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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
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SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2005
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
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SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from ________ to ________
COMMISSION FILE NUMBER: 1-15135
CHANDLER (U.S.A.), INC.
(Exact name of registrant as specified in its charter)
OKLAHOMA 73-1325906
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1010 MANVEL AVENUE, CHANDLER, OKLAHOMA 74834
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (405) 258-0804
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
YES X NO
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Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). YES NO X
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The number of common shares, $1.00 par value, of the registrant outstanding on
July 31, 2005 was 2,484, which are owned by Chandler Insurance Company, Ltd.
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PAGE i
CHANDLER (U.S.A.), INC.
INDEX
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PART I - FINANCIAL INFORMATION
- ------------------------------
ITEM 1.
- -------
Consolidated Balance Sheets as of June 30, 2005 and December 31, 2004 ...... 1
Consolidated Statements of Operations for the three months
ended June 30, 2005 and 2004 ......................................... 2
Consolidated Statements of Operations for the six months
ended June 30, 2005 and 2004 ......................................... 3
Consolidated Statements of Comprehensive Income for the three
months ended June 30, 2005 and 2004 .................................. 4
Consolidated Statements of Comprehensive Income for the six
months ended June 30, 2005 and 2004 .................................. 5
Consolidated Statements of Cash Flows for the six months
ended June 30, 2005 and 2004 ......................................... 6
Notes to Interim Consolidated Financial Statements ........................ 7
ITEM 2.
- -------
Management's Discussion and Analysis of Financial Condition and
Results of Operations ................................................ 8
ITEM 4.
- -------
Controls and Procedures ................................................... 14
PART II - OTHER INFORMATION
- ---------------------------
Item 1. Legal Proceedings .............................................. 15
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds .... 15
Item 3. Defaults Upon Senior Securities ............................... 15
Item 4. Submission of Matters to a Vote of Security Holders ........... 15
Item 5. Other Information ............................................. 15
Item 6. Exhibits ...................................................... 15
Signatures ................................................................ 16
PAGE 1
CHANDLER (U.S.A.), INC.
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands except share amounts)
June 30, December 31,
2005 2004
----------- ------------
(Unaudited)
ASSETS
Investments
Fixed maturities available for sale, at fair value
Restricted (amortized cost $8,390 and $8,421 in 2005 and 2004, respectively) ....... $ 8,240 $ 8,279
Unrestricted (amortized cost $64,855 and $63,636 in 2005 and 2004, respectively) ... 64,639 63,391
Equity securities at fair value (cost $8,109 and $8,058 in
2005 and 2004, respectively) ...................................................... 8,357 8,373
----------- ------------
Total investments .................................................................. 81,236 80,043
Cash and cash equivalents ($141 and $141 restricted in 2005 and 2004, respectively) .. 4,528 6,870
Premiums receivable, less allowance for non-collection
of $158 and $119 at 2005 and 2004, respectively ..................................... 24,411 22,809
Reinsurance recoverable on paid losses, less allowance for
non-collection of $3,108 and $3,035 at 2005 and 2004, respectively .................. 1,743 2,172
Reinsurance recoverable on paid losses from related parties .......................... - 83
Reinsurance recoverable on unpaid losses, less allowance for
non-collection of $209 and $237 at 2005 and 2004, respectively ...................... 41,221 50,381
Reinsurance recoverable on unpaid losses from related parties ........................ 14,122 13,157
Prepaid reinsurance premiums ......................................................... 8,605 9,837
Prepaid reinsurance premiums to related parties ...................................... 11,560 12,315
Deferred policy acquisition costs ................................................... 1,081 57
Property and equipment, net ......................................................... 8,919 9,110
Amounts due from related parties .................................................... 10,098 10,891
State insurance licenses, net ....................................................... 3,745 3,745
Other assets ......................................................................... 12,772 15,827
----------- ------------
Total assets ........................................................................ $ 224,041 $ 237,297
=========== ============
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities
Unpaid losses and loss adjustment expenses ......................................... $ 94,674 $ 108,233
Unearned premiums .................................................................. 48,950 51,109
Policyholder deposits .............................................................. 5,063 4,912
Accrued taxes and other payables ................................................... 5,642 5,578
Premiums payable ................................................................... 2,062 3,674
Premiums payable to related parties ................................................. 140 -
Senior debentures ................................................................... 6,979 6,979
Junior subordinated debentures issued to affiliated trusts ......................... 20,620 20,620
----------- ------------
Total liabilities ................................................................. 184,130 $ 201,105
----------- ------------
Shareholder's equity
Common stock, $1.00 par value, 50,000 shares authorized;
2,484 shares issued and outstanding ................................................ 2 2
Paid-in surplus .................................................................... 60,584 60,584
Accumulated deficit ................................................................. (20,596) (24,346)
Accumulated other comprehensive income (loss):
Unrealized loss on investments available for sale, net of deferred income taxes ..... (79) (48)
----------- ------------
Total shareholder's equity ......................................................... 39,911 36,192
----------- ------------
Total liabilities and shareholder's equity ........................................... $ 224,041 $ 237,297
