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 28, 2011

 

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 28, 2011, at 9:00 A.M. CDT, for the following purposes:

 

1. To elect seven directors;

 

 

Shareholders of record at the close of business on March 8, 2011 are entitled to notice of and to vote at the Company’s Annual Meeting or any adjournment thereof.

 

By Order of the Board of Directors

 

Rosemary Quinn
Senior Vice President, General Counsel and Secretary

 

March 14, 2011

Chicago, Illinois

 

IMPORTANT:

 

PLEASE VOTE AS PROMPTLY AS POSSIBLE BY USING THE INTERNET OR TELEPHONE, OR BY SIGNING, DATING, AND RETURNING THE PROXY CARD INCLUDED WITH THIS NOTICE.

 

Important Notice Regarding the Availability of Proxy Materials for the Shareholder Meeting to be held on April 28, 2011. The Proxy Statement and the 2010 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 provided to you on or about March 14, 2011 in connection with the solicitation by our Board of Directors of proxies to be voted at our Annual Meeting of Shareholders (the “Annual Meeting”) which will be held on Thursday, April 28, 2011 at our business offices located at 333 S. Wabash Ave., 41st Floor, Chicago, Illinois 60604, at 9:00 A.M. CDT. Please note that throughout this Proxy Statement we refer to CNA Surety Corporation as the “Company,” “we,” “us,” and “our.”

 

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 14, 2011.

 

VOTING SECURITIES AND PROXIES

 

Only shareholders of record at the close of business on March 8, 2011 (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, 44,850,470 shares of the Company’s Common Stock (“Common Stock”) were issued and outstanding. Each outstanding share is entitled to one vote upon each matter to be voted upon at the Annual Meeting. The shareholders of a majority of the Company’s Common Stock, present in person or represented by proxy, shall constitute a quorum at the Annual Meeting.

 

In accordance with applicable law, the affirmative vote of shares representing a majority of our Common Stock present and entitled to vote is required to approve any proposal, other than the election of directors, to be voted on at this Annual Meeting. Directors shall be elected by a plurality of the votes of the shares of our Common Stock present in person or represented by proxy at the Annual Meeting and entitled to vote on the election of directors. 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. However, shares that are voted to abstain with respect to any matter and broker non-votes will not be counted and will have no effect on the outcome of the voting for any matters to be considered at the Annual Meeting. If a quorum is not present, the Annual Meeting will reconvene at such time as a quorum is present or

represented 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.

 

All properly executed proxies received by us prior to the Annual Meeting will be voted at the meeting. You may revoke your proxy at any time before it is exercised at the Annual Meeting by granting a proxy bearing a later date that is duly received by the Company or by voting in person. The mere presence at the Annual Meeting of a shareholder who appointed a proxy does not itself revoke the appointment. If a proxy 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 in accordance with the Board of Directors’ recommendations. Whether or not you plan to attend the meeting, you may submit a proxy to vote your shares by internet, telephone, or mail as described below:

 

 

ELECTION OF DIRECTORS
(PROPOSAL 1)

 

Our Board of Directors has fixed the number of directors constituting the full Board at seven. Accordingly, 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 each nominee, see the “Directors and Executive Officers of the Registrant” section of this Proxy Statement.

 

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 F. 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 has been given or indicated, for the election of the nominees named above. Our Board has no reason to believe that any of the nominees will be unwilling or unable to serve as a director. However, if prior to the election of directors any of the nominees named above 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.

 

THE BOARD RECOMMENDS A VOTE IN FAVOR OF THE 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 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 64; Director of the Company since 1998; Retired; Senior Vice President Insurance Industry Division of Bank One, NA (formerly First Chicago NBD) from 1988 through 2002.

 

With his experience at Bank One, NA, Mr. Britt brings valuable insight into the Company’s investment management strategy which is a key part of the Company’s overall strategy. In particular, Mr. Britt understands the investment considerations that are unique to the surety and insurance business and has the skills necessary to lead our Investment Committee.

 

Anthony S. Cleberg, age 58; Director of the Company since 2007; Chief Financial Officer (“CFO”) and Executive Vice President of Black Hills Corp. since 2008; Independent Consultant and Investor from 2002 to 2008.

 

As CFO of Black Hills Corp. and his prior service at Champion Enterprises as CFO from 2000 to 2002, Mr. Cleberg has experience dealing with accounting principles, financial reporting rules and regulations, evaluating financial results, and overseeing the financial reporting process of a publicly-traded corporation. His knowledge and experience positions him well to serve as the Chair of our Audit Committee.

 

John F. Corcoran, age 46; Senior Vice President and CFO of the Company since 2004.

 

Michael A. Dougherty, age 52; Senior Vice President and Chief Information Officer of the Company since 2007; Senior Vice President Field Operations and Distribution from 2001 until 2007.

 

David B. Edelson, age 51; Director of the Company since 2007 and Chairman since 2009; Since 2005, Senior Vice President of Loews Corporation (“Loews”), the parent corporation of CNA Financial Corporation (“CNAF”) (that, through its insurance subsidiaries, owns 61.29% of the Company’s stock as of December 31, 2010); Executive Vice President and Corporate Treasurer of JPMorgan Chase & Co. from 2003 until 2005. Mr. Edelson joined the Board of Directors of AutoNation, Inc. in 2008 and is also a member of its Audit Committee.

 

With his years of experience at JPMorgan Chase & Co. and Loews, Mr. Edelson has demonstrated leadership capability and extensive knowledge of complex financial and operational issues facing large organizations. His understanding of financial strategy and the elements relevant to be a successful publicly-traded company provide him the skills necessary to serve as the Chairman of our Board of Directors.

 

Douglas W. Hinkle, age 58; Senior Vice President and Chief Underwriting Officer of the Company since 2004.

 

D. Craig Mense, age 59; Director of the Company since 2007; Executive Vice President and CFO of CNAF since 2004.

 

Mr. Mense possesses both financial and operational knowledge of the insurance and surety industries through his current CFO responsibilities at CNAF and his prior experience at the executive level in certain insurance and surety operations of Travelers Property Casualty Corporation.

 

Rosemary Quinn, age 56; Senior Vice President, General Counsel and Secretary of the Company since 2008; Assistant Vice President and Assistant General Counsel of the Company from 2006 through 2008; General Counsel of GeoVera Insurance Company from 2005 through 2006; Assistant Vice President of St. Paul Travelers’ Bond Department from 2004 through 2005.

 

Robert A. Tinstman, age 64; Director of the Company since 2004; Member of the Board of Directors of Primoris Services Corporation since 2009; Member of the Board of Directors of Home Federal Bancorp Inc. and Chairman of its Audit Committee since 1999. He also 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 was Executive Chairman of Angelo Iafrate Construction Company and James Construction Group from 2002 to 2007.

 

Mr. Tinstman has extensive knowledge of the financial and operational issues facing the types of construction firms that are bonded by our Company based on his positions at Angelo Iafrate Construction Company and James Construction Group as well as prior executive positions in the construction industry. Also, his leadership role on other boards of directors gives Mr. Tinstman a deep understanding of the role of the Board of Directors and provides him the skills to serve as the Chair of our Compensation Committee.

 

John F. Welch, age 54; Director, President, and Chief Executive Officer (“CEO”) of the Company since 2003.

 

In addition to his experience as our CEO and President, Mr. Welch was previously the Chief Underwriting Officer of the surety operations of the St. Paul Companies from 2002 until 2003 and the President of Afianzadora Insurgentes SA CA located in Mexico City, Mexico from 2000 to 2002. His experience has provided him a deep knowledge of the surety industry, which includes the financial, operational, and regulatory aspects of the business. This breadth of exposure to the surety business positions him well to serve on our Board of Directors.

 

Peter W. Wilson, age 51; Director of the Company since 2009; President and Chief Operating Officer of U.S. Specialty Operations of CNAF’s insurance operations since 2009; Executive Vice President, Global Specialty Lines of the insurance subsidiaries of CNAF from 2001 until 2009.

 

Mr. Wilson brings an understanding of the operational, marketing, financial, and regulatory issues facing the insurance industry, which includes surety. He also served as the Company’s Board Chairman from 2001 through 2003. His demonstrated leadership capability and knowledge of the Company’s business provide him the skills to serve on our Board of Directors.

