexico City, Mexico from August 2000 until May 2002.

 

Peter W. Wilson, age 49; Director of the Company since January 2009; Executive Vice President, Global Specialty Lines of the insurance subsidiaries of CNAF since 2001. He also served on the Company’s Board of Directors from 2001 to 2003.

 

Board and Committee Meetings

 

In excess of 50% of the Company’s shares are held by the insurance subsidiaries of CNAF. Pursuant to the listing standards of the New York Stock Exchange (“Exchange” or “NYSE”), the Company is a “Controlled Company” and consequently is exempt from the Exchange’s requirements relating to maintenance of a majority of independent directors and independent nominating/corporate governance and compensation committees. However, the Company’s Compensation and Audit Committee members include only independent directors. The Board of Directors considers shareholder director nominees under the same criteria utilized by the Board of Directors to evaluate nominees proposed by management or members of the Board of Directors. These criteria include a potential nominee’s character, judgment, business experience and areas of expertise, among other relevant considerations, such as requirements of the Exchange.

 

Director Independence

 

The Board of Directors annually reviews its performance. For 2008, the Board and the Audit Committee completed anonymous self-evaluation forms. The Audit Committee and Board of Directors discussed these evaluations at their respective meetings on February 4 and 5, 2009. Both the self evaluations of the Audit Committee and the Board of Directors indicated that the Board and the Audit Committee believe they are functioning well and receive adequate access to and information from Company management.

 

Under the rules of the Exchange, listed companies, like CNA Surety, that have a controlling stockholder are not required to have a majority of independent directors. Accordingly, the slate of director nominees for the Board of Directors is not composed of a majority of directors who are independent.

 

The following nominees qualify as independent directors pursuant to the applicable rules of the Exchange and the SEC: Philip Britt, Robert Tinstman and Anthony Cleberg. In determining independence, the Board affirmatively determined whether or not each director or nominee has any material relationship with the Company. In assessing materiality, the Board considered all relevant facts and circumstances, not merely from the standpoint of the director or nominee, but from that of any person or organization with which the director or nominee has an affiliation. The Board considers the frequency and regularity of any services provided by or to, or other transactions between the Company and the director or nominee or affiliated organization, whether they are being carried out at arm’s length in the ordinary course of business and whether they are being provided or conducted substantially on the same terms

as those prevailing at the time from unrelated parties for comparable transactions. Material relationships can include commercial banking, industrial, legal, accounting, charitable, employment and familial relationships.

 

Consistent with the listing requirements of the Exchange, the Board follows the standards provided below to assist it in determining director independence so that a director would not be considered independent if any of the following relationships exists: (i) the director is, or has been within the last three years, an employee of the Company, or an immediate family member is, or has been within the last three years, an executive officer of the Company; (ii) the director has received, or has an immediate family member who has received, during any twelve-month period within the last three years, more than $120,000 in direct compensation from the Company, other than director and committee fees and pension or other forms of deferred compensation for prior service (provided such compensation is not contingent in any way on continued service); (iii) the director is a current partner or employee or an immediate family member is a current partner of a firm that is the Company’s internal or external auditor, or an immediate family member is a current employee of such a firm and personally works on the Company’s audit, or within the last three years, the director or an immediate family member was a partner or employee of such a firm and personally worked on the Company’s audit within that time; (iv) the director or an immediate family member is, or has been within the last three years, employed as an executive officer of another company where any of the Company’s present executive officers at the same time serves or served on that company’s compensation committee; or (v) the director is a current employee, or an immediate family member is a current executive officer, of a company that has made payments to, or received payments from, the Company for property or services in an amount which, in any of the last three fiscal years, exceeds the greater of $1 million or 2% of such other company’s consolidated gross revenues.

 

Corporate Governance and Ethics

 

The Board has adopted Corporate Governance Guidelines and a Code of Business Ethics that are available on the Company’s website at www.cnasurety.com, and will be provided to any shareholder upon request to Gail Carey, representative of the Company, at 333 S. Wabash Ave., 41st Floor, Chicago, Illinois 60604, (312) 822-5199. Such copies will be furnished promptly at no charge. The Corporate Governance Guidelines provide that shareholders and other interested parties may communicate with the non-management members of the Board by sending such communications in care of the Company’s General Counsel, 333 S. Wabash Ave., 41st Floor, Chicago, Illinois 60604. It is the Company’s policy to forward all such communications to the Board.

 

Committees of the Board

 

The Board has an Executive Committee, an Audit Committee, a Compensation Committee and an Investment Committee. In 2008, the Audit Committee and the Compensation Committee consisted entirely of independent directors. The Company does not have a nominating/corporate governance committee. The Board relies on the Exchange exemption for controlled companies in not having a nominating/corporate governance committee, but the Board’s current policy is that all directors participate in the consideration of director nominees.