=========== ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 2
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Amounts in thousands)
Three months ended June 30,
--------------------------------
2005 2004
------------ ------------
Premiums and other revenues
Direct premiums written and assumed ............................ $ 24,501 $ 28,326
Reinsurance premiums ceded .................................... (4,759) 78
Reinsurance premiums ceded to related parties .................. (5,371) (8,131)
------------ ------------
Net premiums written and assumed .............................. 14,371 20,273
Decrease (increase) in unearned premiums ....................... 1,923 (3,541)
------------ ------------
Net premiums earned ........................................... 16,294 16,732
Investment income, net .......................................... 683 641
Interest income, net from related parties ....................... 162 108
Realized investment gains, net ................................. 3 -
Other income .................................................... 59 67
------------ ------------
Total premiums and other revenues ............................. 17,201 17,548
------------ ------------
Operating costs and expenses
Losses and loss adjustment expenses, net of amounts
ceded to related parties of $3,748 and $5,290 in
2005 and 2004, respectively .................................. 7,727 15,561
Policy acquisition costs, net of ceding commissions
received from related parties of $2,046 and $3,083 in
2005 and 2004, respectively .................................. 2,838 3,266
General and administrative expenses ........................... 3,522 3,049
Interest expense ............................................... 629 593
------------ ------------
Total operating costs and expenses ............................ 14,716 22,469
------------ ------------
Income (loss) before income taxes .............................. 2,485 (4,921)
Federal income tax benefit (provision) .......................... (890) 1,624
------------ ------------
Net income (loss) .............................................. $ 1,595 $ (3,297)
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 3
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Amounts in thousands)
Six months ended June 30,
-------------------------------
2005 2004
------------ ------------
Premiums and other revenues
Direct premiums written and assumed ............................ $ 56,162 $ 59,987
Reinsurance premiums ceded .................................... (10,530) (9,072)
Reinsurance premiums ceded to related parties .................. (13,285) (14,882)
------------ ------------
Net premiums written and assumed .............................. 32,347 36,033
Decrease (increase) in unearned premiums ....................... 171 (5,429)
------------ ------------
Net premiums earned ........................................... 32,518 30,604
Investment income, net ......................................... 1,352 1,776
Interest income, net from related parties ....................... 314 211
Realized investment gains, net .................................. 3 463
Other income .................................................... 123 546
------------ ------------
Total premiums and other revenues ............................. 34,310 33,600
------------ ------------
Operating costs and expenses
Losses and loss adjustment expenses, net of amounts
ceded to related parties of $7,334 and $7,970 in
2005 and 2004, respectively .................................. 15,627 26,193
Policy acquisition costs, net of ceding commissions
received from related parties of $5,025 and $5,640 in
2005 and 2004, respectively .................................. 5,190 5,774
General and administrative expenses ........................... 6,393 6,362
Interest expense ............................................... 1,245 1,188
------------ ------------
Total operating costs and expenses ............................ 28,455 39,517
------------ ------------
Income (loss) before income taxes .............................. 5,855 (5,917)
Federal income tax benefit (provision) .......................... (2,105) 2,040
------------ ------------
Net income (loss) .............................................. $ 3,750 $ (3,877)
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 4
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(Amounts in thousands)
Three months ended June 30,
----------------------------
2005 2004
------------ ------------
Net income (loss) .............................................. $ 1,595 $ (3,297)
------------ ------------
Other comprehensive income (loss), before income tax:
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during period ....... 1,368 (3,004)
Less: Reclassification adjustment for gains included
in net income (loss) ......................................... (3) -
------------ ------------
Other comprehensive income (loss), before income tax ............ 1,365 (3,004)
Income tax benefit (provision) related to items of other
comprehensive income (loss) ................................... (464) 1,021
------------ ------------
Other comprehensive income (loss), net of income tax ............ 901 (1,983)
------------ ------------
Comprehensive income (loss) ..................................... $ 2,496 $ (5,280)
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 5
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(Amounts in thousands)
Six months ended June 30,
----------------------------
2005 2004
------------ ------------
Net income (loss) .............................................. $ 3,750 $ (3,877)
------------ ------------
Other comprehensive loss, before income tax:
Unrealized losses on securities:
Unrealized holding losses arising during period ............... (44) (2,070)
Less: Reclassification adjustment for gains
included in net income (loss) ................................ (3) (463)
------------ ------------
Other comprehensive loss, before income tax ..................... (47) (2,533)
Income tax benefit related to items of other
comprehensive income .......................................... 16 861
------------ ------------
Other comprehensive loss, net of income tax ..................... (31) (1,672)
------------ ------------
Comprehensive income (loss) ..................................... $ 3,719 $ (5,549)
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 6
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Amounts in thousands)
Six months ended June 30,
---------------------------
2005 2004
------------ ------------
OPERATING ACTIVITIES
Net income (loss) ...................................................... $ 3,750 $ (3,877)
Add (deduct):
Adjustments to reconcile net income (loss) to cash provided by
(applied to) operating activities:
Realized investment gains, net ........................................ (3) (463)
Gain on retirement of debentures ...................................... - (36)
Net gains on sale of property and equipment ........................... (5) (371)