 

CORPORATE GOVERNANCE

 

Director Independence

 

As provided by the listing standards of the New York Stock Exchange (“Exchange” or “NYSE”), the Company is a “Controlled Company” because more than 50% of the voting shares of the Company are held by the insurance subsidiaries of CNAF. Because the Company is a controlled company, it is exempt from the Exchange’s requirements relating to maintenance of a majority of independent directors. Nevertheless, our Board of Directors has determined that the following directors are independent under the NYSE’s listing standards (each, an “Independent Director” and collectively, the “Independent Directors”): Philip H. Britt, Anthony S. Cleberg, and Robert A. Tinstman.

 

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 Guidelines and Code of Business Conduct and Ethics

 

The Board has adopted Corporate Governance Guidelines that outline the responsibilities and operation of the Board to help ensure that the effectiveness of policy and decision making of the Board management are aligned with the interests of the Company’s shareholders. The Company also has a Code of Business Conduct and Ethics that applies to all employees, officers, and directors of the Company and its wholly-owned subsidiaries, including, but not limited to, our executive officers, principal financial officer, and principal accounting officer.

 

Copies of the Corporate Governance Guidelines and the Code of Business Conduct and Ethics are available on our website at www.cnasurety.com and will be provided to any shareholder at no charge upon request to Adrianne T. Baker, representative of the Company, at 333 S. Wabash Ave., 41st Floor, Chicago, Illinois 60604, (312) 822-4971.

 

Board Nomination Process

 

Our Board of Directors does not have a Nominating Committee. Under the rules of the NYSE, companies like us that have a controlling shareholder are not required to have a Nominating Committee. Our Board of Directors, as a whole, performs the functions of a Nominating Committee. 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. The Board seeks to create a Board that has a diversity of skills and experience with respect to knowledge of the construction industry, surety and insurance markets, finance and accounting, investment management, and corporate governance. The unique skills and experience that each nominee brings to the Board of Directors is described earlier in this Proxy Statement in the “Directors and Executive Officers of the Registrant” section.

 

Board Leadership Structure

 

The positions of Chairman of the Board and Chief Executive Officer are held by separate people. This is due in part to the fact that the Company has a controlling shareholder. Our current Chairman is an executive officer of Loews which is the controlling shareholder of CNAF. Our Board believes this structure provides a balance of different perspectives which fosters discussion during Board meetings. Also, the Chairman serves as the liaison between the Board and the Company’s senior management which is beneficial when determining agenda and providing information for the Board meetings.

 

Risk Oversight

 

Our Board oversees an enterprise approach to risk management that is intended to support the operational and strategic objectives of the Company. The President reports to and seeks the involvement of the full Board in setting the Company’s business goals and objectives. Through this process, the Board and senior management assess the appropriate level of business risk for the Company. The entire Board receives reports at each meeting from the President and his executive team on the primary areas of risk which include financial risk, investment risk, legal/compliance risk, and operations/strategic risk. The Company also reports to the full Board each quarter on the credit risk of the Company’s portfolio of bond customers.

While the Board has ultimate oversight responsibility, the various committees of the Board also have responsibility for risk management. In particular, the Audit Committee receives reports at each of its regularly scheduled meetings from the Company’s CFO and the Company’s external auditor on financial risk and compliance with reporting requirements, including internal controls. The Audit Committee also receives reports at each quarterly meeting from the Company’s internal auditors.

 

In addition to setting compensation for the Company’s executive team, the Compensation Committee provides guidance on the creation of Company-wide bonus programs that encourage employee risk-taking consistent with the Company’s business strategy. The Investment Committee sets the strategy for the Company’s investment portfolio and meets with the Company’s investment adviser at each meeting to review the performance of the portfolio. In addition to reviewing and approving the investment transactions each quarter, the Investment Committee considers whether the level of market risk in the investment portfolio is consistent with the Company’s business strategy and whether modifications may be appropriate.

 

BOARD OF DIRECTORS AND BOARD COMMITTEES

 

General

 

Our business is managed under the direction of the Board of Directors, which is currently comprised of seven members. The Board of Directors and the Audit Committee annually review their performance. The Audit Committee and Board of Directors discussed their anonymous self-evaluations at their respective meetings on February 2, 2011. The self-evaluations of both the Audit Committee and the Board of Directors indicated that they are functioning well and receive adequate access to and information from Company management.

 

Committees of the Board

 

The Board has an Executive Committee, an Audit Committee, a Compensation Committee, and an Investment Committee. As discussed under the “Board Nomination Process” section of this Proxy Statement, the Company does not have a nominating/corporate governance committee. Our Audit Committee and Compensation Committee have written charters which can be found on our website at www.cnasurety.com and are available in print to any shareholder who requests a copy by writing to our Corporate Secretary.

 

Executive Committee. The Executive Committee is authorized to act on behalf of the full Board in the management and business affairs of the Company during 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. The Executive Committee did not meet during 2010. The members of the Executive Committee are David B. Edelson, Robert A. Tinstman, and John F. Welch.

 

Audit Committee. The Audit Committee’s primary function is to assist the Board in fulfilling its responsibility to monitor the Company’s financial reporting process and internal control system, the qualifications and independence of our independent auditors, the performance of our internal auditors and independent auditors, and our compliance with legal and regulatory requirements. Our Audit Committee has sole authority to retain, compensate, and evaluate the Company’s independent registered public accounting firm, and the scope of and fees for their audits. The Audit Committee also establishes the policy and procedures for the review and approval of related party agreements and arrangements between the Company and its affiliates.

 

The current members of the Audit Committee are Anthony S. Cleberg (Chairman), Philip H. Britt, and Robert A. Tinstman, each of whom is “independent” under SEC rules and NYSE listing standards applicable to audit committee members. The Board has determined that each of the Audit Committee members is financially literate and that Mr. Cleberg is an “audit committee financial expert” under the Exchange and SEC standards. The Audit Committee held eight meetings during 2010. The Audit Committee members are annually asked the number of audit committees on which they serve and no director reported serving on more than two audit committees during 2010.

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 most highly compensated executive officers. In addition, it reviews and approves the availability of equity grants to all other eligible Company employees. The current members of the Company’s Compensation Committee are Robert A. Tinstman (Chairman), Philip H. Britt, and Anthony S. Cleberg. During 2010, the Compensation Committee held seven 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 Philip H. Britt (Chairman), David B. Edelson, and John F. Welch. During 2010, the Investment Committee held four 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

 

The Board of Directors met six times during 2010. Each of the directors attended not less than 75% of all Board meetings and all meetings of all committees on which he served as a member. All of our directors also attended the 2010 Annual Meeting of Shareholders.

 

COMPENSATION OF INDEPENDENT DIRECTORS

 

Our independent directors, who are not employees of the Company or any of its affiliates or subsidiaries, receive an annual retainer of $45,000 if the director serves on three committees or $40,000 if the director serves on two committees. This arrangement compensates the independent directors for four Board meetings per year, each committee meeting four times per year, plus up to four additional meetings per year by either the Board or committees. If the number of Board and/or committee meetings exceeds the number covered by this compensation structure, the director will be paid $1,500 for each additional meeting. This additional meeting fee also applies to any seminars that the independent directors may attend at the request of the Company. In recognition of the additional responsibilities associated with serving as chair of a Board committee, the chairs of each committee receive the following additional annual retainer: Audit Chair receives $35,000 and the Investment and Compensation Chairs each receive $30,000. In addition to the compensation described above, each of the independent directors was compensated for their services in connection with the Special Committee. The definition and purpose of the Special Committee is found on page 23 of this Proxy Statement under the heading “CNAF Proposal.” Messrs. Cleberg and Tinstman were each paid a fee of $100,000 and Mr. Britt, as chairman of the Special Committee, was paid a fee of $120,000.

 

The table shown below reflects the compensation paid to our independent directors for the year ended December 31, 2010. This table includes fees earned in 2010 but paid in 2011 for additional meetings and seminars that were subject to the director payment arrangements described above.

