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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 SEPTEMBER 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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Indicate by check mark whether the registrant is a shell company (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
October 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 September 30, 2005 and December 31, 2004 .. 1
Consolidated Statements of Operations for the three months
ended September 30, 2005 and 2004 ...................................... 2
Consolidated Statements of Operations for the nine months
ended September 30, 2005 and 2004 ...................................... 3
Consolidated Statements of Comprehensive Income for the three
months ended September 30, 2005 and 2004 ............................... 4
Consolidated Statements of Comprehensive Income for the nine
months ended September 30, 2005 and 2004 ............................... 5
Consolidated Statements of Cash Flows for the nine months
ended September 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)
September 30, December 31,
2005 2004
------------- --------------
(Unaudited)
ASSETS
Investments
Fixed maturities available for sale, at fair value
Restricted (amortized cost $8,375 and $8,421 in 2005 and 2004, respectively) ....... $ 8,097 $ 8,279
Unrestricted (amortized cost $64,482 and $63,636 in 2005 and 2004, respectively) ... 63,182 63,391
Equity securities at fair value (cost $8,136 and $8,058 in
2005 and 2004, respectively) ....................................................... 8,790 8,373
------------- --------------
Total investments .................................................................. 80,069 80,043
Cash and cash equivalents ($141 and $141 restricted in 2005 and 2004, respectively) .. 3,984 6,870
Premiums receivable, less allowance for non-collection
of $163 and $119 at 2005 and 2004, respectively .................................... 27,640 22,809
Reinsurance recoverable on paid losses, less allowance for
non-collection of $3,166 and $3,035 at 2005 and 2004, respectively .................. 3,234 2,172
Reinsurance recoverable on paid losses from related parties .......................... - 83
Reinsurance recoverable on unpaid losses, less allowance for
non-collection of $194 and $237 at 2005 and 2004, respectively ...................... 58,108 50,381
Reinsurance recoverable on unpaid losses from related parties ........................ 14,417 13,157
Prepaid reinsurance premiums ......................................................... 10,901 9,837
Prepaid reinsurance premiums to related parties ...................................... 12,124 12,315
Deferred policy acquisition costs .................................................... 683 57
Property and equipment, net .......................................................... 8,826 9,110
Amounts due from related parties ..................................................... 9,776 10,891
State insurance licenses, net ........................................................ 3,745 3,745
Other assets ......................................................................... 12,873 15,827
------------- --------------
Total assets ......................................................................... $ 246,380 $ 237,297
============= ==============
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities
Unpaid losses and loss adjustment expenses .......................................... $ 112,636 $ 108,233
Unearned premiums ................................................................... 55,155 51,109
Policyholder deposits ............................................................... 5,224 4,912
Accrued taxes and other payables .................................................... 3,694 5,578
Premiums payable .................................................................... 2,376 3,674
Premiums payable to related parties ................................................. 65 -
Senior debentures ................................................................... 6,979 6,979
Junior subordinated debentures issued to affiliated trusts .......................... 20,620 20,620
------------- --------------
Total liabilities .................................................................. 206,749 201,105
------------- --------------
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 ................................................................. (20,345) (24,346)
Accumulated other comprehensive income (loss):
Unrealized loss on investments available for sale, net of deferred income taxes .... (610) (48)
------------- --------------
Total shareholder's equity ......................................................... 39,631 36,192
------------- --------------
Total liabilities and shareholder's equity ........................................... $ 246,380 $ 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 September 30,
--------------------------------
2005 2004
------------ ------------
Premiums and other revenues
Direct premiums written and assumed ............................ $ 35,156 $ 38,228
Reinsurance premiums ceded ..................................... (7,862) (7,778)
Reinsurance premiums ceded to related parties .................. (7,224) (9,305)
------------ ------------
Net premiums written and assumed .............................. 20,070 21,145
Increase in unearned premiums .................................. (3,344) (4,071)