Amortization and depreciation expense ................................. 737 750
Provision for non-collection of premiums .............................. 51 (32)
Provision for non-collection of reinsurance recoverables .............. 57 324
Net change in non-cash balances relating to operating activities:
Premiums receivable .................................................. (1,653) 1,342
Reinsurance recoverable on paid losses ............................... 343 4,936
Reinsurance recoverable on paid losses from related parties .......... 83 271
Reinsurance recoverable on unpaid losses ............................. 9,189 2,337
Reinsurance recoverable on unpaid losses from related parties ........ (965) (2,843)
Prepaid reinsurance premiums ......................................... 1,232 5,756
Prepaid reinsurance premiums to related parties ...................... 755 (1,954)
Deferred policy acquisition costs .................................... (1,024) (928)
Other assets ......................................................... 3,042 (1,506)
Unpaid losses and loss adjustment expenses ........................... (13,559) 10,727
Unearned premiums .................................................... (2,159) 1,627
Policyholder deposits ................................................ 151 (566)
Accrued taxes and other payables ..................................... 64 797
Premiums payable ..................................................... (1,612) (210)
Premiums payable to related parties .................................. 140 446
------------ ------------
Cash provided by (applied to) operating activities .................... (1,386) 16,527
------------ ------------
INVESTING ACTIVITIES
Unrestricted fixed maturities available for sale:
Purchases ............................................................. (3,977) (30,756)
Sales ................................................................. 2,091 12,176
Maturities ............................................................ 388 2,056
Equity securities available for sale:
Purchases ............................................................. (51) -
Cost of property and equipment purchased ............................... (258) (95)
Proceeds from sale of property and equipment ........................... 58 41
------------ ------------
Cash applied to investing activities .................................. (1,749) (16,578)
------------ ------------
FINANCING ACTIVITIES
Payment on retirement of debentures .................................... - (225)
Debt issue costs ....................................................... - (18)
Payments and loans from related parties ................................ 1,408 1,812
Payments and loans to related parties .................................. (615) (4,098)
------------ ------------
Cash provided by (applied to) financing activities ................... 793 (2,529)
------------ ------------
Decrease in cash and cash equivalents during the period ................. (2,342) (2,580)
Cash and cash equivalents at beginning of period ........................ 6,870 7,126
------------ ------------
Cash and cash equivalents at end of period .............................. $ 4,528 $ 4,546
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 7
CHANDLER (U.S.A.), INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
SIX MONTHS ENDED JUNE 30, 2005 AND 2004
(Unaudited)
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Chandler
(U.S.A.), Inc. ("Chandler USA") have been prepared in accordance with
generally accepted accounting principles for interim financial information and
with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. They do
not include all information and footnotes required by generally accepted
accounting principles for complete financial statements. However, except as
disclosed herein, there have been no material changes in the information
included in Chandler USA's Annual Report on Form 10-K for the year ended
December 31, 2004. In the opinion of management, all adjustments (consisting
of normal recurring adjustments) considered necessary for a fair presentation
have been included. The results of operations for the three and six month
periods ended June 30, 2005 are not necessarily indicative of the results that
may be expected for the year.
The consolidated financial statements include the accounts of Chandler
USA and all wholly owned subsidiaries that meet consolidation requirements
including National American Insurance Company ("NAICO") and Chandler Insurance
Managers, Inc.
NOTE 2. SEGMENT INFORMATION
Chandler USA has one reportable operating segment for property and
casualty insurance. Net premiums earned and losses and loss adjustment
expenses within the property and casualty segment can be identified to
Chandler USA designated insurance programs. Chandler USA's chief operating
decision makers review net premiums earned and losses and loss adjustment
expenses in assessing the performance of an insurance program. In addition,
Chandler USA's chief operating decision makers consider many other factors
such as the lines of business offered within an insurance program and the
states in which the insurance programs are offered. Certain discrete financial
information is not readily available by insurance program, including assets,
investment income, and investment gains or losses, allocated to each insurance
program. Chandler USA does not consider its insurance programs to be
reportable segments, however, the following supplemental information pertaining
to each insurance program's net premiums earned and losses and loss adjustment
expenses is presented for the property and casualty segment.
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- --------------------------
2005 2004 2005 2004
------------ ------------ ------------ ------------
(In thousands)
INSURANCE PROGRAM
- -----------------------------------------
NET PREMIUMS EARNED
Standard property and casualty .......... $ 13,934 $ 14,353 $ 27,949 $ 25,950
Political subdivisions .................. 1,700 1,759 3,477 3,445
Homeowners ............................. 449 - 449 -
Surety bonds ............................ 127 462 439 966
Other (1) ............................... 84 158 204 243
------------ ------------ ------------ ------------
$ 16,294 $ 16,732 $ 32,518 $ 30,604
============ ============ ============ ============
LOSSES AND LOSS ADJUSTMENT EXPENSES
Standard property and casualty .......... $ 7,801 $ 13,138 $ 14,257 $ 20,656
Political subdivisions .................. 1,302 1,327 2,159 3,752
Homeowners .............................. 325 - 325 -
Surety bonds ............................ (1,313) 473 (823) 873
Other (1) ............................... (388) 623 (291) 912
------------ ------------ ------------ ------------
$ 7,727 $ 15,561 $ 15,627 $ 26,193
============ ============ ============ ============
<FN>
- --------------------------------------------------------
(1) This program is comprised primarily of the run-off of other discontinued programs
and NAICO's participation in various mandatory workers compensation pools.