 

AUDIT COMMITTEE REPORT

 

As discussed above under the heading “Committees of the Board — Audit Committee” and more fully described in its charter, the Audit Committee’s primary responsibility is the oversight of the Company’s financial reporting process and management of its relationship with the independent auditors. Management has day-to-day responsibility for the Company’s financial reporting process, including assuring that the Company develops and maintains adequate financial controls and procedures and monitoring and assessing compliance with those controls and procedures, including internal control over financial reporting. The Company’s independent auditors are responsible for auditing the annual financial statements prepared by management, expressing an opinion as to whether those financial statements fairly present the financial position of the Company in conformity with accounting principles generally accepted in the United States (“generally accepted accounting principles”) and discussing with the Audit Committee any issues they believe should be raised. The independent auditors are also responsible to the Audit Committee and the Board for testing the integrity of the financial accounting and reporting control systems, for issuing a report on the Company’s internal control over financial reporting, and for such other matters as the Audit Committee and Board determine. At its October 20, 2010 meeting, the Audit Committee also agreed to be designated as the independent audit committee for each of the Company’s three insurance company subsidiaries, Western Surety Company, Surety Bonding Company of America, and Universal Surety of America, consistent with the requirements of the South Dakota insurance laws and the National Association of Insurance Commissioner’s Model Audit Rule on financial reporting. The independent auditors did not provide non-audit services to the Company in 2010.

 

In the performance of its oversight function, the Audit Committee has reviewed and discussed the audited financial statements with management and the Company’s independent registered public accounting firm. The Audit Committee has also discussed with the independent auditors 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. 114, (Codification of Statements on Auditing Standards, AU380), Communication with Audit Committees, and SEC Rule 2-07 as currently in effect. The independent auditors also had discussions with the Audit Committee concerning the Corporate Governance Listing Standards of the Exchange. The Audit Committee has received the written disclosures and the letter from our independent auditors as required by PCAOB Ethics and Independence Rule 3526, Communication with Audit Committees Concerning Independence, and has discussed with Deloitte & Touche LLP its independence from the Company.

 

The members of the Audit Committee rely, without independent verification, on the information provided to them by management and the independent registered public accounting firm and on management’s representation that our financial statements have been prepared with integrity and objectivity. The Audit Committee members do not provide any expert or special assurance as to our financial statements or any professional certification as to the independent registered public accounting firm’s work. Accordingly, our Audit Committee’s oversight does not provide an independent basis to determine that management has applied appropriate accounting and financial reporting principles or internal controls and procedures, that the audit of our financial statements has been carried out in accordance with the standards of the PCAOB, that our financial statements are presented in accordance with generally accepted accounting principles, or that our independent registered public accounting firm is in fact “independent.”

 

Based upon the reports and discussions described in this report, and subject to the limitations on the role and responsibilities of the Audit Committee referred to above, the Audit 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, 2010 filed with the SEC.

SUBMITTED BY THE AUDIT COMMITTEE
OF THE COMPANY’S BOARD OF DIRECTORS
Anthony S. Cleberg
Philip H. Britt
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 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 2010, the Company’s Compensation Committee (the “Compensation Committee”) was composed entirely of independent directors. The Compensation Committee administers the Company’s executive compensation program, oversees the Company’s compensation and benefit plans and policies, administers our Long Term Incentive Plan (including approving equity grants to employees), and approves annually all compensation decisions relating to the Company’s NEOs. The Compensation Committee’s charter sets forth its general responsibilities and is available on the Company’s website at www.cnasurety.com.

 

Setting Compensation — Benchmarking

 

The Process: The CEO, the Company’s Chief Human Resources Officer, and the Company’s 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 Chairman of the Board to the Committee.

 

Surveys Consulted: The Company reviews a number of general business and property and casualty compensation surveys. We are in a unique business situation in that we are the only publicly-held surety company. All of the Company’s competitors are either privately-held or are business units of a larger publicly-held insurance company. Thus, there are no direct competitors who have CEOs and an executive team with public company responsibilities. Because there are no comparable publicly-held companies to use for benchmarking purposes, the Company utilizes data collected from an industry survey and broader property and casualty and financial industry surveys. Those surveys are discussed in more detail below.

 

Surety & Fidelity Association of America Salary Survey: This survey is conducted annually and includes approximately 25 surety and fidelity organizations. The positions and data that we use for benchmarking NEO positions include Top/Chief Bonding Officer, Top Underwriting Officer, and Top Field Management Officer. In regards to this survey, we look at the range of 50^th to 75^th percentile taking into consideration the size of the Company’s surety writings compared to other surety operations reflected in the survey.

 

P&C/Financial Surveys: As noted above, the Compensation Committee reviews several surveys conducted by consulting companies for the property and casualty and financial industries. There are a wide range of companies and thus we determine an appropriate benchmark based on the premium size of the companies that participate in each survey. For the surveys that include companies with less than $2 billion of direct written premium, we use the 50th percentile. For surveys that include companies with less than $25 billion of assets, we discount the midpoint.

We consider this data for the Top Underwriting Executive, Chief Financial Officer, Chief Information Officer, Top Field Operations Executive, and the Top Legal Executive positions.

 

For each of the NEOs, the Compensation Committee considers each compensation element separately and then considers the NEO’s total compensation. The Compensation 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 Compensation Committee also considers 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 Compensation 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 Compensation Committee discusses and approves any changes in compensation to the NEOs at its first regularly scheduled meeting of the year, which in 2010 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 Compensation Committee evaluates the Company’s performance versus its goals and the performance of each NEO, and then approves all of the following variable compensation pay awards: Annual Cash Bonuses, Long Term Cash Incentives, and equity grants. The Compensation 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 Compensation Committee. The 2010 targets and achievement are discussed below under the individual “Elements of Compensation” section of this Proxy Statement.

 

Adjustment of Awards

 

The Compensation 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 statement restatements that resulted in a reduction of financial performance.

 

Tax Considerations — Deductibility of Compensation

 

The Compensation 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 nonqualified deferred compensation plan (“2005 Deferred Compensation Plan” or the “Plan”) intended to permit participants to avoid tax penalties under IRC Section 409A. The 2005 Deferred Compensation Plan was amended in 2009 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 Compensation 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 2010, thus compensation for the Company’s NEOs is expected to be deductible.

 

Elements of Compensation

 

The core elements of the NEOs’ compensation, which are discussed below, include base salary, benefits, performance-based annual cash incentive awards, long term cash based incentive awards, and long term equity.

 

Base Salaries

 

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 Compensation Committee uses the market

data discussed in the “Setting Compensation-Benchmarking” section of this Proxy Statement, as well as the salary history, individual performance, and experience of the individual executive officer, when assessing base salary. The base salaries of the NEOs and other officers are reviewed on an annual basis. During such review in 2010, the Compensation Committee recommended, and the Board approved, an increase in the CEO’s base salary from $470,000 to $500,000 in light of the Company’s multi-year success.

 

Broadly-Available Benefit Plans During 2010

 

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 2010 a modest allotment for reimbursements for club memberships and financial counseling services. Please refer to the “Executive Perquisites” column of the “All Other Compensation Table” in the “Executive Compensation” section of this Proxy Statement.

 

Annual Cash Bonus

 

The Company’s Annual Incentive Bonus (“AIB”) Plan (“AIB Plan”) is a broad plan that covers eligible employees, including the NEOs. The AIB Plan delivers short term incentive compensation based on the Company’s achievement of Net Operating Income (“NOI”) against established goals. Under the AIB Plan, the Company establishes a pool of 0% to 150% of goal achievement for NEOs other than the CEO. The CEO makes a recommendation to the Compensation Committee for individual NEO bonus payments which is based primarily on the NOI achievement and then considers overall individual performance. The Compensation 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, if the threshold goal was not met. The Compensation Committee also reserves discretion to adjust the bonus pool up or down, if results were affected by unusual events that in the Compensation Committee’s determination were beyond management’s control. The Compensation Committee retains the power to exercise negative discretion with respect to each NEO even if the Company achieves an NOI target.

 

As referenced above, the size of the bonus pool is dependent on achievement of NOI. The NOI goals approved by the Committee for the 2010 AIB Plan are below:

 

 

When the Compensation Committee set the target NOI for the AIB Plan, it established a formula for adjusting the NOI in order to recognize the impact of prior year reserve development. For 2010, the Company’s adjusted NOI was $116.8 million. The Committee voted at its February 2, 2011 meeting that the 2010 annual cash bonus pool would be 150% of the target.