 

Executive Committee.  In 2008, the Executive Committee consisted of Messrs. Tinstman and Welch and Mr. James Lewis who resigned as the chair and member of the Board effective December 31, 2008 when he terminated his employment with CNAF. The Executive Committee did not meet during 2008. The Executive Committee possesses and may exercise the full and complete authority of the Board in the management and business affairs of the Company during the intervals between the meetings of the Board. Any action by the Executive Committee is reported to the Board at its next meeting and such action is subject to revision and alteration by the Board, provided that no rights of third persons can be prejudicially affected by the subsequent action of the Board. Vacancies on the Executive Committee are filled by the Board. However, during the temporary absence of a member of the Executive Committee, due to illness or inability to attend a meeting or for other cause, the remaining member(s) of the Executive Committee may appoint a member of the Board to act in the place and with all the authority of such absent member. The current members of the Executive Committee will continue in office until the Committee is dissolved, terminated or reorganized, or if such members are replaced.

 

Audit Committee.  The Audit Committee Charter provides that the Audit Committee is authorized and (a) has the power to review the financial reports and other financial information provided by the Company to governmental

entities and the public, including the certifications made by the principal executive officer and principal financial officer with respect to the Company’s reports filed with the SEC; the Company’s systems of internal controls regarding finance, accounting, internal audit, legal compliance and ethics that the Company’s management and the Board have established; and the Company’s auditing, accounting and financial reporting processes generally including the review of critical accounting policies and financial statement presentation, (b) has the sole authority to retain, compensate and evaluate the Company’s independent registered public accounting firm, and the scope of and fees for their audits, and (c) addresses any and all related party agreements and arrangements between the Company and its affiliates and any disputes that may arise hereunder. However, the Company’s management is responsible for its financial statements and reporting process, including its system of internal controls. The Company’s independent auditors are responsible for expressing an opinion on the conformity of the Company’s audited financial statements with accounting principles generally accepted in the United States. A copy of the Audit Committee Charter as amended and restated is available on the Company website at www.cnasurety.com, and will be provided to any shareholder upon request to Gail Carey, representative of the Company, at 333 S. Wabash Ave., 41st Floor, Chicago, Illinois 60604, (312) 822-5199. Copies will be furnished promptly at no charge.

 

The current members of the Audit Committee are Messrs. Britt, Cleberg (Chairperson) and Tinstman. Messrs. Britt, Cleberg and Tinstman are considered “independent” as that term is used in Exchange Act Section 10A (m)(3). Each of the current members is financially literate as determined by the Board and Mr. Cleberg is an “audit committee financial expert” under the Exchange and SEC standards. During 2008, the Audit Committee held ten (10) meetings. The Board members are asked annually to report to the Company the number of audit committees on which such Director serves. During 2008, no director reported serving on more than three audit committees.

 

Compensation Committee.  The Compensation Committee sets the Company’s compensation policies, and reviews and administers all compensation matters for the Company’s executive officers including the five (5) most highly compensated executive officers. In addition, it reviews and approves the availability of stock options granted to all other Company employees. A copy of the Compensation Committee Charter is available on the Company website at www.cnasurety.com and will be provided to any shareholder upon request by contacting Gail Carey, representative of the Company, at 333 S. Wabash Ave., 41st Floor, Chicago, Illinois 60604, (312) 822-5199. The current members of the Company’s Compensation Committee are Messrs. Britt, Cleberg and Tinstman (Chairperson). During 2008, the Compensation Committee held five (5) meetings.

 

Investment Committee.  The primary function of the Investment Committee is to establish investment policies and oversee the management of the Company’s investment portfolio. The current members of the Investment Committee are Messrs. Britt (Chairperson), Edelson and Welch. During 2008, the Investment Committee held four (4) meetings.

 

Executive Sessions of Non-Management Directors

 

The Board meets without management in Executive Session at its regularly scheduled meetings. The members have decided that a presiding director is not necessary and that the independent directors will rotate the task of presiding over Executive Sessions.

 

Director Attendance at Meetings

 

During 2008, four (4) meetings of the Board of Directors were held. During 2008, each of the directors attended 100% of the Board meetings and all committee meetings on which he served as a member. The Company encourages directors to attend its annual meetings. All of our directors attended the 2008 Annual Meeting of Shareholders.