PAGE 8
NOTE 3. COMMITMENTS AND CONTINGENCIES
During March 2001, Chandler USA entered into a $3.8 million sale and
leaseback transaction for certain owned equipment for a three year term.
During March 2004, the lease was extended for an additional three years with
monthly rental installments equal to the sum of (i) $17,512 plus (ii) interest
on the unpaid lease balance at a floating interest rate of 1% over JP Morgan
Chase Bank prime, which was 6.25% at June 30, 2005. Chandler USA has the
option to repurchase the equipment at the end of the lease for approximately
$2.4 million (the "Balloon Payment"), or may elect to have the lessor sell the
equipment. If the election to sell the equipment is made, Chandler USA would
retain any proceeds exceeding the Balloon Payment. If the proceeds were less
than the Balloon Payment, Chandler USA would be required to pay the difference
between the proceeds and the Balloon Payment, not to exceed approximately $1.9
million.
Chandler USA has guaranteed the obligations of Chandler Capital Trust I
and Chandler Capital Trust II (the "Capital Trusts"). The Capital Trusts are
wholly owned non-consolidated subsidiaries of Chandler USA that have a total
of $20.0 million of trust preferred securities outstanding. Chandler USA
guarantees payment of distributions and the redemption price of the trust
preferred securities until the securities are redeemed in full.
NOTE 4. NEW ACCOUNTING STANDARDS
In December 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 153, EXCHANGES OF
NONMONETARY ASSETS - AN AMENDMENT OF APB OPINION NO. 29. SFAS No. 153 amends
APB Opinion No. 29 to eliminate the exception for nonmonetary exchanges of
similar productive assets and replaces it with a general exception for
exchanges of nonmonetary assets that do not have commercial substance. SFAS
No. 153 is to be applied prospectively for nonmonetary exchanges occurring in
fiscal periods beginning after June 15, 2005. The adoption of SFAS No. 153 is
not expected to have a material impact on Chandler USA's financial position or
results of operations.
In May 2005, the FASB issued SFAS No. 154, ACCOUNTING CHANGES AND ERROR
CORRECTIONS which replaces APB Opinion No. 20, ACCOUNTING CHANGES and FASB
Statement 3, REPORTING ACCOUNTING CHANGES IN INTERIM FINANCIAL STATEMENTS.
This statement changes the requirements for the accounting for and reporting
of a change in accounting principle. This statement applies to all voluntary
changes in accounting principles. It also applies to changes required by an
accounting pronouncement in the unusual instance that the pronouncement does
not include specific transition provisions. This statement requires voluntary
changes in accounting principles be recognized retrospectively to prior
periods' financial statements, rather than recognition in the net income of
the current period. Retrospective application requires restatements of prior
period financial statements as if that accounting principle had always been
used. This statement carries forward without change the guidance contained in
Opinion 20 for reporting the correction of an error in previously issued
financial statements and a change in accounting estimate. The provisions of
SFAS No. 154 are effective for accounting changes and corrections of errors
made in fiscal years beginning after December 15, 2005.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
Some of the statements made in this Form 10-Q report, as well as
statements made by Chandler (U.S.A.), Inc. ("Chandler USA") in periodic press
releases and oral statements made by Chandler USA's officials constitute
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. Such forward-looking statements involve known
and unknown risks, uncertainties and other factors that may cause the actual
results, performance or achievements of Chandler USA to be materially different
from any future results, performance or achievements expressed or implied by
the forward-looking statements. Such factors include, among other things,
(i) general economic and business conditions; (ii) interest rate changes;
(iii) competition and regulatory environment in which Chandler USA and its
subsidiaries operate, including the ability to implement price increases;
(iv) claims frequency; (v) claims severity; (vi) catastrophic events of
unanticipated frequency or severity; (vii) the number of new and renewal policy
applications submitted to National American Insurance Company ("NAICO") by its
agents; (viii) the ability of NAICO to obtain adequate reinsurance in amounts
and at rates that will not adversely affect its competitive position; (ix) the
ability of NAICO to collect reinsurance recoverables; (x) the ability of NAICO
to maintain favorable insurance company ratings; and (xi) various other factors.