 

Annual Cash Bonuses — NEOs other than the CEO

 

The Compensation Committee considers both NOI and individual performance when determining the compensation of the NEOs with NOI being the material factor when determining the annual cash bonus. The annual process for evaluating achievement of each NEO’s objectives consists of a performance evaluation by the CEO that is presented to the Compensation Committee for discussion. Although NOI is the material factor when determining annual bonuses for the NEOs, the CEO evaluation includes an analysis of each NEO’s individual performance when determining whether the AIB should be at, above, or below the target bonus award reflected

below in the “Executive Annual Incentive” table of this Proxy Statement. Following discussion of the CEO’s evaluation and recommendation, the Compensation Committee approves, rejects, or modifies the CEO’s recommendation. Set forth below for each NEO, other than the CEO, is a summary of the individual performance objectives which were considered, in addition to NOI, by the Compensation Committee when determining AIB.

 

For John Corcoran, the individual objectives in 2010, all qualitative, were management of the Company’s planning, analysis and financial reporting functions, oversight of the Company’s investment portfolio and investment manager, management of the Company’s capital structure, stewardship of key relationships with banks, rating agencies and regulators, and execution of technology projects specific to Finance. Mr. Welch reported to the Committee that Mr. Corcoran successfully fulfilled all of his individual objectives. Also, under Mr. Corcoran’s leadership our rating agency relationships remain strong and the investment strategy continues to perform well in a weak economy. The Compensation Committee approved Mr. Welch’s bonus recommendation for Mr. Corcoran as reflected below in the “Executive Annual Incentive” table of this Proxy Statement.

 

For Douglas Hinkle, the individual factors considered for his 2010 performance included adherence to the underwriting expense plan, effective oversight of the underwriting strategy, and marketing of key agents and customers. The underwriting expense goal was $94.2 million and the actual was $93.5 million, excluding additional incentive compensation accruals. Numerical targets were not established for Mr. Hinkle’s other performance factors. The CEO noted that again in 2010 Mr. Hinkle successfully oversaw a sound underwriting strategy and continued to maintain and expand his strong agent and customer relationships. Mr. Hinkle’s oversight of the Company’s underwriting strategy for the several previous years was credited for the Company’s strong NOI in 2010. The Compensation Committee approved Mr. Welch’s bonus recommendation for Mr. Hinkle as reflected below in the “Executive Annual Incentive” table of this Proxy Statement.

 

For Michael Dougherty, the individual objectives in 2010, all qualitative in nature, included implementing several key IT initiatives, managing the capital expense budget, developing and executing on long term strategies for continued improvement in business operations, and maintaining IT system performance and stability for the Company. Under his leadership, key technology and business process initiatives were successfully implemented. Mr. Dougherty continues to execute on IT and business operation strategies while maintaining a stable IT system for the Company. The Compensation Committee approved Mr. Welch’s bonus recommendation for Mr. Dougherty as reflected below in the “Executive Annual Incentive” table of this Proxy Statement.

 

For Thomas Pottle, the primary individual objective prior to his termination on November 26, 2010 was management of the Company’s field operations, branch audits, credit analysis function, and implementation of branch technology improvements. As provided by the General Release and Settlement Agreement entered between Mr. Pottle and the Company, Mr. Pottle’s short and long term bonuses would be calculated as all other employee bonuses if the Company exceeded 100% of the performance targets established for 2010. Since the Company exceeded 100% of the performance targets set for 2010 and in recognition of his performance achievements during 2010, the Compensation Committee approved Mr. Welch’s bonus recommendation for Mr. Pottle as reflected below in the “Executive Annual Incentive” table of this Proxy Statement.

 

For Rosemary Quinn, the primary objectives in 2010 were all qualitative in nature. The primary responsibilities were facilitation of and communication with the Board of Directors, providing high-level legal expertise for large contract and commercial bonds, consulting with claims management regarding legal issues that impact the industry as well as claim handling, serving as legal advisor for all non-claim and litigation matters, managing the Company’s public affairs division, and overseeing the Company’s compliance practices based on state and federal requirements. Ms. Quinn was successful in following through on all objectives and the Compensation Committee approved Mr. Welch’s bonus recommendation as reflected below in the “Executive Annual Incentive” table of this Proxy Statement.

 

Annual Cash Bonus — CEO

 

The Compensation 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 Compensation Committee. As provided in his employment contract, Mr. Welch has a target of 100% of his base salary of $500,000. At its February 3, 2010 meeting, the Compensation Committee established a maximum for Mr. Welch’s annual bonus of 2.25% of the Company’s actual NOI for the 2010 performance year. However, the Compensation Committee retained discretion to reduce the amount of his annual bonus based upon its evaluation of his performance. After evaluating his 2010 performance at its February 2, 2011 meeting, the Compensation Committee voted to pay Mr. Welch an annual cash bonus of $1,000,000, or 200% of his base salary, which is the maximum target, based primarily on the Company’s 2010 adjusted NOI of $116.8 million. Although the material factor used by the Compensation Committee when determining Mr. Welch’s AIB is NOI, it also considers several qualitative factors which include: strategic direction and leadership; talent management; drive for results; and development of relationships with customers, regulators, analysts, the Board, and the Company’s shareholders. The Compensation Committee concluded that he consistently fulfilled all of these qualitative factors since becoming the Company’s CEO in 2003 which has resulted in the Company’s financial strength today. In recognition of the NOI achievement far in excess of the 2010 goal, the Compensation Committee recommended, and the Board approved, the bonus award reflected in the table below.

 

The 2010 annual cash bonus targets and awards for each NEO, including the CEO, were:

 

 

Long Term Incentives

 

Long Term Cash Incentive

 

The Company’s Long Term Incentive (“LTI”) Plan (“LTI Plan”) motivates executives to meet the Company’s long term performance objectives as well as promotes executive continuity. Each year the Compensation Committee approves an annual Return on Equity (“ROE”) target. ROE, for the purposes of the LTI Plan, 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 Compensation Committee does not use individual performance measures for LTI bonuses under the LTI Plan. All NEOs have a target LTI bonus of 20% of their base salary, except Mr. Welch who has a target LTI bonus of 50% of his base salary based on his employment agreement. As with all variable compensation, the Compensation 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.

 

If the LTI Plan goals for a performance year are achieved, one third of the payment attributable to that LTI Plan 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 Plan year in which the goal was achieved. Each March, any LTI payment potentially consists of portions of awards from three LTI Plan years. Thus, the LTI payments made on March 11, 2011 represented payments for performance in three years: 2008, 2009, and 2010 (1/3 of the award for each year). The NEO must be actively employed on the payment date to receive any 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.

At its February 3, 2010 meeting, the Compensation Committee set the following ROE targets for 2010:

 

 

The Compensation Committee reserves the discretion to adjust LTI payments based on events beyond the NEO’s control. In addition, when the Compensation Committee set the ROE target, it established a formula for adjusting the ROE in order to recognize the impact of prior year reserve development. The Company’s adjusted ROE for 2010 was 13.1%. Accordingly, the NEOs were eligible for an LTI payment of 200% of target for the 2010 performance year.

 

Long Term Incentive-Equity

 

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 Compensation Committee grants equity as part of total compensation to executive officers, officers, and certain other employees. As a general practice, each year the Compensation 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 Compensation Committee has granted the CEO stock options equal to approximately 50% of his annual base salary based on a Black-Scholes valuation.

 

The Compensation Committee approves all equity grants pursuant to the LTI Plan. The Compensation Committee decides and approves equity grants at its first regularly scheduled meeting of each year in order to coincide with the awards of other variable compensation. In 2010, NEO’s received stock options as outlined in the 2010 Grants of Plan-Based Awards Table.

 

During 2010, the Compensation Committee solicited the advice of an outside consultant, Towers Watson Pennsylvania Inc. (“Towers Watson”), to review the Company’s LTI Plan since it had been several years since it was subject to an external review. Towers Watson offered recommendations for adjusting the LTI Plan based on current best practices and alignment with Company goals. The only change implemented by the Committee for 2011 following such review was the use of restricted stock as a replacement for stock options.