------------ ------------
Net premiums earned ........................................... 16,726 17,074
Investment income, net .......................................... 705 715
Interest income, net from related parties ....................... 175 138
Realized investment gains, net .................................. - 3
Other income .................................................... 76 50
------------ ------------
Total premiums and other revenues ............................. 17,682 17,980
------------ ------------
Operating costs and expenses
Losses and loss adjustment expenses, net of amounts
ceded to related parties of $3,025 and $2,485 in
2005 and 2004, respectively ................................... 11,073 13,389
Policy acquisition costs, net of ceding commissions
received from related parties of $2,928 and $3,652 in
2005 and 2004, respectively ................................... 2,326 2,900
General and administrative expenses ............................ 3,183 2,743
Interest expense ............................................... 640 601
------------ ------------
Total operating costs and expenses ............................ 17,222 19,633
------------ ------------
Income (loss) before income taxes ............................... 460 (1,653)
Federal income tax benefit (provision) .......................... (209) 475
------------ ------------
Net income (loss) .............................................. $ 251 $ (1,178)
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 3
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Amounts in thousands)
Nine months ended September 30,
-------------------------------
2005 2004
------------ ------------
Premiums and other revenues
Direct premiums written and assumed ............................ $ 91,318 $ 98,215
Reinsurance premiums ceded ..................................... (18,392) (16,850)
Reinsurance premiums ceded to related parties .................. (20,509) (24,187)
------------ ------------
Net premiums written and assumed .............................. 52,417 57,178
Increase in unearned premiums .................................. (3,173) (9,500)
------------ ------------
Net premiums earned ........................................... 49,244 47,678
Investment income, net .......................................... 2,057 2,491
Interest income, net from related parties ....................... 489 349
Realized investment gains, net .................................. 3 466
Other income .................................................... 199 596
------------ ------------
Total premiums and other revenues ............................. 51,992 51,580
------------ ------------
Operating costs and expenses
Losses and loss adjustment expenses, net of amounts
ceded to related parties of $10,359 and $10,455 in
2005 and 2004, respectively ................................... 26,700 39,582
Policy acquisition costs, net of ceding commissions
received from related parties of $7,953 and $9,292 in
2005 and 2004, respectively ................................... 7,516 8,674
General and administrative expenses ............................ 9,576 9,105
Interest expense ............................................... 1,885 1,789
------------ ------------
Total operating costs and expenses ............................ 45,677 59,150
------------ ------------
Income (loss) before income taxes ............................... 6,315 (7,570)
Federal income tax benefit (provision) .......................... (2,314) 2,515
------------ ------------
Net income (loss) .............................................. $ 4,001 $ (5,055)
============ ============
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 September 30,
--------------------------------
2005 2004
------------ ------------
Net income (loss) .............................................. $ 251 $ (1,178)
------------ ------------
Other comprehensive income (loss), before income tax:
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during period ....... (805) 1,830
Less: Reclassification adjustment for gains included
in net income (loss) ......................................... - (3)
------------ ------------
Other comprehensive income (loss), before income tax ............ (805) 1,827
Income tax benefit (provision) related to items of other
comprehensive income (loss) .................................... 274 (621)
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Other comprehensive income (loss), net of income tax ............ (531) 1,206
------------ ------------
Comprehensive income (loss) ..................................... $ (280) $ 28
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 5
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(Amounts in thousands)
Nine months ended September 30,
-------------------------------
2005 2004
------------ ------------
Net income (loss) .............................................. $ 4,001 $ (5,055)
------------ ------------
Other comprehensive loss, before income tax:
Unrealized losses on securities:
Unrealized holding losses arising during period ............... (849) (240)
Less: Reclassification adjustment for gains
included in net income (loss) ................................ (3) (466)
------------ ------------
Other comprehensive loss, before income tax ..................... (852) (706)
Income tax benefit related to items of other
comprehensive income ........................................... 290 240
------------ ------------
Other comprehensive loss, net of income tax ..................... (562) (466)