PAGE 9
RESULTS OF OPERATIONS
PREMIUMS EARNED
The following table sets forth premiums earned on a gross basis (before
reductions for premiums ceded to reinsurers) and on a net basis (after such
reductions) for each insurance program for the three and six month periods
ended June 30, 2005 and 2004:
GROSS PREMIUMS EARNED NET PREMIUMS EARNED
--------------------------- --------------------------
THREE MONTHS ENDED JUNE 30, 2005 2004 2005 2004
------------------------------------ ------------ ------------ ------------ ------------
(In thousands)
Standard property and casualty ..... $ 23,458 $ 22,856 $ 13,934 $ 14,353
Political subdivisions ............. 4,819 5,494 1,700 1,759
Homeowners ......................... 518 - 449 -
Surety bonds ....................... 181 645 127 462
Other .............................. 84 158 84 158
------------ ------------ ------------ ------------
TOTAL .............................. $ 29,060 $ 29,153 $ 16,294 $ 16,732
============ ============ ============ ============
GROSS PREMIUMS EARNED NET PREMIUMS EARNED
--------------------------- --------------------------
SIX MONTHS ENDED JUNE 30, 2005 2004 2005 2004
------------------------------------ ------------ ------------ ------------ ------------
(In thousands)
Standard property and casualty ..... $ 47,135 $ 45,532 $ 27,949 $ 25,950
Political subdivisions ............. 9,836 11,254 3,477 3,445
Homeowners ......................... 518 - 449 -
Surety bonds ....................... 625 1,331 439 966
Other .............................. 206 243 204 243
------------ ------------ ------------ ------------
TOTAL .............................. $ 58,320 $ 58,360 $ 32,518 $ 30,604
============ ============ ============ ============
Gross premiums earned decreased $93,000 or less than 1% and $40,000 or
less than 1% in the second quarter and first six months of 2005, respectively,
compared to the 2004 periods. Gross premiums earned in Oklahoma decreased
$278,000 and $965,000 in the second quarter and first six months of 2005,
respectively, from the 2004 periods, and gross premiums earned in Texas
decreased $657,000 and $109,000 in these periods. The decreases in Oklahoma
and Texas were partially offset by an increase in gross premiums earned in New
Mexico of $535,000 and $1.1 million for the second quarter and first six months
of 2005, respectively, from the 2004 periods. Net premiums earned decreased
$438,000 or 3% and increased $1.9 million or 6% for the second quarter and
first six months of 2005, respectively. The increase for the first six months
of 2005 is due primarily to changes in NAICO's excess of loss reinsurance
program covering its casualty and workers compensation risks. Effective April
1, 2004, NAICO increased its net retention to include 56% of the layer covering
$500,000 excess $500,000 of loss per occurrence for its casualty and workers
compensation risks from 70% of the first $500,000 of loss per occurrence.
Effective July 1, 2004, NAICO increased its net retention to 70% of the first
$1,000,000 of loss per occurrence. Casualty and workers compensation risks
accounted for approximately 77% of NAICO's gross premiums earned in the first
six months of 2005. These reinsurance changes increased NAICO's net retention
for these lines of business and also increased net premiums earned.
Gross premiums earned in the standard property and casualty program
increased $602,000 or 3% and $1.6 million or 4% in the second quarter and first
six months of 2005, respectively, compared to the 2004 periods. Gross premiums
earned in Texas decreased $891,000 and $123,000 in the second quarter and first
six months of 2005, respectively, compared to the 2004 periods while gross
premiums earned in Oklahoma increased $485,000 and $478,000 in the respective
periods compared to the 2004 periods. The increase in gross premiums earned in
New Mexico, described above, partially offsets the decrease in gross premiums
earned in Texas. Net premiums earned in this program decreased $419,000 or 3%
and increased $2.0 million or 8% in the second quarter and first six months of
2005, respectively, compared to the 2004 periods. The increase in the first
six months of 2005 is due primarily to the reinsurance changes described above.
Casualty and workers compensation risks accounted for approximately 87% of
NAICO's gross premiums earned in this program in the first six months of 2005.
PAGE 10
Gross premiums earned in the political subdivisions program decreased
$675,000 or 12% and $1.4 million or 13% in the second quarter and first six
months of 2005, respectively, compared to the 2004 periods. The decrease in
gross premiums earned is due primarily to increased competition in the school
districts portion of the program in Oklahoma. Net premiums earned in this
program decreased $59,000 or 3% and increased $32,000 or 1% in the second
quarter and first six months of 2005, respectively. Casualty and workers
compensation risks accounted for approximately 34% of NAICO's gross premiums
earned in this program in the first six months of 2005.
In the second quarter of 2005, NAICO began writing homeowner and dwelling
policies in the state of Texas through a general agent. NAICO expects premiums
earned in this program to increase during the remainder of 2005.
Gross premiums earned in the surety bond program decreased $464,000 or 72%
and $706,000 or 53% in the second quarter and first six months of 2005,
respectively, compared to the 2004 periods. Gross premiums earned in the bail
bond portion of the program, which was discontinued in 2003, decreased $30,000
and $113,000 in the second quarter and first six months of 2005, respectively.
Net premiums earned in the surety bond program decreased $335,000 or 73% and
$527,000 or 55% in the second quarter and first six months of 2005,
respectively. NAICO is no longer actively writing surety business, and expects
premium volume to decline substantially in 2005.
NET INVESTMENT INCOME AND NET REALIZED INVESTMENT GAINS
At June 30, 2005, Chandler USA's investment portfolio consisted primarily
of fixed income U.S. Treasury and government agency bonds, high-quality
corporate bonds and mutual funds that invest in equity securities, with
approximately 5% invested in cash and money market instruments. Income
generated from this portfolio is largely dependent upon prevailing levels of
interest rates. Chandler USA's portfolio contains no non-investment grade
bonds or real estate investments. Chandler USA also receives interest income
from related parties on intercompany loans.