 

The Compensation Committee’s policy is to make no grants of equity during the year other than those made at its first regularly scheduled meeting of the year, except for grants to certain newly-hired senior executives. In the event the Compensation Committee determines that a newly-hired senior executive should be awarded grants, the Compensation Committee’s intention is to grant any such shares at the Compensation Committee’s first regularly scheduled meeting after commencement of such executive’s employment. Such shares will be 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 75% of base salary on a before-tax basis into the plan, subject to a maximum of $16,500 in 2010 ($22,000 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 (base salary) does not include bonuses or other contingent compensation. In addition, eligible compensation for 2010 was capped at $245,000.

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. The payment is based on Combined Ratio achievement against established goals. For the definition of Combined Ratio, please see “Results of Operations” in Item 7., Management’s Discussion and Analysis of Financial Condition and Results of Operations, in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010. The NEOs, including the CEO, fall under the same conditions of payout as all other Company employees. The Combined Ratio target for a 2% payout in 2010 was 83.00% or better. Since the Company’s 2010 Combined Ratio was better than 83.00%, the Compensation Committee, at its February 2, 2011 meeting, approved a Performance Contribution equal to 2% of salary to participants’ accounts. Set forth below are the Performance Contribution targets that were established by the Compensation Committee for 2010:

 

 

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 Statement 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 nonqualified 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 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 Plan are general assets of the Company. However, the Company has funded grantor trusts established to make payments under the 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, 2010

 

The compensation and benefit plans provided to our employees and executive officers do not provide for any benefit in the event of a change-in-control. However, under the CNA Surety Corporation’s 2006 Long Term Equity Compensation Plan, the Compensation Committee has the discretion to amend the terms of a stock option award in the event of a change-in-control.

The Company did have, as of December 31, 2010, liability for severance benefits to those executive officers listed below pursuant to contracts entered with such executives:

 

 

 

Employment Agreement

 

The termination benefit shown above for Mr. Welch reflects the maximum termination benefit payable at December 31, 2010 under his employment agreement. As provided under his employment agreement, the above termination payment is comprised of severance and earned but unpaid AIB and LTI payments as of December 31, 2010. Under the terms of an employment agreement, approved by the Compensation Committee, 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. In such event, the severance benefit Mr. Welch will receive includes: any unpaid base salary prorated to the termination date and earned but unpaid bonuses from the previous year; plus his base salary and the target AIB and the target LTI payments prorated through the end of the contract term which is December 31, 2011, but in no event less than twelve months. These severance payments would be paid in equal monthly installments. In addition, after the Compensation Committee’s review of actual performance results for the year in which the termination occurs, Mr. Welch is eligible to receive a prorated AIB and prorated LTI payment based on actual performance for the year in which Mr. Welch’s employment is terminated. These payments would be made at the same time that AIB 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. This agreement also provides that 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 AIB, and target LTI award 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) prorated AIB and LTI payments (based on actual performance) for the year in which his employment is terminated, payable when AIB 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.

 

Retention and Severance Agreements

 

The Company entered into a retention bonus agreement with Mr. Hinkle on April 1, 2010, with Compensation Committee approval that provides for a retention bonus of $250,000, paid out over four installments, to induce Mr. Hinkle to remain employed with the Company through April 15, 2014. As provided by the agreement, the Company paid Mr. Hinkle the first installment of the bonus in the amount of $50,000 on April 15, 2010. The Company will pay Mr. Hinkle the second and third installments of the bonus of $50,000 in April 2011 and 2012 and the final installment of $100,000 in April 2013. If Mr. Hinkle terminates his employment with the Company, Mr. Hinkle must repay any bonus payments paid to him within twelve months prior to his termination. The agreement also contains certain non-competition and non-solicitation provisions.

 

The Company extended the existing severance agreement entered into with Mr. Corcoran, with the approval of the Compensation Committee. This agreement provides that in the event the Company terminates Mr. Corcoran’s employment prior to April 1, 2013, other than for cause, death or disability, Mr. Corcoran will receive a lump-sum severance payment equal to one year of his base salary. In addition, he will be eligible to continue in the Company’s

group health plan for a period of one year from the date of termination running concurrently with any benefit eligibility under COBRA.

 

Compensation Committee Interlocks and Insider Participation

 

The Compensation Committee met seven times in 2010. In 2010, the Company’s Compensation Committee was comprised of Robert A. Tinstman (Chairman), Philip H. Britt, and Anthony S. Cleberg, all of whom are independent directors and none of whom 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 Adrianne T. Baker, representative of the Company, at 333 S. Wabash Ave., 41st Floor, Chicago, Illinois 60604, (312) 822-4971.

 

COMPENSATION COMMITTEE REPORT

 

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

 

EXECUTIVE COMPENSATION

 

The following tables show information with respect to the annual compensation (including stock option awards) for services rendered to the Company for the years ended December 31, 2010, December 31, 2009, and December 31, 2008 by the Chief Executive Officer, the Chief Financial Officer, and other NEOs as of December 31, 2010.

 

2010 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, 2010.

 

All Other Compensation Table

 

 

2010 Grants of Plan-Based Awards Table

 

 

 

Outstanding Equity Awards at Fiscal Year-End Table

 

The equity awards of the NEOs outstanding at December 31, 2010 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 February 6, 2009 grant date, 25% of the shares granted vested on February 6, 2010, 25% of the shares vested on February 6, 2011, 25% of the shares will vest on February 6, 2012, and the remaining 25% of the shares will vest on February 6, 2013. 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, 2010.

 

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 as of December 31, 2010.

 

Non-Qualified Deferred Compensation

 

The 2005 Deferred Compensation Plan was adopted to replace the Company’s 2000 Deferred Compensation Plan which after December 31, 2004 no longer accepted contributions. Accordingly, the 2000 Deferred Compensation Plan shown in the below chart only shows Earnings and Aggregate Year End Balances for Fiscal Year End 2010 (“FYE 2010”).

 

 

(a) For the 2005 Deferred Compensation Plan, this column includes the Company’s Deferred Compensation Basic, Matching, and Discretionary Contributions to the NEOs for FYE 2010. Additionally, the 2005 Deferred Compensation Plan amounts are a component of the values listed in the “All Other Compensation Table” of the Summary Compensation Table of this Proxy Statement attributable to annual Company contributions to defined contribution plans. For a more detailed discussion of the 2005 Deferred Compensation Plan, refer to the “Deferred Compensation” section of the “Compensation Discussion and Analysis” section of this Proxy Statement.

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

 

Principal Shareholders

 

The following table contains certain information as of February 8, 2011 (unless otherwise noted) as to all entities which, to the Company’s knowledge, were the beneficial owners of 5% or more of the outstanding shares of the Company’s Common Stock. Information in the table is based upon reports filed with the SEC pursuant to Section 13(d) and 16(a) under the Securities Exchange Act of 1934 (the “Exchange Act”) and other written representations received by the Company with respect to entities named in the tables. Beneficial ownership is defined for this purpose as the sole or shared power to vote or to direct the disposition of the Common Stock. Unless otherwise noted, the persons in the following table have sole voting and investment power with respect to all shares shown as beneficially owned by them:

 

 

 

MANAGEMENT AND DIRECTORS

 

The following table shows certain information, at February 28, 2011, as to the shares of the Company’s Common Stock beneficially owned by each director and nominee, each NEO named in the Summary Compensation Table, and all of the Company’s executive officers and directors as a group, based on information furnished by them.

 

 

 

 

Equity Compensation Plan Information

 

 

In 2006, the shareholders of the Company approved the CNA Surety Corporation 2006 Long Term Equity Compensation Plan (“2006 Plan”). The 2006 Plan included 3,000,000 total shares comprised of: 2,453,598 newly authorized shares and 546,402 carryover shares which were previously available for grant under the CNA Surety Corporation 1997 Long Term Equity Compensation Plan (“1997 Plan”). The 1,093,181 shares listed above have been granted and are available for exercise, subject to vesting rules, under the both the 2006 Plan and the 1997 Plan. A total of 281,260 stock options were granted in 2010.