 

2008 Director Compensation

 

The directors who are not employees of the Company or any of its subsidiaries or affiliates received an annual retainer in 2008 of $30,000 paid in quarterly installments. In addition, the directors received $1,500 per Board meeting attended, members of the Audit Committee received $2,500 per meeting attended and members of the Compensation and Investment Committees received $1,500 per meeting attended. Mr. Cleberg was paid an additional annual retainer of $7,500 as chairperson of the Audit Committee in recognition of the workload involved

as Audit Committee chairperson. The Company determines director compensation taking the following factors into account: the amount of time involved in attending and preparing for Board and various Committee meetings, participation in special projects assigned by the Board, actual Committee and Board attendance, business expertise and various competitive factors.

 

At its October 23, 2008 meeting, the Board approved a change to the compensation plan for its directors who are not employees of the Company or any of its subsidiaries or affiliates. The new plan, which became effective as of January 1, 2009, provides for an increase to the annual retainer but such annual retainer now includes payment for the four (4) regularly scheduled board meetings and four (4) regularly scheduled meetings for each of the committees. The retainer beginning on January 1, 2009 is $45,000 if a Director serves on three (3) committees and $40,000 if the Director is a member of two (2) committees. If the Board and/or committee meets more than four times per year, the Director will be paid $1,500 for each additional meeting. In recognition of the additional responsibilities associated with serving as chair of a Board committee, the chairs of each committee will receive the following additional annual retainer beginning January 1, 2009: Audit Chair shall be paid $35,000 and the Investment and Compensation Chairs shall be paid $30,000.

 

The table shown below reflects the amount of cash compensation paid for service during 2008 for each non-employee, unaffiliated director. This table, however, does not include the fees for a special Audit Committee meeting held on December 18, 2008 since such fees were paid in 2009.

 

 

AUDIT COMMITTEE REPORT

 

The Audit Committee serves as an independent and objective party to:

 

 

In 2008, the Audit Committee (the “Committee”) was composed of three non-employee directors, each of whom is “independent” as required by applicable listing standards of the Exchange. Mr. Cleberg qualifies as an independent director as that term is used in Exchange Act Section 10A(m)(3) and qualifies as a financial expert. The Committee anonymously completed a self evaluation of its performance and discussed the responses at a February 4, 2009 committee meeting.

 

The Committee met ten (10) times in 2008. The meetings were designed, among other things, to facilitate and encourage communication among the Committee, management, the internal auditors and Deloitte & Touche LLP (“Deloitte & Touche”), the Company’s independent registered public accounting firm. The Committee discussed with the Company’s internal auditors and Deloitte & Touche the overall scope and plans for their respective audits. The Committee met with the internal auditors and the independent registered public accounting firm, with and without management present, to discuss the results of their examination and their evaluations of the Company’s internal controls and consolidated financial statements. The Committee reviewed the Company’s internal controls and, consistent with Section 302 of the Sarbanes-Oxley Act of 2002 and the rules adopted thereunder, met with

management, Deloitte & Touche and the Company’s internal auditors prior to the filing of officers’ certifications required by that statute to receive any information concerning (a) significant deficiencies in the design or operation of internal controls which could adversely affect the Company’s ability to record, process, summarize and report financial data and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Company’s internal controls. During fiscal year 2008, management continued its testing and evaluation of the adequacy of the Company’s system of internal control over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act of 2002 and related rules and regulations. The Committee also met separately with management and internal auditors to discuss the performance of Deloitte & Touche.

 

In the performance of its oversight function, the Committee has considered and discussed the audited financial statements with management and the independent registered public accounting firm. The Committee has also discussed with Deloitte & Touche the matters required to be discussed by the standard adopted or referenced by the Public Company Accounting Oversight Board (“PCAOB”) including the Statement on Auditing Standards No. 61, (Codification of Statements on Auditing Standards, AU380), Communication with Audit Committees, and SEC Rule 2-07 as currently in effect. Deloitte & Touche also had discussions with the Committee concerning the Corporate Governance Listing Standards of the Exchange. Finally, the Committee has received the written disclosures and the letter from the independent auditors required by PCAOB and/or Independence Standards Board Standard No. 1, Independence Discussions with Audit Committees, as currently in effect. The Committee has discussed with Deloitte & Touche their independence from the Company.

 

Based upon the reports and discussions described in this report, and subject to the limitations on the role and responsibilities of the Committee referred to above and in the Charter, the Committee recommended to the Board that the audited financial statements be included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008 filed with the SEC. Deloitte & Touche did not provide non-audit services to the Company in 2008.