Net investment income, excluding interest income from related parties,
increased $42,000 or 7% and decreased $424,000 or 24% in the second quarter and
first six months of 2005, respectively. The decrease in the six month period
was due primarily to an arbitration award in favor of NAICO in the first
quarter of 2004 that included approximately $577,000 in interest. Excluding
the arbitration award, net investment income increased $153,000 or 13% in the
six month period. Cash and invested assets were $85.8 million at June 30,
2005 compared to $80.8 million at June 30, 2004. Net interest income from
related parties increased $54,000 or 50% and $103,000 or 49% in the second
quarter and first six months of 2005, respectively, due primarily to higher
interest rates during 2005.
Chandler USA had net realized investment gains of $3,000 during the second
quarter of 2005 compared to no net realized investment gains during the second
quarter of 2004. Net realized investment gains were $3,000 during the first
six months of 2005 compared to $463,000 during the first six months of 2004.
OTHER INCOME
Chandler USA's other income included $368,000 in the first six months of
2004 for the amortization of the deferred gain related to a sale and leaseback
transaction. No amortization was recorded in 2005 as the deferred gain was
fully amortized at March 31, 2004.
LOSSES AND LOSS ADJUSTMENT EXPENSES
Chandler USA estimates losses and loss adjustment expenses based on
historical experience and payment and reporting patterns for the type of risk
involved. These estimates are based on data available at the time of the
estimate and are periodically reviewed by independent professional actuaries.
Although such estimates are management's best estimates of the expected values,
the ultimate liability for unpaid claims may vary from these values.
PAGE 11
The percentage of losses and loss adjustment expenses to net premiums
earned ("loss ratio") was 47.4% and 48.1% for the second quarter and first six
months of 2005, compared to 93.0% and 85.6% in the corresponding 2004 periods.
The decrease in the 2005 loss ratios was due to a decrease in losses incurred
related to prior accident years. For the second quarter and first six months
of 2004, losses and loss adjustment expenses incurred related to prior accident
years were $9.0 million and $12.8 million, respectively, and increased the
respective loss ratios by 53.7 and 41.9 percentage points. The adverse loss
development during 2004 was generally the result of ongoing analysis of loss
development trends that reflected an increase in loss severity in the workers
compensation and liability lines for NAICO's standard property and casualty
program, primarily in the 1997-2001 accident years. During 2005, adverse loss
development totaling $876,000 and $1.8 million for the second quarter and first
six months of 2005, respectively, increased the respective loss ratios by 5.4
and 5.6 percentage points. The adverse loss development in 2005 was due
primarily to an increase in losses for prior accident years in the standard
property and casualty program and the political subdivisions program. This was
partially offset by a reduction in losses for prior accident years in the
surety bond program.
Weather-related losses from wind and hail totaled $48,000 and $110,000 in
the second quarter and first six months of 2005 and increased the respective
loss ratios by less than 1.0 percentage point. Weather-related losses totaled
$173,000 and $316,000 in the second quarter and first six months of 2004, and
increased the respective 2004 loss ratios by 1.0 percentage point.
POLICY ACQUISITION COSTS
Policy acquisition costs consist of costs associated with the acquisition
of new and renewal business and generally include direct costs such as premium
taxes, commissions to agents and ceding companies and premium-related
assessments and indirect costs such as salaries and expenses of personnel who
perform and support underwriting activities. NAICO also receives ceding
commissions from the reinsurers who assume premiums from NAICO under certain
reinsurance contracts and the ceding commissions are accounted for as a
reduction of policy acquisition costs. Direct policy acquisition costs and
ceding commissions are deferred and amortized over the terms of the policies.
When the sum of anticipated losses, loss adjustment expenses and unamortized
policy acquisition costs exceeds the related unearned premiums, including
anticipated investment income, a provision for the indicated deficiency is
recorded.
The following table sets forth Chandler USA's policy acquisition costs for
each of the three and six month periods ended June 30, 2005 and 2004:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------- ----------------------
2005 2004 2005 2004
---------- ---------- ---------- ----------
(In thousands)
Commissions expense ....................... $ 3,709 $ 3,844 $ 7,593 $ 8,144
Other premium related assessments ......... 223 268 444 564
Premium taxes ............................. 585 653 1,326 1,387
Excise taxes .............................. 54 81 133 149
Dividends to policyholders ................ - - - -
Other expense ............................. 182 119 351 183
---------- ---------- ---------- ----------
Total direct expenses ..................... 4,753 4,965 9,847 10,427
Indirect underwriting expenses ............ 1,621 1,925 3,342 3,803
Commissions received from reinsurers ...... (2,895) (2,846) (6,975) (7,528)
Adjustment for deferred acquisition costs.. (641) (778) (1,024) (928)
---------- ---------- ---------- ----------
Net policy acquisition costs .............. $ 2,838 $ 3,266 $ 5,190 $ 5,774
========== ========== ========== ==========
Total gross direct and indirect expenses as a percentage of direct written
and assumed premiums were 26.0% and 23.5% for the second quarter and first six
months of 2005, compared to 24.3% and 23.7% in the corresponding year ago
periods. Commission expense as a percentage of gross written and assumed
premiums was 15.1% and 13.5% in the second quarter and the first six months of
2005 compared to 13.6% in both corresponding 2004 periods. The percentage
increase in the second quarter of 2005 compared to 2004 is due primarily to the
new homeowners program that began during the second quarter of 2005. This new
program has a higher average commission rate than most of the other programs
due to the use of a general agent who performs certain underwriting, claims
and administrative functions.