 

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

 

CNAF Proposal

 

In October 2010, the Company received an unsolicited proposal from CNAF to acquire all of the outstanding shares of common stock that are not currently owned by subsidiaries of CNAF at a purchase price of $22.00 per share in cash (the “CNAF Proposal”). The Company’s Board of Directors appointed a special committee (the “Special Committee”), comprised solely of the Company’s three independent directors, to review and evaluate the CNAF Proposal. The Special Committee retained both legal and financial advisors to assist in their consideration of the CNAF Proposal. On February 4, 2011, the Special Committee announced that it does not support the terms of the proposal and advised CNAF that it is open to alternate proposals.

 

Related Party Transactions

 

It is our policy that any transaction involving the Company or any of its subsidiaries in which any of our directors, executive officers, or principal shareholders had or will have a direct or indirect material interest be submitted to our Audit Committee for its consideration. In each case, such consideration and discussion is without the participation of any Audit Committee member who may be involved in the transaction. The Audit Committee, which consists entirely of Independent Directors, considers all relevant facts in order to determine whether the transaction is fair and reasonable to us and our shareholders, including our minority shareholders. Although there is no written statement of the review procedure, the Audit Committee’s review, approval, or ratification of such related party

transactions is reflected in the meeting records of the Audit Committee. The last such review took place on February 2, 2011.

 

Related Party Reinsurance

 

The Surety Quota Share Treaty (the “Quota Share Treaty”), the Services and Indemnity Agreement, the Aggregate Stop Loss Reinsurance Contract (the “Stop Loss Contract”), and the Surety Excess of Loss Reinsurance Contract (the “Excess of Loss Contract”) discussed below were originally entered on September 30, 1997 (the “Merger Date”). Although the contracts entered into on the Merger Date have expired, some have been renewed on different terms as discussed below.

 

Through the Quota Share Treaty, surety business, other than Canadian business, written or renewed by Continental Casualty Company (“CCC”) and Continental Insurance Company (“CIC”) (CCC and CIC are subsidiaries of CNAF) after the Merger Date is transferred to the Company’s subsidiary, Western Surety Company (“Western Surety”). The Quota Share Treaty, which was renewed on January 1, 2010 and expired on December 31, 2010, was renewed for one year on January 1, 2011 on substantially the same terms as 2010. CCC and CIC transfer the related liabilities of business covered by this treaty and pay to Western Surety an amount equal to CCC’s and CIC’s net written premiums written on all such business, minus a quarterly ceding commission to be retained by CCC and CIC equal to $50,000 plus 25% of net written premiums written on all such business. Under the terms of the Quota Share Treaty, CCC has guaranteed the loss and loss adjustment expense reserves transferred to Western Surety as of the Merger Date 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 was no adverse reserve development for the period from the Merger Date through December 31, 2010.

 

The Services and Indemnity Agreement provides the Company’s insurance subsidiaries with the authority to perform various administrative, management, underwriting, and claim functions concerning the surety business of CCC and CIC ceded to Western Surety under the Quota Share Treaty. As of December 31, 2010, there were no amounts due our insurance subsidiaries under the Services and Indemnity Agreement. This Agreement was renewed with the same terms on January 1, 2011 and expires on December 31, 2011 and is annually renewable thereafter.

 

Through the Stop Loss Contract, the Company’s insurance subsidiaries were protected from adverse loss development on certain business underwritten after the Merger Date. The Stop Loss Contract between the Company’s 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 exceeds 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 Company’s insurance subsidiaries a dollar amount equal to (i) the amount, if any, by which the Company’s 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 Company’s insurance subsidiaries pay CCC an annual premium of $20,000. Losses incurred under the Stop Loss Contract were $47.2 million through December 31, 2010. At December 31, 2010, the amount received under the Stop Loss Contract included $2.7 million held by the Company for losses covered by this contract that were incurred but not paid.

 

On January 1, 2010, the Company and CCC entered into two separate agreements that provide for the transfer of the Canadian surety business of CCC to Western Surety. These agreements, which include a quota share treaty (the “Canadian Quota Share Treaty”) and a services and indemnity agreement (the “Canadian Services and Indemnity Agreement”), are substantially similar to the Quota Share Treaty and the Services and Indemnity Agreement discussed above. The Canadian Services and Indemnity Agreement provides Western Surety with the authority to supervise various administrative, underwriting, and claim functions associated with the surety business written by CCC, through its Canadian branch, on behalf of Western Surety. Through the Canadian Quota Share Treaty, this Canadian surety business is transferred to Western Surety. Pursuant to these agreements, CCC will transfer the

subject premium and related liabilities of such business and pay to Western Surety an amount equal to CCC’s net written premiums on all such business, minus a ceding commission of 33.5% of net written premiums. Further, Western Surety will pay an additional ceding commission to CCC in the amount of actual direct expense in producing such premium. These agreements, which expired on December 31, 2010, were renewed on the same terms on January 1, 2011 with an expiration of December 31, 2011 and are annually renewable thereafter.

 

As of December 31, 2010, Western Surety had an insurance receivable balance from CCC and CIC of $10.8 million, comprised of premiums receivable. Western Surety had no reinsurance payables to CCC and CIC as of December 31, 2010.

 

Under the terms of an excess of loss agreement with First Insurance Company of Hawaii, Ltd. and its subsidiaries which include First Indemnity Insurance of Hawaii, Inc., First Fire and Casualty Insurance of Hawaii, Inc., and First Security Insurance of Hawaii, Inc. (collectively, “FICOH”), Western Surety assumed $0.1 million of premium in 2010. This agreement provides that FICOH retains losses of $2 million per principal and Western Surety assumes 80% of $5 million per principal subject to an aggregate annual limit of $8 million. CNAF, through its insurance subsidiaries, owns approximately 50% of the outstanding common stock of First Insurance Company of Hawaii, Ltd. This agreement was renewed with the same terms on January 1, 2011 and expires on December 31, 2011.

 

All agreements discussed above were approved by the Audit Committee.

 

Other Related Party Transactions

 

CNA Surety and CCC are parties to an Administrative Services Agreement (“ASA”), which has been in effect since July 1, 2004, that allows the Company to purchase and/or have access to certain services provided by CCC and its affiliates, including the leasing of executive and branch offices. Pursuant to the ASA, the Company paid CCC $4.6 million during 2010 for leased office space and services. The Company was also charged $0.2 million in 2010 for the direct costs incurred by CCC on the Company’s behalf. As provided by the ASA, CCC paid the Company $1.3 million for the year ended December 31, 2010 for insurance agent licensing services provided by the Company. This agreement shall remain in effect until CNAF or its affiliates or shareholders cease being a majority shareholder of CNA Surety unless otherwise terminated by either party. This agreement is approved annually by the Audit Committee.

 

Pursuant to procedures approved by the Audit Committee, Western Surety from time to time provides license and permit bonds and appeal bonds for CCC and its affiliates as well as for clients of CCC and its affiliates. As of December 31, 2010, the aggregate outstanding liability of these bonds was $27.8 million. The premium for all such bonds written was $0.3 million in 2010.

 

Western Surety also has liability, either directly or through assumed reinsurance, under bonds written for Loews and certain of its subsidiaries which include Diamond Offshore Drilling, Inc. (“Diamond Offshore”) and Mexdrill Offshore, S. DE R.L. DE C. V , which is a subsidiary of Diamond Offshore. As of December 31, 2010, Loews owned 50.4% of Diamond Offshore. As of December 31, 2010, the aggregate liability under all such bonds was approximately $79.9 million and the premium was less than $0.1 million in 2010. All bonds for Loews and its subsidiaries were approved by the Audit Committee.

 

Section 16(a) Beneficial Ownership Reporting Compliance

 

Section 16(a) of the Exchange Act requires the Company’s officers and directors, and persons who own more than ten percent of the Company’s outstanding Common Stock (“Reporting Persons”), to file reports of ownership and changes in ownership of such securities with the SEC. Reporting Persons are required to deliver copies of all Section 16(a) forms to the Company simultaneously for filing with the SEC. Based solely upon review of the copies of the forms furnished to the Company, and written representations from certain Reporting Persons that no other reports were required, the Company believes that for 2010 all reports required by Section 16(a) of the Exchange Act have been timely filed.