 

SUBMITTED BY THE AUDIT COMMITTEE
OF THE COMPANY’S BOARD OF DIRECTORS

Philip H. Britt

Anthony S. Cleberg

Robert A. Tinstman

 

COMPENSATION DISCUSSION AND ANALYSIS

 

Objectives of Compensation Program

 

The Company’s philosophy is to provide a compensation package that attracts, motivates and retains quality executive talent. We aim to reward performance and hold executives accountable for underperformance through financial consequences. The compensation practice of the Company for its executive officers (including those named in the Summary Compensation Table (the Named Executive Officers, individually referred to as “NEO” and collectively referred to as “NEOs”)) is to pay base salaries, annual incentive bonuses, and long term incentives in addition to fringe benefits and other benefits that are competitive, internally consistent and recognize the accomplishment of the Company’s stated goals of building a financial services business focusing on surety, fidelity and related products. We seek to link executive compensation to the short and long term performance goals of the Company. As such, NEOs and other Company executives have a higher percentage of their total compensation weighted towards variable pay than other Company managers as they have greater opportunity to impact bottom line results.

 

For 2008, the Company’s Compensation Committee (the “Committee”) was composed entirely of independent directors. The Committee administers the Company’s executive compensation program, oversees the Company’s compensation and benefit plans and policies, administers our stock option program (including approving stock option grants to employees) and approves annually all compensation decisions relating to the Company’s NEOs. The Committee’s charter sets forth its general responsibilities and is available on the Company’s web site at www.cnasurety.com.

Setting Compensation — Benchmarking

 

The Process:  The CEO, the Company’s Chief Human Resources Officer and the Company’s non-executive Chairman of the Board make recommendations to the Committee on general compensation philosophy and specific elements of compensation and goals for the NEOs. Recommendations for the CEO’s compensation are made by the Company’s non-executive Chairman of the Board to the Committee.

 

Surveys Consulted:  The Company reviews a number of general business and property & casualty compensation surveys, including Mercer Property & Casualty Executive Survey, Mercer’s Benchmark database, Hewitt’s Total Compensation Measurement Survey and the Towers Perrin Financial Services Industry Executive Compensation Survey. The size of the companies that participate in the surveys range from $2 billion in assets to $25 billion in assets. The NEO positions are benchmarked against top executive and second level executive jobs. In benchmarking surveys where the scope is $20-25 billion, the 25^th percentile is used. CNA Surety is not a participant in any of the above named surveys.

 

The Company also participates in and utilizes an annual survey conducted by the Surety and Fidelity Association of America. Approximately 25 surety and fidelity companies of varying size participate in this survey. The positions benchmarked for NEO purposes are the Chief Underwriting Officer and Top Field Officer. Because no other participants of the survey are a public surety and fidelity company, the data is used only as a reference.

 

For each of the NEOs, the Committee considers each compensation element separately and then considers the NEO’s total compensation. The Committee reviews the salary surveys referenced above, as well as the NEO’s experience, individual professional performance and individual influence on the Company’s current financial results and long term strategies. The Committee also seeks internal equity in compensation and accordingly considers each NEO’s total compensation in reference to the compensation of the Company’s other officers. In setting compensation, the Committee also considers the amount of influence each NEO has on the Company’s overall business strategy as well as the abundance or scarcity of qualified candidates, if finding a replacement should become necessary.

 

The Company does not consult with an outside compensation consultant. The Committee reserves the right to consult with an outside compensation consultant but to date has not exercised that right.

 

The Committee discusses and approves any changes in compensation to the NEOs at its first regularly scheduled meeting of the year, which in 2008 was held in February. Any changes in base compensation are effective in April (when base salary increases for all of the Company’s employees occur). Also, at its first scheduled meeting of the year, the Committee evaluates the Company’s performance versus its goals and the performance versus goals of each NEO, and then approves all of the following variable compensation pay awards: Annual Cash Bonuses, Long Term Cash Incentives (“LTI”), stock option grants and performance contributions to the Company’s qualified retirement savings plan. The Committee also approves the aggregate amount of annual bonuses paid to all bonus eligible employees based on the achievement of certain net income targets set by the Committee. The 2008 targets and achievement are discussed below under the individual “Elements of Compensation” section of this proxy.

 

Adjustment of Awards

 

The Committee does not have, and has no current plans to have, a policy concerning retroactive adjustments to any cash or equity based incentive compensation if the payment of such compensation was based on financial performance measures that were subsequently affected by a restatement. However, to date, the Company has had no financial restatements that resulted in a reduction of financial performance.