PAGE 12
Indirect underwriting expenses were 6.6% and 6.0% of total direct written
and assumed premiums in the second quarter and first six months of 2005,
respectively, compared to 6.8% and 6.3% in the corresponding 2004 periods.
Indirect expenses include general overhead and administrative costs associated
with the acquisition of new and renewal business, some of which is relatively
fixed in nature, thus, the percentage of such expenses to direct written and
assumed premiums will vary depending on Chandler USA's overall premium volume.
Commissions received from reinsurers as a percent of ceded reinsurance premiums
were 28.6% and 29.3% in the second quarter and first six months of 2005,
respectively, compared to 35.3% and 31.4% in the corresponding 2004 periods.
The percentage decrease in 2005 compared to the respective periods in 2004 is
due primarily to a decrease in premiums ceded during 2005 under a quota share
reinsurance contract with Chandler Insurance Company, Ltd. ("Chandler
Insurance"). Quota share reinsurance contracts typically have a ceding
commission while excess of loss reinsurance contracts generally do not.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses were 12.1% and 11.0% of gross premiums
earned in the second quarter and first six months of 2005, respectively,
compared to 10.5% and 10.9% for the corresponding 2004 periods. General and
administrative expenses increased $473,000 in the second quarter of 2005
compared to the corresponding 2004 period due primarily to an increase in legal
expense and employee related expenses. During the second quarter of 2004,
Chandler USA received a recovery of previously expensed legal costs of $167,000
from Chandler USA's previous director and officer liability insurer. General
and administrative expenses have historically not varied in direct proportion
to Chandler USA's revenues. A portion of such expenses is allocated to policy
acquisition costs (indirect underwriting expenses) and loss and loss adjustment
expenses based on various factors including employee counts, salaries,
occupancy and specific identification. Because certain types of expenses are
fixed in nature, the percentage of such expenses to revenues will vary
depending on Chandler USA's overall premium volume.
INTEREST EXPENSE
Interest expense increased $36,000 and $57,000 in the second quarter and
first six months of 2005, respectively, compared to the 2004 periods.
Substantially all of Chandler USA's interest expense is related to its
outstanding senior debentures and junior subordinated debentures.
LIQUIDITY AND CAPITAL RESOURCES
In the first six months of 2005, Chandler USA used $1.4 million in cash
from operations due primarily to the payment of losses from prior accident
years. Unpaid losses and loss adjustment expenses decreased $13.6 million
during the first six months of 2005. This was partially offset by a decrease
in reinsurance recoverable on unpaid losses of $9.2 million. In the first six
months of 2004, Chandler USA provided $16.5 million in cash from operations.
At June 30, 2005, Chandler Insurance owed approximately $10.1 million to
Chandler USA versus $10.9 million at December 31, 2004 under an Intercompany
Credit Agreement (the "Credit Agreement") covering intercompany loans between
the parties. The Credit Agreement requires interest to be paid at the prime
interest rate published in the Wall Street Journal each month, and balances
owed by either party are payable at any time upon demand.
During March 2001, Chandler USA entered into a $3.8 million sale and
leaseback transaction for certain owned equipment for a three year term.
During March 2004, the lease was extended for an additional three years with
monthly rental installments equal to the sum of (i) $17,512 plus (ii) interest
on the unpaid lease balance at a floating interest rate of 1% over JP Morgan
Chase Bank prime, which was 6.25% at June 30, 2005. Chandler USA has the
option to repurchase the equipment at the end of the lease for approximately
$2.4 million (the "Balloon Payment"), or may elect to have the lessor sell
the equipment. If the election to sell the equipment is made, Chandler USA
would retain any proceeds exceeding the Balloon Payment. If the proceeds were
less than the Balloon Payment, Chandler USA would be required to pay the
difference between the proceeds and the Balloon Payment, not to exceed
approximately $1.9 million.
PAGE 13
Chandler USA is a holding company receiving cash principally through
borrowings, subsidiary dividends and other payments, subject to various
regulatory restrictions. The capacity of insurance companies to write
insurance is based on maintaining liquidity and capital resources sufficient
to pay claims and expenses as they become due. The primary sources of
liquidity for Chandler USA's subsidiaries are funds generated from insurance
premiums, investment income, capital contributions from Chandler USA and
proceeds from sales and maturities of portfolio investments. The principal
expenditures are payment of losses and loss adjustment expenses, insurance
operating expenses and commissions.
A significant portion of Chandler USA's consolidated assets represents
assets of NAICO that may not be immediately transferable to Chandler USA in the
form of shareholder dividends, loans, advances or other payments.
