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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 MARCH 31, 2006
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 a large accelerated
filer, an accelerated filer, or a non-accelerated filer. See definition of
"accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange
Act.)
Large accelerated filer Accelerated filer Non-accelerated filer X
--- --- ---
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). YES NO X
--- ---
The number of common shares, $1.00 par value, of the registrant
outstanding on April 30, 2006 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. FINANCIAL STATEMENTS:
- ------------------------------
Consolidated Balance Sheets as of March 31, 2006 and December 31, 2005.... 1
Consolidated Statements of Operations for the three months
ended March 31, 2006 and 2005 .......................................... 2
Consolidated Statements of Comprehensive Income for the three
months ended March 31, 2006 and 2005.................................... 3
Consolidated Statements of Cash Flows for the three months
ended March 31, 2006 and 2005........................................... 4
Notes to Interim Consolidated Financial Statements ....................... 5
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
- ------------------------------------------------------------------------
RESULTS OF OPERATIONS .................................................... 7
---------------------
ITEM 4. CONTROLS AND PROCEDURES ........................................... 11
- --------------------------------
PART II - OTHER INFORMATION
- ---------------------------
Item 1. Legal Proceedings ................................................ 12
Item 1A. Risk Factors ..................................................... 12
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds ...... 12
Item 3. Defaults Upon Senior Securities .................................. 12
Item 4. Submission of Matters to a Vote of Security Holders .............. 12
Item 5. Other Information ................................................ 12
Item 6. Exhibits ......................................................... 12
Signatures ................................................................. 13
PAGE 1
CHANDLER (U.S.A.), INC.
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands except share amounts)
March 31, December 31,
2006 2005
----------- ------------
(Unaudited)
ASSETS
Investments
Fixed maturities available for sale, at fair value
Restricted (amortized cost $11,768 and $11,789 in 2006 and 2005, respectively) ..... $ 11,188 $ 11,330
Unrestricted (amortized cost $60,318 and $61,954 in 2006 and 2005, respectively) ... 58,058 60,405
Equity securities available for sale, at fair value (cost $7,293 and $8,558 in 2006
and 2005, respectively) ............................................................ 8,095 9,071
----------- ------------
Total investments .................................................................. 77,341 80,806
Cash and cash equivalents ($255 and $209 restricted in 2006 and 2005, respectively) .. 8,549 5,510
Premiums receivable, less allowance for non-collection
of $131 and $223 at 2006 and 2005, respectively .................................... 29,571 28,346
Reinsurance recoverable on paid losses ............................................... 2,807 2,875
Reinsurance recoverable on unpaid losses, less allowance for non-collection
of $166 and $174 at 2006 and 2005, respectively ..................................... 49,144 54,708
Reinsurance recoverable on unpaid losses from related parties ........................ 14,364 14,284
Prepaid reinsurance premiums ......................................................... 10,177 9,763
Prepaid reinsurance premiums to related parties ...................................... 12,077 12,247
Deferred policy acquisition costs .................................................... 1,813 1,225
Property and equipment, net .......................................................... 8,571 8,640
Amounts due from related parties ..................................................... 9,045 9,360
State insurance licenses, net ........................................................ 3,745 3,745
Other assets ......................................................................... 13,301 13,550
----------- ------------
Total assets ......................................................................... $ 240,505 $ 245,059
=========== ============
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities
Unpaid losses and loss adjustment expenses .......................................... $ 102,876 $ 109,541
Unearned premiums ................................................................... 55,326 55,034
Policyholder deposits ............................................................... 5,342 5,684
Accrued taxes and other payables .................................................... 5,153 5,221
Premiums payable .................................................................... 4,093 2,181
Premiums payable to related parties ................................................. 205 113
Senior debentures ................................................................... 6,979 6,979
Junior subordinated debentures issued to affiliated trusts .......................... 20,620 20,620
----------- ------------
Total liabilities .................................................................. 200,594 205,373
----------- ------------
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 ................................................................. (19,329) (19,913)
Accumulated other comprehensive income (loss):
Unrealized loss on investments available for sale, net of deferred income taxes .... (1,346) (987)
----------- ------------
Total shareholder's equity ........................................................ 39,911 39,686
----------- ------------
Total liabilities and shareholder's equity ........................................... $ 240,505 $ 245,059
=========== ============
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 March 31,
--------------------------------
2006 2005
------------- ------------
Premiums and other revenues
Direct premiums written and assumed ............................ $ 29,535 $ 31,661
Reinsurance premiums ceded ..................................... (6,371) (5,771)
Reinsurance premiums ceded to related parties .................. (6,251) (7,914)
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Net premiums written and assumed .............................. 16,913 17,976
Increase in unearned premiums .................................. (48) (1,752)