RATIFICATION OF APPOINTMENT OF INDEPENDENT

REGISTERED PUBLIC ACCOUNTING FIRM

(PROPOSAL 2)

 

The Audit Committee has selected Deloitte & Touche LLP as the Company’s independent registered public accounting firm for the 2011 fiscal year. Deloitte & Touche LLP has served in this capacity since the last three months ended December 31, 1997. A representative of Deloitte & Touche LLP will be present at the Annual Meeting and will have an opportunity to make a statement if he or she so desires and will be available to respond to appropriate questions. A description of the fees paid to Deloitte & Touche LLP in fiscal year 2010 is outlined below.

 

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 ratify the appointment, by the Board of Directors, of Deloitte & Touche LLP as the Company’s independent registered public accounting firm. It is the present intention of the Company’s Proxy Agents to vote at the Annual Meeting 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 ratification of the appointment of Deloitte & Touche LLP as the Company’s independent registered public accounting firm.

 

For the years ended December 31, 2010 and 2009, professional services were performed by Deloitte & Touche LLP.

 

Audit Fees

 

The aggregate fees billed for the audit of the Company’s annual financial statements for the fiscal years ended December 31, 2010 and 2009 and for the reviews of the financial statements included in the Company’s Quarterly Reports on Form 10-Q were $1,165,000 and $1,357,801, respectively. The fees for the fiscal year ended December 31, 2010 reflect those fees billed by Deloitte & Touche LLP as of March 2, 2011.

 

Audit-Related Fees

 

The aggregate fees billed for the audit-related services for the years ended December 31, 2010 and 2009 were $0 and $12,000, respectively. These fees generally include fees for consents and comfort letters, accounting consultations, Sarbanes-Oxley Act Section 404 advisory services, and SEC related matters.

 

Tax Fees

 

None.

 

All Other Fees

 

None.

 

The Audit Committee has established a pre-approval policy with regard to audit, audit-related, and certain non-audit engagements by the Company of its independent registered public accounting firm. Under this policy, the Audit Committee annually pre-approves certain limited, specified recurring services which may be provided by Deloitte & Touche LLP, subject to maximum dollar limitations. All other engagements for services to be performed by Deloitte & Touche LLP must be separately pre-approved by the Audit Committee. The Audit Committee has also designated the Chairperson of the Committee as having authority to pre-approve such engagements as allowed by the policy, subject to reporting on such pre-approvals to the Audit Committee at its next scheduled meeting. All audit fees and audit related fees were pre-approved by the Audit Committee.

 

Vote Required

 

The proposal to ratify the Audit Committee’s appointment of the Company’s independent registered public accounting firm, Deloitte & Touche LLP, for fiscal year 2011 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 “FOR” THE RATIFICATION OF DELOITTE & TOUCHE LLP AS THE COMPANY’S INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM FOR FISCAL YEAR 2011. IF A CHOICE IS SPECIFIED ON THE PROXY BY THE SHAREHOLDER, THE SHARES WILL BE VOTED AS SPECIFIED. IF NO SPECIFICATION IS MADE, SHARES WILL BE VOTED “FOR” RATIFICATION OF DELOITTE & TOUCHE LLP AS THE COMPANY’S INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM.

 

APPROVAL OF THE RESTATED CNA SURETY CORPORATION
LONG-TERM EQUITY COMPENSATION PLAN

(PROPOSAL 3)

 

Introduction

 

In April 2006, the shareholders approved the 2006 Long-Term Equity Compensation Plan (the “2006 Plan”) which was designed to reflect our commitment to best practices in compensation and corporate governance. We are now asking our shareholders to approve the restated 2006 Plan. Shareholder approval of the restated 2006 Plan is necessary, among other reasons, to allow performance-based awards made under the 2006 Plan to executive officers of the Company to be fully deductible by the Company for federal income tax purposes under Code Section 162(m) if and to the extent the Compensation Committee of the Board (“Committee”) determines that compliance with the performance-based exception to tax deductibility limitations under Code Section 162(m) is desirable.

 

A copy of the restated 2006 Plan is attached as Exhibit A to this Proxy Statement. The summary below is qualified in its entirety by the text of the restated 2006 Plan.

 

Purpose of the 2006 Plan; Summary of Amendments

 

The 2006 Plan as restated is intended to allow selected employees, directors and consultants of the Company and its subsidiaries to acquire or increase equity ownership in the Company, thereby strengthening their commitment to the success of the Company and stimulating their efforts on behalf of the Company, and to assist our Company and its subsidiaries in attracting new employees, directors and consultants and retaining existing employees, directors and consultants. The restated 2006 Plan is also intended to optimize the profitability and growth of the Company through incentives that are competitive with the Company’s goals; to provide employees, directors and consultants with an incentive for excellence in individual performance, and to promote teamwork among employees, directors and consultants. The restated 2006 Plan is not intended to be the exclusive vehicle for providing incentive or other compensation to employees and officers.

 

No substantive changes are proposed to the 2006 Plan. The only changes included in the restated 2006 Plan are: (1) addition of book value as a performance measure; and (2) revised definition of “retirement.” While the Company recognizes the value of the net operating income measure utilized under the 2006 Plan, the Company proposes the inclusion of a book value measure in order to provide a stronger linkage to the creation of shareholder value. As further provided in the restated 2006 Plan, the range of performance measures in the restated 2006 Plan are listed below under “Performance-Based Awards.” With the exception of book value, all other performance measures are the same as those found in the 2006 Plan that was previously approved by the shareholders. The restated 2006 Plan revises the definition of “retirement” by referencing the award agreement entered between the Company and the grantee at the time of an award.

 

Description of Material Terms of Restated 2006 Plan

 

Administration

 

The restated 2006 Plan will be administered by the Committee consisting of two or more members of the Board. If and to the extent that compliance with Rule 16b-3 under the Exchange Act or the performance-based exception to tax deductibility limitations under Section 162(m) of the Code is desirable, the Committee must be comprised of two or more directors who qualify as “non-employee directors” under Rule 16b-3 and “outside directors” under Section 162(m) of the Code. Subject to the terms of the restated 2006 Plan, the Committee has full power and

discretion to select those persons to whom awards will be granted; to determine the terms, conditions, sizes and types of awards; to determine the consideration to be received (if any) for restricted stock; to amend any award agreement; to cancel awards and grant substitute awards; to accelerate exercisability or waive other terms and conditions of any award; to cancel, with the grantee’s consent, outstanding awards and to grant new awards in substitution therefore; to make adjustments in the terms and conditions of awards in recognition of unusual or nonrecurring events; to construe and interpret the restated 2006 Plan and any award agreement; to establish, amend and revoke rules and regulations for the administration of the restated 2006 Plan; and to take any other action with respect to matters relating to the Plan for which it is responsible.

 

The Board may reserve to itself or delegate to another committee of the Board consisting of one or more directors any or all of its authority. Unless expressly provided to the contrary, such delegation shall not extend to awards to executive officers or awards that are intended to comply with the performance-based exception to tax deductibility limitations under Section 162(m) of the Code unless the committee to which such authority is delegated consists of two or more directors who qualify as “non-employee directors” under Rule 16b-3 and “outside directors” under Section 162(m) of the Code.

 

Eligibility

 

The Restated 2006 Plan provides for awards to employees (including employees on leave of absence), directors of the Company or any subsidiary, and consultants to the Company or a subsidiary. Some awards will be provided to officers and others who are deemed by the Company to be “insiders” for purposes of Section 16 of the Exchange Act. As of December 31, 2010, the Company and its Subsidiaries had approximately 725 full-time employees (including officers), all of whom will be eligible to participate in the restated 2006 Plan. A subsidiary is defined in the restated 2006 Plan (for purposes other than the grant of incentive stock options) as a corporation with respect to which the Company owns 50% or more of the then-outstanding stock, or a limited liability company, partnership, joint venture or other unincorporated entity with respect to which the Company owns 50% or more of the then-outstanding profits interest.

 

Shares Available

 

2,009,269 shares of the Company’s common stock ($0.01 par value) are available under the terms of the restated 2006 Plan for issuance in settlement of awards. On March 8, 2011, the last reported sale price of the Company’s common stock on the New York Stock Exchange was $25.39 per share.