------------ ------------
Comprehensive income (loss) ..................................... $ 3,439 $ (5,521)
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 6
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Amounts in thousands)
Nine months ended September 30,
-------------------------------
2005 2004
------------ ------------
OPERATING ACTIVITIES
Net income (loss) ...................................................... $ 4,001 $ (5,055)
Add (deduct):
Adjustments to reconcile net income (loss) to cash provided by
(applied to) operating activities:
Realized investment gains, net ........................................ (3) (466)
Gain on retirement of debentures ...................................... - (36)
Net gains on sale of property and equipment ........................... (2) (372)
Amortization and depreciation expense ................................. 1,114 1,135
Provision for non-collection of premiums .............................. 106 (14)
Provision for non-collection of reinsurance recoverables .............. 102 201
Net change in non-cash balances relating to operating activities:
Premiums receivable .................................................. (4,937) (7,417)
Reinsurance recoverable on paid losses ............................... (1,207) 6,092
Reinsurance recoverable on paid losses from related parties .......... 83 271
Reinsurance recoverable on unpaid losses ............................. (7,684) 731
Reinsurance recoverable on unpaid losses from related parties ........ (1,260) (2,143)
Prepaid reinsurance premiums ......................................... (1,064) 3,920
Prepaid reinsurance premiums to related parties ...................... 191 (4,094)
Deferred policy acquisition costs .................................... (626) (267)
Other assets ......................................................... 3,202 (1,590)
Unpaid losses and loss adjustment expenses ........................... 4,403 14,530
Unearned premiums .................................................... 4,046 9,674
Policyholder deposits ................................................ 312 (188)
Accrued taxes and other payables ..................................... (1,885) 2,082
Premiums payable ..................................................... (1,298) 759
Premiums payable to related parties .................................. 65 324
------------ ------------
Cash provided by (applied to) operating activities .................... (2,341) 18,077
------------ ------------
INVESTING ACTIVITIES
Unrestricted fixed maturities available for sale:
Purchases ............................................................. (3,976) (30,756)
Sales ................................................................. 2,091 13,683
Maturities ............................................................ 622 3,857
Equity securities available for sale:
Purchases ............................................................. (78) (2,500)
Cost of property and equipment purchased ............................... (389) (113)
Proceeds from sale of property and equipment ........................... 70 47
------------ ------------
Cash applied to investing activities .................................. (1,660) (15,782)
------------ ------------
FINANCING ACTIVITIES
Payment on retirement of debentures .................................... - (226)
Debt issue costs ....................................................... - (18)
Payments and loans from related parties ................................ 1,921 3,173
Payments and loans to related parties .................................. (806) (4,578)
------------ ------------
Cash provided by (applied to) financing activities .................... 1,115 (1,649)
------------ ------------
Increase (decrease) in cash and cash equivalents during the period ...... (2,886) 646
Cash and cash equivalents at beginning of period ........................ 6,870 7,126
------------ ------------
Cash and cash equivalents at end of period .............................. $ 3,984 $ 7,772
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 7
CHANDLER (U.S.A.), INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED SEPTEMBER 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 nine month
periods ended September 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 SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- -------------------------------
2005 2004 2005 2004
------------ ------------ ------------ ------------
(In thousands)
INSURANCE PROGRAM
- ---------------------------------
NET PREMIUMS EARNED
Standard property and casualty .. $ 13,619 $ 14,462 $ 41,568 $ 40,412
Political subdivisions .......... 1,687 1,975 5,164 5,420
Homeowners ...................... 1,200 - 1,649 -
Surety bonds .................... 121 526 561 1,492
Other (1) ....................... 99 111 302 354
------------ ------------ ------------ ------------
$ 16,726 $ 17,074 $ 49,244 $ 47,678
============ ============ ============ ============
LOSSES AND LOSS ADJUSTMENT EXPENSES
Standard property and casualty .. $ 10,518 $ 11,388 $ 24,775 $ 32,110
Political subdivisions .......... 996 1,273 3,155 5,037
Homeowners ...................... 305 - 630 -
Surety bonds .................... (897) 607 (1,720) 1,480
Other (1) ....................... 151 121 (140) 955
------------ ------------ ------------ ------------
$ 11,073 $ 13,389 $ 26,700 $ 39,582
============ ============ ============ ============