 

Tax Considerations; Deductibility of Compensation

 

The Committee considers the impact of Internal Revenue Code (“IRC”) Sections 409A and 162(m) when determining forms and amounts of compensation. In 2005, the Company adopted a new non-qualified deferred compensation plan (“2005 Deferred Compensation Plan”) intended to permit participants to avoid tax penalties under IRC Section 409A. The 2005 Deferred Compensation Plan was amended in 2008 to comply with final regulations under IRC Section 409A. The 2005 Deferred Compensation Plan is more fully described in the “Deferred Compensation” section of this proxy statement. IRC Section 162(m) places a limit on the tax deduction

for compensation in excess of $1 million paid to certain executives. The Company does consider the deductibility of compensation when considering compensation for the CEO, and structures his annual cash bonus, as performance-based (with the discretion to decrease the award even if the goal is achieved), so as to retain the potential for a deduction. In addition, the CEO’s employment contract allows the Committee to defer the payment of compensation that would not be deductible by the Company under IRC Section 162(m) until the CEO’s separation from service. The compensation of the remaining NEOs will not exceed $1 million for 2008, thus compensation for the Company’s NEOs is expected to be deductible.

 

Elements of Compensation

 

The core elements of the NEOs’ compensation include base salary, benefits, perquisites, performance based annual incentive awards (cash bonus), long term cash based incentive awards and long term equity (stock options).

 

Base Salaries

 

Inasmuch as the surety business is a mature and small niche industry, the Committee believes that except for the CEO, more than fifty percent of cash compensation should be in the form of base salaries, rather than in incentive or variable pay. The division between base salaries and cash incentive compensation for both the CEO and the rest of the NEOs is similar to the division between cash incentive compensation and base salaries at many public and private insurers and sureties that compete with the Company for executive talent. The Committee uses the market data discussed in the “Setting Compensation-Benchmarking” section of this proxy, as well as the salary history and experience of the individual executive officer, when setting the base salary for new executive officers.

 

The base salaries of the NEOs and other officers are reviewed on an annual basis. The Committee granted modest base salary increases to some NEOs in 2008, but does not expect to grant increases in base salaries to the NEOs every year. Increases in base salary are based on an evaluation of the individual’s performance and level of pay compared to (where available) similarly situated jobs as shown in the survey data.

 

Broadly-Available Benefit Plans

 

Our NEOs participate in the same basic benefits package as all other Company employees. This includes a basic benefits package consisting of retirement, medical, dental, vision, paid time off, life insurance and accident insurance plans, and short and long term disability coverage, as well as flexible spending arrangements for health care, dependent care and transit expenses.

 

Perquisites

 

The Company made available to the NEOs in 2008 certain fringe benefits which include reimbursement for club memberships and financial counseling services. In addition, Mr. Welch was provided a physical examination in 2007 that was reimbursed in 2008.

 

Annual Cash Bonus

 

Annual cash bonuses are intended to reward eligible employees, including the NEOs, for Company and individual performance during the year. Annual cash bonuses, long term cash incentives, and stock option awards are made under the Company’s 2006 Long Term Equity Compensation Plan approved by shareholders in April 2006.

 

Annual Cash Bonuses: Bonus Eligible Employees and NEOs other than the CEO

 

Currently, the Committee annually establishes a bonus pool for all bonus eligible employees, except for the CEO, including the NEOs. The target pool is the aggregation of the target bonus amounts for all bonus eligible employees, except for the CEO. The target bonus amounts are set by the Committee as percentages of base salaries,

generally ranging from 7.5% of an employee’s base salary to 40% of an employee’s base salary. The 2008 annual cash bonus targets for each NEO was 40% of base salary, which for the following NEOs was:

 

John F. Corcoran, Chief Financial Officer, had a target bonus of 40% of his base salary of $250,000 or $100,000;

 

Doug W. Hinkle, Chief Underwriting Officer, had a target bonus of 40% of his base salary of $250,000 or $100,000;

 

Michael A. Dougherty, Senior Vice President and Chief Information Officer, had a target bonus 40% of his base salary of $231,000 or $92,400; and

 

Thomas A. Pottle, Senior Vice President Credit and Field Operations, had a target bonus 40% of his base salary of $211,150 or $84,460.

 

Availability of the target bonus pool is dependent on achievement of a Net Operating Income (“NOI”) target, which for 2008 the Committee set at $100.8 million. If a minimum NOI is not met, then there is no annual bonus pool. However, the Committee may, in its discretion, establish a bonus pool of up to 25% of the target bonus pool that it may use to pay certain employees, including the NEOs. The Committee also reserves discretion to adjust the bonus pool up or down, if results were affected by unusual events that in the Committee’s determination were beyond management’s control. Once the pool is established, the CEO makes bonus recommendations for each NEO based on performance against established performance objectives. The Committee retains the power to exercise negative discretion with respect to each NEO even if the Company achieves a NOI target. Likewise, the Committee retains the discretion to award a cash bonus in excess of the target award established for any NEO as long as the aggregate of all cash bonuses awarded to all bonus eligible employees in the pool does not exceed the target pool.