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Net premiums earned ........................................... 16,865 16,224
Investment income, net .......................................... 717 669
Interest income, net from related parties ....................... 178 152
Realized investment gains, net .................................. 56 -
Other income .................................................... 47 64
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Total premiums and other revenues ............................. 17,863 17,109
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Operating costs and expenses
Losses and loss adjustment expenses, net of amounts
ceded to related parties of $3,599 and $3,586 in
2006 and 2005, respectively ................................... 10,115 7,900
Policy acquisition costs, net of ceding commissions
received from related parties of $2,365 and $2,979 in
2006 and 2005, respectively ................................... 3,171 2,352
General and administrative expenses ............................ 2,991 2,871
Interest expense ................................................ 655 616
------------- ------------
Total operating costs and expenses ............................ 16,932 13,739
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Income before income taxes ...................................... 931 3,370
Federal income tax provision .................................... (347) (1,215)
------------- ------------
Net income ..................................................... $ 584 $ 2,155
============= ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 3
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(Amounts in thousands)
Three months ended March 31,
--------------------------------
2006 2005
------------- ------------
Net income ............................................... $ 584 $ 2,155
------------- ------------
Other comprehensive income (loss), before income tax:
Unrealized losses on securities:
Unrealized holding losses arising during period ........ (488) (1,412)
Less: Reclassification adjustment for gains included
in net income ......................................... (56) -
------------- ------------
Other comprehensive income (loss), before income tax ..... (544) (1,412)
Income tax benefit related to items of other
comprehensive income (loss) ............................. 185 480
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Other comprehensive income (loss), net of income tax ..... (359) (932)
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Comprehensive income ..................................... $ 225 $ 1,223
============= ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 4
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Amounts in thousands)
Three months ended March 31,
------------------------------
2006 2005
------------ ------------
OPERATING ACTIVITIES
Net income .................................................................. $ 584 $ 2,155
Add (deduct):
Adjustments to reconcile net income to cash provided by
(applied to) operating activities:
Realized investment gains, net ............................................ (56) -
Net gains on sale of property and equipment ............................... - (5)
Amortization and depreciation ............................................. 343 371
Provision for non-collection of premiums .................................. 1 11
Provision for non-collection of reinsurance recoverables .................. 17 20
Net change in non-cash balances relating to operating activities:
Premiums receivable ...................................................... (1,226) (3,611)
Reinsurance recoverable on paid losses ................................... 43 (882)
Reinsurance recoverable on paid losses from related parties .............. - 83
Reinsurance recoverable on unpaid losses ................................. 5,571 8,449
Reinsurance recoverable on unpaid losses from related parties ............ (80) (155)
Prepaid reinsurance premiums ............................................. (414) 103
Prepaid reinsurance premiums to related parties .......................... 170 (751)
Deferred policy acquisition costs ........................................ (588) (383)
Other assets ............................................................. 420 2,076
Unpaid losses and loss adjustment expenses ............................... (6,665) (11,691)
Unearned premiums ........................................................ 292 2,400
Policyholder deposits .................................................... (342) 481
Accrued taxes and other payables ......................................... (68) (468)
Premiums payable ......................................................... 1,912 (2,381)
Premiums payable to related parties ...................................... 92 554
------------ ------------
Cash provided by (applied to) operating activities ........................ 6 (3,624)
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INVESTING ACTIVITIES
Unrestricted fixed maturities available for sale:
Purchases ................................................................. (995) -
Maturities ................................................................ 2,510 183
Equity securities available for sale:
Purchases ................................................................. (2,022) (25)
Sales ..................................................................... 3,343 -
Cost of property and equipment purchased ................................... (142) (57)
Proceeds from sale of property and equipment ............................... 24 32
------------ ------------
Cash provided by investing activities ..................................... 2,718 133
------------ ------------
FINANCING ACTIVITIES
Payments and loans from related parties .................................... 719 883
Payments and loans to related parties ...................................... (404) (338)
------------ ------------
Cash provided by financing activities ..................................... 315 545
------------ ------------
Increase (decrease) in cash and cash equivalents during the period .......... 3,039 (2,946)
Cash and cash equivalents at beginning of period ............................ 5,510 6,870
------------ ------------
Cash and cash equivalents at end of period .................................. $ 8,549 $ 3,924
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 5
CHANDLER (U.S.A.), INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED MARCH 31, 2006 AND 2005
(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, 2005.