<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 6.75% at September 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 nine month periods
ended September 30, 2005 and 2004:
GROSS PREMIUMS EARNED NET PREMIUMS EARNED
--------------------------- --------------------------
THREE MONTHS ENDED SEPTEMBER 30, 2005 2004 2005 2004
------------------------------------ ------------ ------------ ------------ ------------
(In thousands)
Standard property and casualty ...... $ 22,588 $ 23,997 $ 13,619 $ 14,462
Political subdivisions .............. 4,596 5,323 1,687 1,975
Homeowners .......................... 1,494 - 1,200 -
Surety bonds ........................ 172 748 121 526
Other ............................... 101 112 99 111
------------ ------------ ------------ ------------
TOTAL .............................. $ 28,951 $ 30,180 $ 16,726 $ 17,074
============ ============ ============ ============
GROSS PREMIUMS EARNED NET PREMIUMS EARNED
--------------------------- --------------------------
NINE MONTHS ENDED SEPTEMBER 30, 2005 2004 2005 2004
------------------------------------ ------------ ------------ ------------ ------------
(In thousands)
Standard property and casualty ..... $ 69,723 $ 69,529 $ 41,568 $ 40,412
Political subdivisions ............. 14,432 16,578 5,164 5,420
Homeowners ......................... 2,012 - 1,649 -
Surety bonds ....................... 798 2,079 561 1,492
Other .............................. 307 354 302 354
------------ ------------ ------------ ------------
TOTAL ............................. $ 87,272 $ 88,540 $ 49,244 $ 47,678
============ ============ ============ ============
Gross premiums earned decreased $1.2 million or 4% and $1.3 million or 1%
in the third quarter and first nine months of 2005, respectively, compared to
the 2004 periods. Gross premiums earned in Oklahoma decreased $850,000 and
$1.8 million in the third quarter and first nine months of 2005, respectively,
from the 2004 periods, and gross premiums earned in Texas decreased $1.1
million and $1.2 million in these periods. The decreases in Oklahoma and Texas
were partially offset by an increase in gross premiums earned in New Mexico of
$409,000 and $1.5 million for the third quarter and first nine months of 2005,
respectively, from the 2004 periods. Net premiums earned decreased $348,000 or
2% and increased $1.6 million or 3% for the third quarter and first nine months
of 2005, respectively. The increase for the first nine 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. 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 76% of NAICO's gross premiums
earned in the first nine 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
decreased $1.4 million or 6% and increased $194,000 or less than 1% in the
third quarter and first nine months of 2005, respectively, compared to the
2004 periods. Gross premiums earned in Texas decreased $2.3 million and $2.4
million in the third quarter and first nine months of 2005, respectively,
compared to the 2004 periods while gross premiums earned in Oklahoma increased
$34,000 and $512,000 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 $843,000 or 6% and increased $1.2 million or 3% in the
third quarter and first nine months of 2005, respectively, compared to the 2004
periods. The increase in the first nine 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 nine months of 2005.
PAGE 10
Gross premiums earned in the political subdivisions program decreased
$727,000 or 14% and $2.1 million or 13% in the third quarter and first nine
months of 2005, respectively, compared to the 2004 periods. The decrease in
gross premiums earned is due primarily to increased competition related to
Oklahoma school districts. Net premiums earned in this program decreased
$288,000 or 15% and $256,000 or 5% in the third quarter and first nine 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
nine 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. Gross premiums earned
for the homeowner's program were $1.5 million and $2.0 million in the third
quarter and first nine months of 2005, and net premiums earned were $1.2
million and $1.6 million in these periods. NAICO expects premiums earned in
this program to increase during the remainder of 2005.
Gross premiums earned in the surety bond program decreased $576,000 or 77%
and $1.3 million or 62% in the third quarter and first nine months of 2005,
respectively, compared to the 2004 periods. Net premiums earned in the surety
bond program decreased $405,000 or 77% and $931,000 or 62% in the third quarter
and first nine 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 September 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,
decreased $10,000 or 1% and decreased $434,000 or 17% in the third quarter and
first nine months of 2005, respectively. The decrease in the nine 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 $143,000 or 7% in the
nine month period. Cash and invested assets were $84.1 million at September
30, 2005 compared to $84.9 million at September 30, 2004. Net interest income
from related parties increased $37,000 or 27% and $140,000 or 40% in the third
quarter and first nine months of 2005, respectively, due primarily to higher
interest rates during 2005.
Chandler USA had no net realized investment gains during the third quarter
of 2005 compared to $3,000 net realized investment gains during the third
quarter of 2004. Net realized investment gains were $3,000 during the first
nine months of 2005 compared to $466,000 during the first nine months of 2004.