 

The size of the bonus pool is dependent on achievement of NOI. For 2008, the threshold, target and maximums were set as follows:

 

 

For 2008, the Company’s NOI was $111.3 million. The Committee voted at its February 4, 2009 meeting that the 2008 annual cash bonus pool would be 150% of the target bonuses.

 

Annual Cash Bonus — CEO

 

John Welch, the Company’s CEO, is not included in the annual cash target bonus pool established by the Committee. The Committee believes that it is appropriate that the CEO’s incentive compensation, including the annual target bonus and maximum annual bonus potential be larger than the other NEOs. Mr. Welch’s annual bonus parameters are determined by his employment contract and by the yearly NOI goal set by the Committee. Based upon his employment contract, Mr. Welch has a target of 100% of his base salary of $435,000. At its February 6, 2008 meeting, the Committee established a maximum for Mr. Welch’s annual bonus of 1.25% of the Company’s actual NOI. However, the Committee retained discretion to reduce the amount of his annual bonus based upon its evaluation of his performance. The Company’s actual NOI for 2008 was $111.3 million. After evaluating his performance at its February 4, 2009 meeting, the Committee voted to pay Mr. Welch an annual cash bonus of $870,000, or 200% of his base salary, which is the maximum target.

The 2008 annual cash bonus targets and awards for each NEO, including the CEO, were:

 

 

Long Term Incentives

 

Long Term Cash Incentives

 

LTI is designed to promote executive continuity through three year performance measures and payouts, helping motivate executives to meet the Company’s long term performance objectives. Each year the Compensation Committee approves an annual ROE target. ROE, for the purposes of the LTI, is operating return on equity based upon the equity at the beginning of the calendar year adjusted to exclude effects of any unrealized gains and losses. The Committee does not use individual performance measures for LTI. All NEOs have a target LTI bonus of 20% of their base salary, except Mr. Welch. Pursuant to his employment contract, Mr. Welch has an LTI target bonus of 50% of his base salary or $217,500 for 2008. As with all variable compensation, the Committee believes that the CEO has the ultimate responsibility for the Company’s results and believes a greater amount of his compensation should be variable and dependent upon the Company’s financial results.

 

At its February 6, 2008 meeting, the Committee set the following ROE targets for 2008:

 

 

For achievement between the threshold and target LTI and between target and maximum, the Committee has the discretion to determine the exact LTI payout percentage. In addition, the Committee reserves the discretion to adjust LTI payments based on events beyond the NEO’s control, including but not limited to the impact of prior year’s reserve developments. The Company’s ROE for 2008, as defined for the LTI plan, was 16.9%. Accordingly, the NEO’s were eligible for payment of 180% of target.

 

If the LTI year goals are achieved, one third of the payment attributable to that LTI calendar year will be paid out each year for the following three years beginning with the first payment made in March of the year immediately following the LTI year in which the goal was achieved. Each March, any LTI payment potentially consists of portions of awards from three LTI years. Thus, the LTI payments made on March 13, 2009 represented payments for performance in three years: 2006, 2007 and 2008 (1/3 of the award for each year). The NEO must be actively employed on the payment date to receive an LTI payment for the calendar year. Pursuant to the terms of his employment agreement, if Mr. Welch’s employment is terminated by the Company without cause or if he terminates his employment for good reason, he will be entitled to an LTI payment for the calendar year in which his employment is terminated based on actual performance and prorated for the period of service through his

termination date. The chart below shows outstanding LTI award payments to NEOs which have not yet been made as of December 31, 2008.

 

Outstanding LTI Installment Payments Due NEOs as of 12/31/2008

 

 

Stock Options

 

Equity-based long term incentive awards serve to align the interests of executives with those of the Company’s shareholders because both shareholders and executives benefit from any appreciation in the Company’s stock price. The Committee grants stock options as part of total compensation to executive officers, officers and certain other employees. As a general practice, each year the Committee has granted the NEOs, with the exception of the CEO, stock options equal to approximately 20% of their base salaries based on a Black-Scholes valuation. Pursuant to his employment contract, the Committee has granted the CEO stock options equal to approximately 50% of his annual base salary based on a Black-Scholes valuation. The Committee approves all grants of stock options.

 

The Committee decides and approves stock option grants at its first regularly scheduled meeting of each year in order to coincide with the awards of other variable compensation.