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-month period ended March 31, 2006 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, interest 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 MARCH 31,
----------------------------
2006 2005
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(In thousands)
INSURANCE PROGRAM
- --------------------------------------------
NET PREMIUMS EARNED
Standard property and casualty ............. $ 13,159 $ 14,015
Political subdivisions ..................... 1,475 1,777
Homeowners ................................. 2,069 -
Surety bonds ............................... 66 312
Other (1) .................................. 96 120
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$ 16,865 $ 16,224
============ ============
LOSSES AND LOSS ADJUSTMENT EXPENSES
Standard property and casualty ............. $ 8,030 $ 6,456
Political subdivisions ..................... 610 857
Homeowners ................................. 706 -
Surety bonds ............................... 883 489
Other (1) .................................. (114) 98
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$ 10,115 $ 7,900
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<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 6
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 8.75% at March 31, 2006. Chandler USA has
exercised its option to repurchase the equipment at the end of the lease for
approximately $2.4 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 February 2006, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards (SFAS") No. 155, "ACCOUNTING FOR
CERTAIN HYBRID FINANCIAL INSTRUMENTS - AN AMENDMENT OF FASB STATEMENTS NO. 133
AND 140." SFAS 155 amends SFAS No. 133, "ACCOUNTING FOR DERIVATIVE INSTRUMENTS
AND HEDGING ACTIVITIES," and SFAS No. 140, "ACCOUNTING FOR TRANSFERS AND
SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENTS OF LIABILITIES." This
Statement also resolves issues addressed in Statement No. 133 Implementation
Issue No. D1, "APPLICATION OF STATEMENT 133 TO BENEFICIAL INTERESTS IN
SECURITIZED FINANCIAL ASSETS." SFAS 155 permits fair value remeasurement for
any hybrid financial instrument that contains an embedded derivative that
otherwise would require bifurcation and clarifies which interest-only strips
and principal-only strips are not subject to the requirements of SFAS 133.
SFAS 140 is amended to eliminate the prohibition on a qualifying special-
purpose entity from holding a derivative financial instrument that pertains to
a beneficial interest other than another derivative financial instrument. SFAS
155 is effective for all financial instruments acquired or issued during fiscal
years beginning after September 15, 2006. Chandler USA does not expect this
statement to have a material impact on its consolidated financial statements.
In March 2006, the FASB isued SFAS No. 156, "ACCOUNTING FOR SERVICING OF
FINANCIAL ASSETS - AN AMENDMENT OF FASB STATEMENT NO. 140." SFAS No. 156
amends SFAS 140, "ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS
AND EXTINGUISHMENTS OF LIABILITIES." SFAS 156 requires an entity to separately
recognize financial assets as servicing assets or servicing entities each time
it undertakes an obligation to service a financial asset by entering into
certain kinds of servicing contracts. The entity must also initially measure
all separately recognized servicing assets and servicing liabilities at fair
value, if practicable. Servicing assets and servicing liabilities subsequently
measured at fair value must be separately presented in the statement of
financial position and additional disclosures for all separately recognized
servicing assets and servicing liabilities. SFAS 156 is effective for Chandler
USA's fiscal year beginning January 1, 2007. Chandler USA does not expect this
statement to have a material impact on its consolidated financial statements.
PAGE 7
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.