 

The shares delivered to settle awards made under the restated 2006 Plan may be authorized and unissued shares or treasury shares. If any shares subject to any award granted under the restated 2006 Plan are forfeited or otherwise terminated without delivery of shares, the shares subject to such awards will again be available for issuance under the restated 2006 Plan. In addition, any shares withheld or applied as payment for shares issued upon exercise of an award, or (other than with respect to restricted stock awards) for the withholding or payment of taxes due upon exercise of the award, will again be available for grant under the restated 2006 Plan. If a SAR is settled in shares, only the number of shares delivered in settlement will be charged against the number of available shares, regardless of the number of shares with respect to which the SAR was originally granted and exercised.

 

If a change in corporate capitalization (including a stock split, share combination, merger, consolidation, separation, spinoff, other distribution of shares, reorganization, partial or complete liquidation, stock dividend or other distribution, reorganization or partial or complete liquidation), affects the shares such that an adjustment is appropriate in order to prevent dilution or enlargement of the rights, the Committee in its sole discretion will make an equitable change or adjustment as it deems appropriate in the number and class of shares and/or the price of shares subject to outstanding awards, and in the number of shares available as set forth above and in the limits on particular awards and types of awards summarized below.

 

Limits On Awards

 

The restated 2006 Plan limits the total number of shares that may be granted as SARs to 1,000,000 shares, as restricted stock to 1,000,000 shares, and as bonus shares to 300,000 shares. In addition, the restated 2006 Plan limits

the number of shares that may be granted annually to a single grantee. This limit for options is 200,000 shares, for SARs is 200,000 shares, for restricted stock is 100,000 shares, and for performance shares or performance units is the value of 100,000 shares. The restated 2006 Plan also limits the maximum aggregate payout annually to a single grantee for cash incentive awards to 300% of base salary up to a maximum base salary of $1,000,000. If the performance period for performance shares or performance units, or for incentive awards, is more than one year, these per-grantee limits apply to each 12-month period in the performance period.

 

Summary of Awards under the restated 2006 Plan

 

The restated 2006 Plan permits the granting of any or all of the following types of awards to all grantees:

 

 

Generally, awards under the restated 2006 Plan will be granted for no consideration other than prior and future services. Awards granted under the restated 2006 Plan may, in the discretion of the Committee, be granted alone or in addition to, in tandem with or in substitution for, any other award under the restated 2006 Plan or other plan of the Company. The material terms of each award, including the extent to which the grantee may exercise the award after termination of employment or other termination of affiliation, are set forth in a written award agreement between the grantee and the Company. The term of an option or SAR or other period during which any award may be outstanding may not exceed 10 years from the grant date. Awards are generally nontransferable except on death, subject to a limited exception for NQSOs noted below.

 

Stock Options

 

The Committee is authorized to grant stock options, including ISOs. A stock option allows a grantee to purchase a specified number of shares at a predetermined price during a fixed period measured from the date of grant. The purchase price per share of stock subject to a stock option (the “option price”) is determined by the Committee and set forth in the award agreement; provided that the option price must be a least 100% of the fair market value per share on the date of grant (110% of fair market value in the case of ISOs granted to a 10% owner).

 

The term of each option is determined by the Committee and set forth in the award agreement, except that the term of a stock option may not exceed ten years. Options are exercisable in whole or in part at such time or times as determined by the Committee and set forth in the award agreement. Options may be exercised by payment of the purchase price in cash, by tender of stock that was purchased in the open market or held for at least six months, or with the approval of the Committee and subject to applicable law, surrender of restricted stock held for at least six months or cashless exercise through a broker. Options are generally nontransferable except on death, and except that to the extent provided in the award agreement, NQSOs may be transferred as gifts to certain family members or their related trusts.

 

SARs

 

The Committee is authorized to grant SARs. A SAR entitles the grantee to receive the excess of the fair market value of a share on the date of exercise over the strike price of the SAR. The strike price of an SAR is determined by the Committee and set forth in the award agreement; provided that the strike price must be at least 100% of the fair market value per share on the date of grant. SARs may be tandem SARs (granted in connection with a related option

or other award expiring at the same time, where exercise of the other award will cancel the SAR and exercise of the SAR will cancel the other award), or free-standing SARs. Times and methods of exercise and settlement and other terms of the SARs are determined by the Committee, subject to the terms of the Plan.

 

Restricted Stock

 

The Committee may award restricted stock in the form of restricted stock shares or restricted stock units. Restricted stock shares are transferred at the time of the award but remain subject to transfer restrictions and risk of forfeiture until restrictions established by the Committee lapse. Restricted stock units are unfunded rights to receive shares in the future, subject to risk of forfeiture until certain restrictions established by the Committee lapse. Restrictions may be time-based or performance-based (or both). A grantee receiving restricted stock shares may have the rights of a shareholder of the Company, including the right to vote the shares and the right to receive any dividends, in the discretion of the Committee and to the extent set forth in the award agreement. A grantee receiving restricted stock units may have the right to receive any dividends, in the discretion of the Committee and to the extent set forth in the award agreement, but not the right to vote the shares (until actually delivered to the grantee).

 

Performance Units/Shares

 

The Committee may grant performance units or performance shares, which entitle a grantee to cash or shares conditioned upon the fulfillment of certain performance conditions and other restrictions as specified by the Committee and reflected in the award agreement. The initial value of a performance unit is determined by the Committee at the time of grant. The initial value of a performance share is the fair market value of a share on the grant date. The Committee will determine the terms and conditions of such awards, including performance and other restrictions placed on these awards, which will be reflected in the award agreement. It is expected that the performance measures for performance and shares units will generally be selected from among those listed in the Plan and noted below.

 

A grantee receiving performance units or performance shares may have the right to receive any dividends on shares earned from the grants of performance units or performance shares in the discretion of the Committee and to the extent set forth in the award agreement; and may have the right to vote the shares in the discretion of the Committee to the extent set forth in the award agreement.

 

Incentive Awards

 

The Committee may grant annual and long-term incentive awards under the restated 2006 Plan for a fiscal year of the Company (for annual awards) or other performance period (for long-term awards). The Committee will determine the eligible employees who are eligible to receive incentive awards. Generally, this determination will be made within the first 90 days of the fiscal year or other performance period, or if an employee is hired or promoted to a position which warrants grant of an incentive award after the first day of the year, within ninety (90) days of such hiring or promotion but not later than the lapse of 25% of the remainder of such fiscal year or other performance period after such hiring or promotion.

 

For each fiscal year or other performance period, the Committee will establish performance measures and performance goals and the threshold, target and maximum bonus opportunity for the grantee upon attainment of the performance goals. The Committee has absolute discretion to reduce (but not increase) the amount of a participant’s incentive award to any amount less than maximum incentive award. A reduction in the amount of the annual incentive award payable to any grantee will not affect the annual incentive award payable to any other grantee. Except as otherwise determined by the Committee in its discretion, a participant will not be entitled to receive an annual incentive award for a performance period if the grantee’s employment terminates during the performance period.

 

As soon as practicable after the end of the fiscal year or other performance period, but not later than March 15 of the calendar year following the end of the performance period, the Committee will determine and certify in writing the degree of attainment of the performance goals, the Committee will determine the amount of the incentive award to be paid to each grantee of an incentive award, and the incentive awards will be paid. In the discretion of the

Committee and as set forth in the award agreement, incentive awards may be paid in cash, shares, restricted stock, options, or other form of equity. In the discretion of the Committee, and subject to applicable tax requirements, an award agreement may provide for the deferral of incentive awards.

 

Bonus Shares

 

Subject to the terms of the Plan, the Committee may grant bonus shares to any eligible person in such amount, and upon such terms and conditions, as the Committee determines.

 

Performance-Based Awards

 

The Committee may require satisfaction of predetermined performance goals, consisting of one or more business criteria and a targeted performance level with respect to such criteria, as a condition of awards being granted or becoming exercisable or payable under the Plan, or as a condition to accelerating the timing of such events.

 

The performance measure(s) to be used for purposes of any awards (other than stock options or SARs) intended to satisfy the “performance based” exception to tax deductibility limitations under Code Section 162(m) will be chosen from among the following (all of which may be determined on an aggregate or per-share basis and on a pre-tax or after-tax basis):