 

At its February 4, 2009 meeting, the Committee voted to grant the NEOs the following stock options with an exercise price equal to the closing stock price on February 6, 2009:

 

 

The Committee’s policy is to make no grants of stock options during the year other than those made at its first regularly scheduled meeting, except for stock option grants to certain newly hired senior executives. In the past, the

Committee approved such grants with a price of the closing price of the Company’s stock on the executive’s first day of employment or at the closing price of the Company’s stock on the date of the Company’s regularly scheduled Compensation Committee meeting. The Committee approved such grants either at a regularly scheduled meeting, through a telephonic meeting or through written consent in lieu of a meeting. The Committee, upon the recommendation of management, may, in the future, grant stock options to certain new executives. The Committee’s current intention is to grant any such options at the Committee’s first regularly scheduled meeting after commencement of such executive’s employment priced at the closing price of the Company’s stock on the day of the grant.

 

Stock Ownership Requirements

 

The Company does not have formal share ownership guidelines or requirements for any executive, employee or director.

 

CNA Surety Corporation 401(k) Plan

 

The CNA Surety Corporation 401(k) plan is a funded, tax-qualified retirement savings plan. Participating employees may contribute up to 20% of compensation on a before tax basis into the plan, subject to a maximum of $15,500 in 2008 ($20,500 for employees over age 50). In addition, the Company matches an amount equal to one dollar for each dollar contributed by participating employees on the first 3% of their eligible compensation and fifty cents for each additional dollar contributed on the next 3% of their eligible compensation. Eligible compensation (salary) does not include bonuses or other contingent compensation. In addition, eligible compensation for 2008 was capped at $230,000.

 

The Company also makes contributions to the 401(k) plan called the “Basic Contribution” for all employees, including the NEOs, equal to 3% of eligible compensation (5% for employees over age 45).

 

In addition, the Compensation Committee annually establishes Company-wide performance targets which, if met, result in an additional Company contribution called the “Performance Contribution.” This Performance Contribution is made to employee 401(k) accounts of each eligible participant and may range from 0% to 2% of the participant’s eligible compensation. Based on the Company’s 2008 performance, at its February 4, 2009 meeting, the Committee approved a Performance Contribution equal to 2% of salary to participants’ accounts.

 

Deferred Compensation

 

The NEOs and certain other officers may participate in the Company’s 2005 Deferred Compensation Plan. Refer to the “Tax Considerations; Deductibility of Compensation” section of this proxy for additional information concerning this plan. The plan allows eligible officers to defer receiving up to 20% of their compensation. The amount that the Company may contribute to the NEOs’ 401(k) accounts for the matching funds, Basic Contribution and the Performance Contribution is limited by federal legislation. The 2005 Deferred Compensation Plan also allows participants to receive non-qualified Company contributions to their deferred compensation accounts in amounts equal to the difference between the amounts of these Company contributions that actually were allocated to the participant’s 401(k) plan account and the amounts that the participant would have received in the absence of legislation limiting such additions to the participant’s 401(k) plan account. Participation in the 2005 Deferred Compensation Plan is not automatic. The Compensation Committee must affirmatively vote that an executive be allowed to participate in the plan and the executive must execute a deferral agreement prior to participating in the plan. Once the executive executes a deferral agreement, the executive may not change or cease participation in the plan or change the deferral amounts during the plan year. Each December, plan participants may change the amount deferred or cease participation in the plan for the following year.

 

All funds in the 2005 Deferred Compensation Plan are general assets of the Company. However, the Company has funded grantor trusts established to make payments under the 2005 Deferred Compensation Plan. The assets of these trusts are available to the Company’s general creditors. These trusts invest in the same mutual funds as are available through the 401(k) plan as chosen by the executives and consequently the returns are not considered “above market” returns. Participants in the plan will receive the funds in their deferred compensation account six months after their termination of employment from the Company.

Change-In-Control and Termination Benefits that would have been Payable As of December 31, 2008

 

Stock options are governed by the CNA Surety Corporation’s 2006 Long Term Equity Compensation Plan which does not have an express change-in-control provision. In the event of a change-in-control, any changes to stock options would be decided by and administered by the Compensation Committee.