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 month periods ended March
31, 2006 and 2005:
GROSS PREMIUMS EARNED NET PREMIUMS EARNED
--------------------------- ---------------------------
THREE MONTHS ENDED MARCH 31, 2006 2005 2006 2005
---------------------------------- ------------ ------------ ------------ ------------
(In thousands)
Standard property and casualty ... $ 22,265 $ 23,678 $ 13,159 $ 14,015
Political subdivisions ........... 3,990 5,018 1,475 1,777
Homeowners ....................... 2,795 - 2,069 -
Surety bonds ..................... 96 445 66 312
Other ............................ 97 120 96 120
------------ ------------ ------------ ------------
TOTAL ............................ $ 29,243 $ 29,261 $ 16,865 $ 16,224
============ ============ ============ ============
Gross premiums earned decreased $18,000 or less than 1% in the first
quarter of 2006 compared to the first quarter of 2005. Net premiums earned
increased $641,000 or 4% in the first quarter of 2006 compared to the first
quarter of 2005. Gross and net premiums earned in the homeowners program in
the 2006 quarter largely offset the decreases in premiums in the other
programs. The homeowners program began in the second quarter of 2005.
Gross premiums earned in the standard property and casualty program
decreased $1.4 million or 6% in the first quarter of 2006 compared to the first
quarter of 2005. The decrease was due to a decrease of $1.3 million in workers
compensation premiums, primarily in the state of Texas. Gross premiums earned
for workers compensation in Oklahoma increased $698,000 in the first quarter,
but this was offset by reductions in other states. Net premiums earned
decreased $856,000 or 6% in the first quarter of 2006 versus the first quarter
of 2005, due primarily to the decrease in gross earned premiums.
Gross premiums earned in the political subdivisions program decreased $1.0
million or 20% in the first quarter of 2006 compared to the first quarter of
2005 due primarily to increased competition related to Oklahoma school
districts. Net premiums earned in the political subdivisions program decreased
$302,000 or 17% in the first quarter of 2006 versus the first quarter of 2005.
The decrease in net premiums earned was significantly less than the decrease
in gross premiums earned because this program has a larger portion of property
risks than other programs, and property risks have more reinsurance than other
lines of business.
PAGE 8
In the second quarter of 2005, NAICO began writing homeowner and dwelling
policies in the state of Texas through a managing general agent. Gross and
net premiums earned in the first quarter of 2006 were $2.8 million and $2.1
million, respectively. NAICO is currently reviewing this program and may
modify or discontinue this program during 2006.
Gross premiums earned in the surety bond program decreased $349,000 or 78%
in the first quarter of 2006 compared to the first quarter of 2005. Net
premiums earned in the surety bond program decreased $246,000 or 79% in the
first quarter of 2006 versus the first quarter of 2005. NAICO is no longer
actively marketing its surety bond program.
NET INVESTMENT INCOME AND NET REALIZED INVESTMENT GAINS
At March 31, 2006, Chandler USA's investment portfolio consisted primarily
of fixed income U.S. Treasury and government agency bonds, high-quality
corporate bonds, equity securities and mutual funds that invest in equity
securities, with approximately 10% 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 $48,000 or 7% in the first quarter of 2006 versus the first quarter
of 2005 due primarily to an increase in cash and invested assets. Cash and
invested assets were $85.9 million at March 31, 2006 compared to $82.2 million
at March 31, 2005. Net interest income from related parties was $178,000 in
the first quarter of 2006 compared to $152,000 in the first quarter of 2005.
The increase in 2006 was due to higher interest rates experienced in the 2006
quarter.
Net realized investment gains were $56,000 in the first quarter of 2006.
There were no net realized investment gains in the first quarter of 2005.
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.
The percentage of losses and loss adjustment expenses to net premiums
earned ("loss ratio") was 60.0% for the first quarter of 2006 versus 48.7% in
the first quarter of 2005. The increase in the 2006 loss ratio was due to an
increase in losses in the standard property and casualty program compared to
the first quarter of 2005. During 2006, adverse loss development of $1.1
million increased the 2006 loss ratio by 6.6 percentage points. The adverse
loss development in the 2006 quarter was due primarily to an increase in surety
bond losses for prior accident years. During the first quarter of 2005, NAICO
experienced adverse loss development totaling $931,000 which increased the 2005
loss ratio by 5.7 percentage points. The adverse loss development in the 2005
quarter was due primarily to an increase in surety bond losses for prior
accident years, and to an increase in workers compensation and casualty losses
for schools in the political subdivisions program.
Weather-related losses from wind and hail totaled $113,000 in the first
quarter of 2006 and increased the loss ratio by 0.7 percentage points.
Weather-related losses totaled $62,000 in the first quarter of 2005, and
increased the 2005 loss ratio by 0.4 percentage points.