Statutes and regulations governing NAICO and other insurance companies
domiciled in Oklahoma regulate the payment of shareholder dividends and other
payments by NAICO to Chandler USA. Under applicable Oklahoma statutes and
regulations, NAICO is permitted to pay shareholder dividends only out of
statutory earned surplus. To the extent NAICO has statutory earned surplus,
NAICO may pay shareholder dividends only to the extent that such dividends are
not defined as extraordinary dividends or distributions. If the dividends are,
under applicable statutes and regulations, extraordinary dividends or
distributions, regulatory approval must be obtained. Under the applicable
Oklahoma statute, and subject to the availability of statutory earned surplus,
the maximum shareholder dividend that may be declared (or cash or property
distribution that may be made) by NAICO in any one calendar year without
regulatory approval is the greater of (i) NAICO's statutory net income,
excluding realized capital gains, for the preceding calendar year; or (ii) 10%
of NAICO's statutory policyholders' surplus as of the preceding calendar year
end, not to exceed NAICO's statutory earned surplus.
As of December 31, 2004, NAICO had statutory earned surplus of $3.8
million. Applying the Oklahoma statutory limits described above, the maximum
shareholder dividend NAICO may pay in 2005 without the approval of the Oklahoma
Department of Insurance is $3.8 million. NAICO paid shareholder dividends to
Chandler USA totaling $3.4 million in June of 2004. NAICO did not pay any
shareholder dividends to Chandler USA in the first six months of 2005.
In addition to the statutory limits described above, the amount of
shareholder dividends and other payments to affiliates can be further limited
by contractual or regulatory restrictions or other agreements with regulatory
authorities restricting dividends and other payments, including regulatory
restrictions that are imposed as a matter of administrative policy. If
insurance regulators determine that payment of a shareholder dividend or other
payments to an affiliate (such as payments under a tax sharing agreement,
payments for employee or other services, or payments pursuant to a surplus
note) would be hazardous to such insurance company's policyholders or
creditors, the regulators may block such payments that would otherwise be
permitted without prior approval.
Historically, NAICO has played a significant role in the servicing of debt
and other obligations of Chandler USA through the payment of shareholder
dividends. Management's expectation is that Chandler Insurance or other
subsidiaries will be able to meet these obligations in the future. It is
possible that dividends from NAICO may be necessary to service Chandler USA's
debt obligations. To the extent that the restrictions discussed previously
limit NAICO's ability to pay shareholder dividends or other payments to
Chandler USA, Chandler USA's ability to satisfy the debt obligations may also
be limited.
A.M. BEST RATING
Effective June 21, 2005, A.M. Best Company downgraded the financial
strength rating to B+ (Very Good) from B++ (Very Good) of NAICO and revised its
outlook to negative from stable. Concurrently, A.M. Best assigned an issuer
credit rating (ICR) of "bb-" to NAICO's parent, Chandler USA, and a debt rating
of "bb-" to Chandler USA's 8.75% senior unsecured debentures due 2014. The ICR
and senior debt ratings were assigned a negative outlook.
These rating actions follow the net loss and decline in surplus in 2004
driven by adverse loss reserve development on prior accident years. Most of
this development stems from accident years 1997 through 2001, a period of
growth and expansion into Texas.
PAGE 14
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
As of the end of the period covered by this report and pursuant to Rule
13a-15 of the Securities Exchange Act of 1934 (the "Exchange Act"), Chandler
USA's management, including the Chief Executive Officer and Chief Financial
Officer, conducted an evaluation of the effectiveness and design of Chandler
USA's disclosure controls and procedures (as that term is defined in Rules
13a-15(e) and 15d-15(e) of the Exchange Act). Based upon that evaluation,
Chandler USA's Chief Executive Officer and Chief Financial Officer concluded,
as of the end of the period covered by this report, that Chandler USA's
disclosure controls and procedures were effective in recording, processing,
summarizing and reporting information required to be disclosed by Chandler USA,
within the time periods specified in the Securities and Exchange Commission's
rules and forms.
CHANGES IN INTERNAL CONTROLS
In addition and as of the end of the period covered by this report, there
have been no changes in internal control over financial reporting (as defined
in Rule 13a-15(f) and 15d-15(f) of the Exchange Act) during the quarter to
which this report relates that have materially affected or are reasonably
likely to materially affect, the internal control over financial reporting.
PAGE 15
PART II. OTHER INFORMATION
-----------------
Item 1. Legal Proceedings
-----------------
Chandler USA and its subsidiaries are not parties to any material
litigation other than as is routinely encountered in their respective
business activities. While the outcome of these matters cannot be
predicted with certainty, Chandler USA does not expect these matters
to have a material adverse effect on its financial condition, results
of operations or cash flows.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
-----------------------------------------------------------
None.
Item 3. Defaults Upon Senior Securities
-------------------------------
None.
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
Effective May 10, 2005, Chandler USA's sole shareholder, Chandler
Insurance, re-elected the following individuals to serve on Chandler
USA's Board of Directors:
W. Brent LaGere W. Scott Martin
Mark T. Paden Robert L. Rice
R. Patrick Gilmore William Thomas Keele
Richard L. Evans
Item 5. Other Information
-----------------
None.
Item 6. Exhibits
--------
31.1 Rule 13a-14(a)/15d-14(a) Certifications.
32.1 Section 1350 Certifications.
PAGE 16
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: August 9, 2005 CHANDLER (U.S.A.), INC.
By: /s/ W. Brent LaGere
------------------------------------
W. Brent LaGere
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
By: /s/ Mark C. Hart
------------------------------------
Mark C. Hart
Vice President - Finance, Chief
Financial Officer and Treasurer
(Principal Accounting Officer)