 

 

 

 

Employment Agreements

 

We amended Mr. Welch’s employment agreement effective January 1, 2009 and extended the term of his agreement until December 31, 2011. This amended agreement was authorized by the Committee. Under the terms of the amended agreement, Mr. Welch is entitled to a severance benefit if his employment is terminated by the Company without cause or by Mr. Welch for good reason contingent upon Mr. Welch’s execution of a general release and his continuing compliance with the non-competition, non-solicitation and confidentiality provisions of the agreement. The severance benefit for termination for good reason by Mr. Welch or without cause by the Company consists of an amount equal to Mr. Welch’s then base salary, the target bonus for the annual cash bonus, long term cash bonus payments at target all prorated through the end of the contract term, December 31, 2011, but in no event less than twelve months. These severance payments would be paid in equal monthly installments. In addition, Mr. Welch would receive a prorated annual bonus and prorated LTI payment based on actual performance for the year in which Mr. Welch terminates his employment for good reason or the Company terminates his employment without cause. These payments would be made at the same time that the annual bonus and LTI payments are made to active employees. Mr. Welch also would be eligible to continue to participate in the Company’s health benefit plan for the period of severance running concurrently with any benefit eligibility under COBRA. In addition, if the Company fails to extend Mr. Welch’s employment agreement, then Mr. Welch’s employment will terminate on April 12, 2012 and he would receive severance benefits consisting of (i) payment of one year of Mr. Welch’s then annual base salary, one year target annual cash bonus, and target long term cash bonus

payable in twelve monthly installments, (ii) continuation in the Company’s health benefit plan for the period of severance running concurrently with any benefit eligibility under COBRA, and (iii) a prorated annual bonus and LTI payment (based on actual performance) for the year in which his employment is terminated payable when annual bonus and LTI payments are made to active employees. To the extent that any portion of Mr. Welch’s severance benefit constitutes deferred compensation for purposes of IRC Section 409A, the payment of such portion of his severance benefit will be delayed until six months after his separation from service. The termination benefit for Mr. Welch as of December 31, 2008 was $1,085,000 and based on his January 2006 through December 2008 contract which was in effect as of December 31, 2008.

 

Compensation Committee Interlocks and Insider Participation

 

The Compensation Committee met five (5) times in 2008. In 2008, the Company’s Compensation Committee was composed entirely of independent directors and none had any relationship requiring disclosure by the Company under the “Certain Relationships and Related Transactions” section of this proxy statement. The Board adopted a Compensation Committee Charter which governs the Compensation Committee and is available on the Company website at www.cnasurety.com and will be provided to any shareholder upon request by contacting Gail Carey, representative of the Company, at 333 S. Wabash Ave., 41st Floor, Chicago, Illinois 60604, (312) 822-5199.

 

COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION

 

The Committee reviewed and discussed the Compensation Discussion and Analysis set forth above with the management of the Company, and, based on such review and discussion, recommended to the Board that the Compensation Discussion and Analysis be included in this Proxy Statement.

 

SUBMITTED BY THE COMPENSATION COMMITTEE
OF THE COMPANY’S BOARD OF DIRECTORS

 

Philip H. Britt
Anthony S. Cleberg
Robert A. Tinstman

 

EXECUTIVE COMPENSATION

 

The following tables show information with respect to the annual compensation (including option grants) for services rendered to the Company (or its predecessors) for the years ended December 31, 2008, December 31, 2007 and December 31, 2006 by the Chief Executive Officer, the Chief Financial Officer and those persons who were, at December 31, 2008, the three other most highly compensated executive officers of the Company.

 

Summary Compensation Table

 

 

 

 

The following table describes each component of the All Other Compensation column in the Summary Compensation table for the year ended December 31, 2008.

 

All Other Compensation Table

 

 

 

 

Grants of Plan-Based Awards Table

 

 

 

 

Outstanding Equity Awards at FYE Table

 

The Equity Awards of the NEOs outstanding at December 31, 2008 are shown in the table below:

 

 

For each grant, 25% of the shares vest annually one year from the grant date, and then an additional 25% vests annually for the next three years. For example, for the 11/11/2003 grant date, 25% of the shares granted vest on 11/11/2004, 25% on 11/11/2005, 25% on 11/11/2006 and 25% on 11/11/2007. The 11/11/2003 grant date for Mr. Corcoran includes two separate grants: one grant for his commencement as a newly hired executive; and a second grant as a prorated percentage of the stock grants made that date to senior executives. Stock options are governed by the CNA Surety Corporation 2006 Long Term Equity Compensation Plan which does not have an express change in control provision. In the event of a change in control, any changes to stock options would be decided by and administered by the Compensation Committee.

The following table provides additional information about the value realized by the NEOs on stock option exercises and stock awards vesting during the year ended December 31, 2008.

 

Option Exercises and Stock Vesting Table

 

 

The value realized by a NEO upon the exercise of an option is determined by multiplying the number of options exercised by the difference between the fair market value on the date of exercise and the exercise price.

 

The following table provides information on contributions, earnings and account balances for the NEOs in the Company’s 2005 Deferred Compensation Plan and the 2000 Deferred Compensation Plan.

 

Non-Qualified Deferred Compensation