PAGE 9
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 the 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 month periods ended March 31, 2006 and 2005:
THREE MONTHS ENDED MARCH 31,
----------------------------
2006 2005
------------ ------------
(In thousands)
Commissions expense ....................... $ 4,625 $ 3,884
Other premium related assessments ......... 281 221
Premium taxes ............................. 647 741
Excise taxes .............................. 63 79
Other expense ............................. 182 169
------------ ------------
Total direct expenses ..................... 5,798 5,094
Indirect underwriting expenses ............ 1,504 1,721
Commissions received from reinsurers ...... (3,543) (4,080)
Adjustment for deferred acquisition costs.. (588) (383)
------------ ------------
Net policy acquisition costs .............. $ 3,171 $ 2,352
============ ============
Total gross direct and indirect expenses as a percentage of direct written
and assumed premiums were 24.7% for the first quarter of 2006 versus 21.5% for
the first quarter of 2005. Commissions expense as a percentage of gross
written and assumed premiums was 15.7% for the first quarter of 2006 versus
12.3% for the 2005 quarter. The increase in commissions expense was due
primarily to the new homeowners program that began in 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 managing general agent who performs certain
underwriting, claims and administrative functions.
Indirect underwriting expenses were 5.1% and 5.4% of total direct written
and assumed premiums in the three month periods ended March 31, 2006 and 2005,
respectively. 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 decreased
$537,000 in the first quarter of 2006 compared to the year-ago quarter due
primarily to a decrease in reinsurance premiums ceded to related parties.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses were 10.2% and 9.8% of gross premiums
earned in the first quarter of 2006 and 2005, respectively. General and
administrative expenses increased $120,000 or 4% in the first quarter of 2006
compared to the 2005 quarter. This increase was due primarily to an increase
in employee related expenses. General and administrative expenses have
historically not varied in direct proportion to the Company's revenues. A
portion of such expenses is allocated to policy acquisition costs (indirect
underwriting expenses) 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.
PAGE 10
INTEREST EXPENSE
Interest expense was $655,000 in the first quarter of 2006 compared to
$616,000 in the year-ago quarter. Substantially all of Chandler USA's interest
expense is related to its outstanding senior debentures and junior subordinated
debentures. The increase in the 2006 period was due primarily to the increase
in interest rates during 2005 and 2006, as a portion of Chandler USA's junior
subordinated debentures were issued with a floating interest rate.
LIQUIDITY AND CAPITAL RESOURCES
In the first quarter of 2006, Chandler USA provided $6,000 in cash from
operations. Unpaid losses and loss adjustment expenses decreased $6.7 million
during the first quarter of 2006, but this was partially offset by a decrease
in reinsurance recoverable on unpaid losses of $5.5 million. In the first
quarter of 2005, Chandler USA used $3.6 million in cash from operations due
primarily to the payment of losses. Unpaid losses and loss adjustment expenses
decreased $11.7 million during the first quarter of 2005, but this was
partially offset by a decrease in reinsurance recoverable on unpaid losses of
$8.3 million. This resulted in a net cash outflow of $3.4 million.
At March 31, 2006, Chandler USA's parent company, Chandler Insurance
Company, Ltd., owed approximately $9.0 million to Chandler USA versus $9.4
million at December 31, 2005 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 8.75% at March 31, 2006. Chandler USA has
exercised its option to repurchase the equipment at the end of the lease for
approximately $2.4 million.
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, 2005, NAICO had statutory earned surplus of $9.6
million. Applying the Oklahoma statutory limits described above, the maximum
shareholder dividend NAICO may pay in 2006 without the approval of the Oklahoma
Department of Insurance is $5.7 million. NAICO did not pay any shareholder
dividends to Chandler USA in 2005 or in the first quarter of 2006.
PAGE 11
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. These obligations include $7.0 million of 8.75% senior debentures
due in 2014, $13.4 million of 9.75% junior subordinated debentures due in 2033,
$7.2 million of floating rate junior subordinated debentures due in 2034 and
the obligations under the sale and leaseback transaction discussed previously.
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.
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 12
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 1A. RISK FACTORS
------------
There have been no material changes from risk factors previously
disclosed in our Annual Report on Form 10-K for the three months
ended March 31, 2006.
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 13
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: May 9, 2006 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)