OTHER INCOME
Chandler USA's other income included $368,000 in the first nine 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 66.2% and 54.3% for the third quarter and first nine
months of 2005, compared to 78.4% and 83.0% 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 third quarter and first nine months
of 2004, losses and loss adjustment expenses incurred related to prior accident
years were $6.9 million and $19.7 million, respectively, and increased the
respective loss ratios by 40.5 and 41.4 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 $3.6 million and $5.4 million for the third quarter and
first nine months of 2005, respectively, increased the respective loss ratios
by 21.5 and 11.0 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 $225,000 and $350,000
in the third quarter and first nine months of 2005, respectively, and
increased the respective loss ratios by 1.3 and 0.7 percentage points. The
weather-related losses in the third quarter of 2005 are primarily from
Hurricane Rita. NAICO could incur additional losses related to Hurricane Rita
as more information becomes known, but the losses are not expected to have a
material impact on NAICO's cash flows or results of operations. NAICO has not
received any claims related to Hurricane Katrina. Weather-related losses
totaled $343,000 and $659,000 in the third quarter and first nine months of
2004, and increased the respective 2004 loss ratios by 2.0 and 1.4 percentage
points.
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 nine month periods ended September 30, 2005 and 2004:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
2005 2004 2005 2004
---------- ---------- ---------- ----------
(In thousands)
Commissions expense ........................ $ 5,186 $ 4,791 $ 12,779 $ 12,935
Other premium related assessments .......... 408 328 852 892
Premium taxes .............................. (57) 645 1,269 2,032
Excise taxes ............................... 72 93 205 242
Other expense .............................. 157 144 509 327
---------- ---------- ---------- ----------
Total direct expenses ...................... 5,766 6,001 15,614 16,428
Indirect underwriting expenses ............. 1,494 1,857 4,835 5,659
Commissions received from reinsurers ....... (5,332) (5,618) (12,307) (13,146)
Adjustment for deferred acquisition costs .. 398 660 (626) (267)
---------- ---------- ---------- ----------
Net policy acquisition costs ............... $ 2,326 $ 2,900 $ 7,516 $ 8,674
========== ========== ========== ==========
Total gross direct and indirect expenses as a percentage of direct written
and assumed premiums were 20.7% and 22.4% for the third quarter and first nine
months of 2005, compared to 20.6% and 22.5% in the corresponding year ago
periods. Commission expense as a percentage of gross written and assumed
premiums was 14.8% and 14.0% in the third quarter and the first nine months of
2005 compared to 12.5% and 13.2% in the corresponding 2004 periods. The
percentage increase in the third 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
Premium taxes decreased by $702,000 in the third quarter of 2005 compared
to the third quarter of 2004. The decrease is attributable to Oklahoma premium
tax credits received in connection with NAICO's purchase of common units for
$330,000 in an Oklahoma rural small business capital company. NAICO received
approximately $674,000 in Oklahoma premium tax credits that can be fully
utilized against NAICO's Oklahoma premium taxes incurred through the third
quarter of 2005.
Indirect underwriting expenses were 4.2% and 5.3% of total direct written
and assumed premiums in the third quarter and first nine months of 2005,
respectively, compared to 4.9% and 5.8% 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 35.3% and 31.6% in the third quarter and first nine months of 2005,
respectively, compared to 32.9% and 32.0% in the corresponding 2004 periods.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses were 11.0% of gross premiums earned in
both the third quarter and first nine months of 2005, respectively, compared to
9.1% and 10.3% for the corresponding 2004 periods. General and administrative
expenses increased $440,000 in the third quarter of 2005 compared to the
corresponding 2004 period due primarily to an increase in legal expense and
employee related expenses. During the third quarter of 2004, Chandler USA
received a recovery of previously expensed legal costs of $359,000 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 $39,000 and $96,000 in the third quarter and
first nine 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 nine months of 2005, Chandler USA used $2.3 million in cash
from operations due primarily to an increase in reinsurance recoverable on
unpaid losses. Reinsurance recoverable on unpaid losses increased $8.9 million
during the first nine months of 2005. This was partially offset by an increase
in unpaid losses and loss adjustment expenses of $4.4 million. In the first
nine months of 2004, Chandler USA provided $18.1 million in cash from
operations.
At September 30, 2005, Chandler USA's parent, Chandler Insurance Company,
Ltd. owed approximately $9.8 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 6.75% at September 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 nine 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
---------------------------------------------------
None.
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: November 8, 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)